Explainer: Stocks have surged, is the worst over?

The pensive bull, this is how Minerva Analysis would describe the next phase of the stock market reaction to the coronavirus. 

Stock markets had one of their best days in decades on Tuesday, and futures markets are pricing in for another positive start for Europe on Wednesday. We analyse the reasons for the recovery and if it is here to stay. 

US stimulus, the market has been waiting for the $2 trillion stimulus package that has just been agreed by Washington to help cushion the US economy from the worst of the economic effects caused by the coronavirus. This is the biggest package ever to be agreed by the US, and, for now, it looks like decent firepower to get the world’s largest economy back on track once the pandemic has passed and life returns to normal. Hence we may see stocks rally again on Wednesday. 

Wuhan, the first city to deal with coronavirus, has finally emerged from more than two months of lockdown. Italy has also seen a sharp fall-off in the growth of new infections. If this pattern continues then we would expect to see stocks continue to rally. 

Vaccine, the recent improvement in market sentiment has also coincided with a global effort to find a vaccine for the coronavirus, with multiple trials going on around the world. The recent stock market rally is, in part, pricing in that a vaccine will be found sooner rather than later, which will allow the world to return to normal. 

President Trump has also said that he expects the US economy to be back up and running by Easter, in just two weeks’ time. While this seems completely unrealistic, the fact that the leader of the world’s largest economy is talking about an end date to the economic shutdown and speaking about returning to normality may also be helping to boost sentiment. 

Money, money money, the US government’s fiscal plan, combined with the Federal Reserve’s announcement on Monday that it would provide a back-stop the corporate bond market is a heady cocktail for investors, and is driving markets higher. 

However, there are reasons to be cautious at this juncture: 

The number of global cases is surging and is currently above 400,000 cases worldwide. Infection rates are also starting to grow in India, and the country of 1.3 billion people has been put on lockdown. Thus, until the number of global infections start to slow, and there is no sign of that happening yet, it is hard to see how the global economy, with its intricate global supply chains and consumption patterns, will recover until the number of global infections start to peak. This could limit a recovery rally. 

The reopening of Wuhan and the Hubei province is a test case for the rest of the world. If life there can get back to normal without another surge in cases then it could mean that the virus passes through economies in 3-4 months, or approx. 1 quarter of economic growth, which seems manageable. However, if Hubei sees a second wave of the virus emerge, as some other Asian cities have seen, then global stock markets are likely to plunge. 

Airlines were some of the biggest beneficiaries of Tuesday’s rally, however, it is hard to see a way out for airlines, particularly in the UK after the government said they would only step in to save airlines as a last resort. This is not what the industry had wanted, especially as it is burning through a huge amount of cash with most aeroplanes grounded around the world. Of course, a recovery in financial markets could make it easier for airlines to tap other forms of finance, however, if the lockdown lasts more than a couple of months some major carriers are likely to reach bankruptcy territory. A surge in bankruptcies is usually bad for stocks. 

Also, while a recovery after an historic market rout is to be expected, be aware of the ‘dead cat bounce’. Will $2 trillion be enough? Will there be a wave of bankruptcies that could hinder economic progress for the long term? And will investors be able to hold their nerve and watch global economic data deteriorate sharply without trying to trim their exposure to risk? 

All of these factors are valid; thus, we would expect any ‘recovery’ in risk sentiment at this stage to be shallow at best as the economic realities of the coronavirus start to emerge. The best we can hope for, without wanting to sound overly pessimistic, is for a recovery that does not move higher in a straight line. And if there are is a second wave of the coronavirus in Wuhan then get ready for another steep sell off. Investors are likely to remain jittery and driven by news headlines, even if stock markets start to move higher.