Three key questions after a week of chaos - Capital Economics
Global Markets

Three key questions after a week of chaos

Global Markets Update
Written by Oliver Jones

At the close of a week of turmoil in equity markets, it is worth taking a step back to think about how things might unfold from here. This Update attempts to answer three key questions: how much further will markets fall; when will we see the start of a sustained recovery; and what will the recovery look like?

  • At the close of a week of turmoil in equity markets, it is worth taking a step back to think about how things might unfold from here. This Update attempts to answer three key questions: how much further will markets fall; when will we see the start of a sustained recovery; and what will the recovery look like?
  • As far as the first question is concerned, while the speed of the falls in US equity prices from their peaks in mid-February has almost no precedent, their scale is still short of many previous bear markets. (See the Table below.) The deeper slumps in the S&P 500 have all coincided with recessions in the US economy, and there is a growing chance that we are on the cusp of another one now.
  • The valuation of the stock market also matters – we will discuss it in much more detail in a forthcoming update. In short, we don’t think that US equities were as overvalued before the latest plunge in the market as the high level of the CAPE suggests. (See the Table again.) Interest rates are far lower now than in the past, justifying higher valuations. But that may to prove cold comfort in the short term. Valuations are still far above the depths plumbed in previous crashes, and are unlikely to preclude further falls in prices.
  • On the second question, it has become clear this week that investors’ faith in monetary and fiscal policymakers’ ability to save the day has been badly shaken. The outbreak is a very different type of economic shock to the last few that have rocked the global economy, and there is little conventional economic policy can do to offset the damage caused by shutdowns to key parts of the economy.
  • So despite the bounce in many stock markets today, we still think that the global spread of the virus will have to slow before a genuine recovery gets underway. You can track the latest data on our dedicated page here. That would be consistent with the experience of previous (albeit less severe) outbreaks. And China’s equities have actually risen since the new case numbers there began to drop in early February.
  • As for the third question, the Table below shows how long US equities have taken to bounce back from previous bear markets. In every case bar one, at least half the ground lost had been made up within a year. But there has been much more variety in the time taken to recoup all the initial losses. After the collapses of 1966 and 1980-82, it took just a few months. But on several other occasions, it was four or five years before the market was back at its previous peak.
  • In our view, this is the one area where there is some cause for optimism. Stock market recoveries have been slowest when they have coincided with long economic downturns (and when the huge bubble deflated after the dot com bubble). For now, we are assuming that the slowdown will be sharp, but short.
  • Once the containment measures associated with the virus are unwound, most economies could bounce back quickly, with little permanent damage compared to a full-blown crisis in the banking system. Some of the measures taken to combat the economic hit from the outbreak, like the Fed’s rate cuts and UK fiscal stimulus, may remain in place afterwards, which could also help fuel a V-shaped recovery. Against this backdrop, markets could bounce back strongly – though we suspect we are still some way from that point.

Table 1: Bear Markets In The S&P 500

Bear

Market

Size (%)

US Recession?

CAPE at

Peak

CAPE at

Trough

Time To Re-Gain

Half Its Losses

Time To Re-Gain

All Its Losses

Feb-66-Oct-66

-22.2

No

24.1

17.9

3 months 13 days

6 months 29 days

Nov-68-May-70

-36.1

Yes

22.8

12.7

6 months 10 days

21 months 29 days

Jan-73-Oct-74

-48.0

Yes

18.9

7.8

7 months 15 days

69 months 28 days

Nov-80-Aug-82

-27.1

Yes

10.0

6.2

24 days

2 months 22 days

Aug-87-Oct-87

-33.2

No

18.7

12.5

12 months 7 days

21 months 6 days

Mar-00-Oct-02

-49.1

Yes

45.8

20.0

15 months 16 days

59 months 12 days

Oct-07-Mar-09

-56.8

Yes

29.9

11.9

9 months 16 days

48 months 19 days

Feb-20-?

-24.0*

?

31.7

23.9**

?

?

*Since 19th February; **As of 13th March; Sources: Refinitiv, Shiller, Capital Economics


Oliver Jones, Senior Markets Economist, +44 20 7808 4061, oliver.jones@capitaleconomics.com