Markets have recovered from the March sell-off and lockdowns are being lifted in a number of countries, but don't get carried away in the equities market just yet, a large investment management firm says.

Stock markets have recovered from their March lows but the state of the underlying economy should make investors cautious, and they should not expect a “V-shaped” recovery once COVID-19 lockdowns are lifted, Legal & General Investment Management told this news service recently. 

The MSCI World Index of developed countries’ equities has fallen by 3.09 per cent since the start of January – almost erasing the losses of mid-March when stocks crashed. On the other hand, economists are bracing for a sharp fall in US gross domestic product. First-quarter US GDP fell by 5 per cent. PIMCO, the US bond fund manager, reckons that GDP could sink by 30 per cent in the second quarter. Unemployment in the US has soared. In other nations, unemployment could also surge as employment furlough schemes come to an end.

Against that background there are risks for equity investors, Chris Teschmacher, who works at LGIM’s multi-asset team, said.

There are concerns that the economy has been scarred by the virus, creating problems regardless of whether there is a second spike in COVID-19 or not, he said. 

“In the first component of the fund we are trying to hold assets in a more long-term way…we have added some risk positions at the end of March, such as in high-yield debt,” he said, noting that the firm has since taken some profit on that move.

“We see a downturn in corporate earnings of about 40 per cent from the peak to the trough,” he said. 

“We have tactical short equity positions now as we have to think about what this all means for the economy and earnings. [A re-emergence of COVID-19] could lead to more economic restrictions to movement and activity and hamper GDP growth,” he said. 

Teschmacher does not think that the equity market lows of March will be revisited, and would require new negative news such as a deterioration of US/China relations or a virus mutation.

Scenarios
In trying to think how best to position investments, Teschmacher has three scenarios in mind: i) strong economic rebound and no major second outbreak of COVID-19; ii) some recovery but with some “scarring” to the underlying economy, high unemployment and tighter credit conditions; and iii) a persistent slump.

Even before the COVID-19 crisis, Teschmacher said that the equity market bull run which had started about a decade ago was looking ragged. The markets were already “late cycle” last year.

“At the margins we started already to cut back on some equity risk, and we also downgraded on some corporate credit over the last few years,” he said. 

The US/China trade frictions are bound to become hotter as the US presidential elections draw closer, he added.