Patrik Lang, Head of Equity Research and Strategy, Bank Julius Baer
In March, within a few weeks, the outbreak of the coronavirus led to an unprecedented sell-off on global equity markets, with the S&P 500 dropping 35%. From mid-March onwards, the S&P 500 started an equally spectacular rally, with the S&P 500 gaining almost 50% within less than three months. This came as a surprise to many analysts as fear of a second wave of infection are widespread. In addition to this, many economists only expect an anemic recovery.
Equity markets – what to expect
Against this backdrop, many investors are anticipating a second market crash. In our view, a major correction is rather unlikely because the economic recovery has already begun and a second wave of infection is unlikely to lead to a general lockdown because most countries will be better prepared for the second wave than they had been for the first one. Countries like Taiwan and South Korea have proven that testing and tracing is a much more efficient way to deal with the pandemic than locking down entire economies. It can be assumed that most countries will follow this example at least as long as no vaccine is available, which could be the case as soon as in September this year.
A fast and strong economic recovery on the cards?
Unlike previous recessions, the current crisis is the result of an exogenous shock. In this respect, the current crisis differs from conventional recessions, which are usually the result of economic imbalances like property bubbles, leverage or over-capacity in certain areas, or a mixture of these factors. In the course of a recession these imbalances are usually corrected and this process makes economic crises long and painful. However, since the corona crisis is not the result of imbalances but a temporary exogenous shock, an above-average recovery after the crisis seems quite possible.
The development of the Chinese economy which was the first economy to go through the crisis suggests this conclusion. In terms of industrial production, China has returned to pre-crisis levels within just a few months. Some observers argue that a wave of bankruptcies will occur, causing unemployment to skyrocket forcing banks to write off bad loans, thus setting off a vicious circle that could ultimately lead to another major financial crisis.
In our opinion, such a scenario is unlikely for two reasons:
First, the duration of the recession is probably too cause systemic damage short and second, fiscal and monetary policy measures are extremely supportive that a vicious circle is unlikely to get off the ground. Hence, the assumption of a faster-than-average and strong recovery seems plausible.
We currently expect the earnings of the S&P 500 to increase by 30% next year after a 24% drop this year. For 2022 we expect earnings to rise by another 15% This would correspond to the average post recession recovery since the end of World War II. Based on those assumptions – which are in our view rather conservative the S&P 500 trades on forward P/E multiples below historical averages. So even based on the expectations of an average recovery US equities do not look overvalued and US equities trade at a high premium to those in the the rest of the world. Moreover, equities continue to be very cheap relative to bonds. There are still hardly any alternatives to stocks. Against this backdrop, the upward movement of the S&P 500 in recent months appears fully justified and we see stock market setbacks as buying opportunities.
Stock markets – A regional perspective
The above considerations can also be applied to Saudi shares. The development of the Saudi Arabia market is a mirror image of the overall economic situation in the USA and the rest of the world. Due to the Saudi Arabian economy’s strong dependence on the oil price, the stock market is highly dependent on the oil price, and oil price developments reflect both the global slump in economic activity and the growing expectation of a rapid recovery since mid-March. In line with our overall economic assessment, we also expect oil prices to continue to rise and this should have a corresponding positive impact on the development of the Saudi stock market.