Investors “overly optimistic” about V-shaped recovery, according to latest NN IP analysis

Markets are pricing in a V-shaped recovery, which may be too optimistic considering current valuations and the extent of the drawdown, according to the latest analysis from NN Investment Partners.

NN IP, the asset manager of NN Group, believes the coronavirus crisis has created extreme levels of uncertainty, and that when the market outlook is so volatile, investors often fall prey to emotions and biases that result in suboptimal investment decisions. 

To navigate this challenging environment, NN says it is essential to combine in-depth analysis of economic and market fundamentals with behavioural science, artificial intelligence, and sentiment data. 

Based on this analysis, investors are seemingly counting on a V-shaped recovery, which may be too optimistic, although corporate earnings should improve significantly in the second half of 2020 as economies are already beginning to gradually reopen.

According to NN IP, several factors point to the equity market bottoming soon. These factors include traditional technical and sentiment indicators, in addition to analysis of liquidity stress and investor capitulation. However, analysis based on current valuations, the extent of drawdowns so far and some high-frequency economic activity data signal the risk of a possible setback.

NN IP notes that equity investors appear to be pricing in a V-shaped recovery, owing to improving medical data on the coronavirus itself and the substantial liquidity that central banks are pumping into markets. However, NN IP believes this represents a disconnect from the real economy, in which people’s fears for their health, jobs and a second wave of coronavirus infections will persist for some time.

Ewout van Schaick, head of Multi Asset at NN Investment Partners, says: “The market’s confidence in positive news on coronavirus is looking overly optimistic and there is a sizeable risk that the opening up of the economy will be much slower than many people think. But we do expect the trough to be reached in the second quarter of the year, followed by significant improvement in corporate earnings in the second half.”

In light of the ongoing uncertainty, NN IP has created a proprietary bottoming-out indicator. This indicator draws on a wide range of information, from traditional survey-based inputs to market-based information and ‘big data’ harvested from news and social media using AI technology. Sentiment analysis of news and social media is particularly significant in the current environment because sentiment drivers have a powerful impact on markets in times of crisis. Analysts use natural language processing to rapidly extract, aggregate and categorise large volumes of text input, ranging from news coverage to blogs and social media feeds. With the resulting indicators, they can better gauge public perceptions of the labour market, business activity, policy uncertainty and other economic conditions.
According to Van Schaick, active asset managers seeking to generate alpha must take account of sentiment data, and especially so in times of market crisis. 

“Exogenous shocks, which have become more frequent over the last decade, create an environment of fundamental uncertainty that makes markets more vulnerable to sentiment. In times like these, strategies that combine traditional ways of measuring sentiment with big data and alternative data-based indicators will be better placed to forge a smooth path through the storm,” he adds.