Start of a bear market or just a correction?
Paul O’Connor, Head of Multi-Asset at Janus Henderson Investors considers whether the recent stock market slump is just a correction or the beginning of a longer-term bear market or global recession…
The ferocity of the sell-off reflects a massive swing in investor sentiment from complacency to panic. Whereas just a few weeks ago, investors were anticipating a “v-“ shaped recovery in global growth, they are now pricing in a high probability of a global recession.
Many stock markets have seen drawdowns of over 20 per cent in recent weeks, putting them technically into bear market territory. Still, the big question from here is whether this is the start of a more sustained decline or whether markets are already looking attractive, now that markets are pricing in fairly gloomy economic outcomes.
The scale of the capitulation in risk assets seen in recent days provides offers some contrarian encouragement. Many tactical indicators of investor sentiment and positioning are already at levels that have typically rewarded buying into equities and other risk assets. Still, given the unusually thick fog of uncertainty surrounding the coronavirus, this sort of evidence argues more for stabilisation in markets than a sustained recovery. A meaningful recovery in risk appetite will probably require some confidence that the coronavirus is being contained. While good progress seems to have been made in this direction in China and South Korea in recent day, the accelerating spread of the virus in Europe and the US remains troubling.
In the short-term, it is far from obvious what will revive market sentiment. Whereas central bank actions have been effective circuit breakers in many past market sell-offs, we see limited scope for game-changing monetary policy interventions today. We expect central banks actions to remain focused on liquidity provision and keeping credit flowing through the financial system rather than trying to deliver big rate cuts or new quantitative easing programmes. Fiscal policy seems the best solution for the world economy’s current ails, but progress here so far has been reactive and piecemeal.
In the absence of any game-changing policy interventions, perceptions of the evolving progress of the Coronavirus are likely to remain the key driver of market sentiment. While, risk assets now offer decent upside potential if the virus stabilises, markets are likely to remain volatile and vulnerable until there is some evidence that COVID-19 is being contained globally.