MARKETS are forward looking. But the rosy picture that many participants foresee doesn't line up with the murkier outlook that seems readily apparent.
Many are focused on hopeful developments, such as the peaking number of Covid-19 cases, optimism over the availability of coronavirus vaccines and therapeutics, and tentative signs that economic activity is reviving as lockdown restrictions are eased.
As welcome as those developments are, they're not sufficient to justify the ebullient price action that we've seen in risky asset markets over the past several weeks.
The depth of the economic hole created by global efforts to halt the spread of the coronavirus matters a great deal. The trajectory of the recovery matters quite a bit, too.
Economies don't come with a start/stop button. They can't easily be switched back on after being abruptly shut down. Companies become unprofitable, supply chains break, highly-trained employees scatter, credit becomes more difficult to access, pushing yet more companies to the brink. The deeper the decline in economic activity and the weaker the rebound, the more tenuous all these relationships become and the greater the likelihood that we experience a much longer-lasting period of weakness.
Lots of uncertainty
And the unpredictable nature of the pandemic adds additional layers of uncertainty to the economic mix. Until there is a vaccine that is proven reliable and with tolerable side effects, how confident will consumers be in boarding a jetliner, subway train or cruise ship? Attending a concert or a ballgame? Lining up at a crowded lunch spot after coming from a hermetically sealed high-rise office building? And how well will thin-margin restaurants run on 50 per cent occupancy, or retail stores on suppressed foot traffic?
Those uncertainties will challenge even the best-run companies.
To be sure, governments, foundations, universities and private companies are all working frantically to find a vaccine to protect against the virus and therapeutics to cure the disease, deploying unprecedented resources to accomplish the task. But while progress apparently is being made, it's far too early to declare victory, as markets seemingly have.
Policymakers have done a pretty good job of backstopping the immediate needs of those most impacted by the lockdowns, and more support is likely in the pipeline.
But these extraordinary interventions won't be limitless.
Already, we're seeing strains in the system, as quickly designed programmes, such as the Paycheck Protection Program (PPP) in the United States, are proving to be too inflexible to address the needs of the vitally important small businesses that the programme was designed to support.
From a macro perspective, we've likely reached peak impact in the fiscal response that governments will marshal to offset the economic impact of the coronavirus.
This isn't to say that there won't be additional fiscal packages in the US and elsewhere, but rather that they'll be less powerful than those already enacted. And if support peaks too early, we're unlikely to rapidly dig ourselves out of the very deep economic hole that the pandemic has created.
For example, in the US, the PPP as presently constituted, expires on June 30, while enhanced unemployment benefits, which include an extra US$600 per week on top of the usual assistance, expire at the end of July.
If not extended, the end of these programmes creates a potential fiscal cliff. While segments of the economy will likely be in better shape by midsummer, it's also probable that many millions of those displaced in March and April will remain unemployed.
Indeed, we could easily see double-digit unemployment rates stretching into 2022.
Similarly, the US Federal Reserve will continue to purchase sovereign debt and ensure that liquidity conditions remain loose, but the shock and awe phase is over. So, while governments and central banks can do more to safeguard their economies, the incremental benefits going forward will be less potent.
Rapid partial recovery
In the coming months, the economic data in developed markets will very probably rebound strongly.
The second quarter will likely be the trough of a very sharp contraction, while the second half of 2020 will probably see something that looks like it could be the beginnings of a robust, V-shaped or U-shaped recovery.
However, the right-hand side of the V or U is most likely to stall well short of where the downturn began.
That's why the depth of the hole that has been dug matters. A rapid partial recovery will give way to a long slog, especially if a vaccine or therapeutic is not discovered in the near term, the premature reopening of economies causes cases to spike again, and/or we see a second wave of infection.
So yes, there are some reasons to be hopeful about the fight against the coronavirus. But investing, whether in bonds or equities, is the purchase of a future stream of cash flows. Tomorrow's cash flows won't look like those of 2019, and the market is set up to disappoint itself when this reality sets in.
- Mr Weisman is chief economist and Mr Almeida is global investment strategist, respectively, at MFS Investment Management.
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