The US stock market has miraculously regained all of its losses for the year despite a recession. What are the stock market recovery risks? There are three things that need to happen for the market recovery to hold. The first is that central banks including the US Federal Reserve need to continue their level of “doing anything necessary.” Second, there needs to be no second wave of covid-19. And, third of all, the shape of the economic recovery needs to be a “V.”
Stock Market Recovery Risks
CNN writes about these issues and says that for the current stock market rally to make sense, all three things we just mentioned need to work out favorably.
The stock market is notoriously forward-looking, and many believe this will be the shortest recession on record given that activity is already picking back up. But plenty of market watchers are still concerned that the recent euphoria has been overblown, pushing valuations too high. After all, the outlook is very different now than it was in January.
How likely is it that all three positive factors will fall into place to reduce any stock market recovery risks?
Will Central Banks Continue Their Support?
The International Monetary Fund writes about central bank support in this downloadable pdf.
Financial stability requires maintaining an adequate supply of credit to households and firms, countering both a sharp tightening in liquidity and the risks of fire-sales, and supporting the functioning of the payments system. These features are integral to monetary transmission and, therefore price stability. In light of these overall objectives, this note considers the following key questions regarding intervention strategy:
Which markets are critical for maintaining financial stability?
How can market dysfunction be identified and what are the appropriate triggers for intervention?
How should programs be designed to address market impairment?
The short version is that the IMF and other central banks and most importantly the US Federal Reserve are all ready and willing to do what it takes to help bring the economies of the world out of the covid-19 recession.
Will We Avoid a “Second Wave” of the Corona Virus?
The concern about a second wave of covid-19 is based on a couple of things. One is that both the Spanish Influenza in 1918 and the 2009-2010 influenza epidemics had particularly bad second waves. The other is that the pandemic was slowed to varying degrees in countries across the globe by strict social distancing measures. There are no effective medicines for this disease and no vaccine is likely to be available until at least next year, if then. As restrictions are eased there is a risk of more infections.
Unlike the central bank issue, this is not about willingness of institutions to act but about the biology of a new virus and its effects on humans. That is a substantially murkier issue! We do know that whenever large crowds get together without appropriate social distancing the disease spreads. We also know that the vast majority of humans are “up to speed” on what needs to be done to protect themselves and their families. As such, it is quite possible that any second wave would be less devastating because of practices already in place.
The bottom line is probably going to be how many more new cases societies are willing to suffer in order to bring businesses back into operation and increase opportunities for social interaction.
The odds are that we will not see as bad a resurgence as the original surge of the disease but any belief that this disease will miraculously get better is pure fantasy. This is a risk to any quick economic recovery and to the resurgence of the stock market.
Will the Recession Be Brief with a V-shaped Recovery?
We wrote about the possible shape of the economic recovery. There is no way that some industries like aviation and aircraft manufacturing will make a V-shaped comeback. The same is true of tourism in general and cruises in particular are likely to suffer for quite some time. On the other hand, there are covid-19 era investment opportunities in big tech and especially in internet-related businesses.
Our take on the situation is that the economy is more likely to see a U-shaped recovery with some sectors in the L-shaped category. Meanwhile, there are businesses that have already snapped back in the V-shaped mode.
The stock market always looks to the future and appears to be discounting the risks of a long term recession and a second wave of covid-19. Not everyone is on board with this approach including the folks at Berkshire Hathaway who are sitting on a hoard of cash and waiting for the right moment to start buying, which they do not think has arrived.
Stock Market Recovery Risks – PDF