Since equity markets have bottomed out between the 17 and 23 March, the rally that followed has been unprecedented. The S&P 500 index and the Dow Jones Industrial index have gained more than 40% over the last three months since their bottom on March 23, recovering most of the lost ground since the beginning of the year and the outburst of the coronavirus pandemic. The MSCI World index, which tracks all the major developed equity indexes weighted by their capitalisation was down by less than -4% on a year-to-date basis on the week ending June 5. This has been boosted by the strong rebound of US equities, second only to Chinese equities – among the major capitalisation weighted indexes – in terms of performance over a one year rolling period. However, the MSCI Emerging Markets ex. China is still -15% below its level at the beginning of the year. The April-May rally has not erased the substantial equity value that has been whipped in the likes of Indonesia, Brazil – where the market has lost one third of its capitalisation on a YTD basis -, Mexico, Russia, Turkey, India, South Africa and Egypt. This is largely due to foreign capital outflows from these markets which have so fare not been fully reversed and to the limited capacity of local institutional investors to shore up the markets.
Equity volatility, as captured by the CBOE’s VIX index, has also receded from the peak at 53 it reached end of March, but it remains at a relatively high level. In contrast, the volatility on 10 Year Treasury Notes futures returned to relatively low levels. The liquidity injections and the massive purchase of sovereign and corporate bonds by the Federal Reserve, the European Central Bank, the BOJ and the BOE have contributed to dampen the volatility on the bond market.
Despite all the macro projections that tend to discard a Vi-shaped recovery, the markets seem to price in such a scenario, perceiving the profile of the current recession to be more similarities with the 1991 and the 2001 recession than with the recession associated with the GFC in 2007-2008.
There is however a real possibility of markets being artficially lifted by the massive liquidity injections and over-reacting to positive news such as the surprising figures from the latest report on US non farm payrolls, as well as to the general improvement of the health situation and reopening of the economy in Europe and in the United States. By all accounts, the long lasting impact of the Great Confinement – through second rounds effects and the possibility of a tepid recovery after the initial post-lockdown activity surge – is not priced by market. Therefore, the probability of a sudden reversal in market sentiment following some unexpected bad news looks increasingly high. An abrupt end to the ongoing euphoria should not be dismissed. Hedging this potential outcome by buying equity puts, bond calls or VIX calls might be a good way to prepare for this eventuality while preserving the gains achieved during this unprecedented rally.
Performance of the equity markets in Developed and Emerging economies
