Finance

Covid-19 Stock Market Downturn is of Long-Term Character

July 24, 2020
stockmarket

Equity markets have staged a powerful rally in recent weeks. The V-shaped stock market recovery awakened hope that the Covid-19 crisis could be overcome after a relatively short period of time. But are these hopes for a rapid economic recovery justified? Research of two finance professors indicates this is not the case. The Covid-19 pandemic has impacted investor’s implied growth expectations substantially. According to them, the stock market downturn is of long-term character. “Short-term reversals are built on hope, rather than sound economic analysis”, according to the new findings of Böni and Zimmermann, the two researchers.

Recent equity market downturns and reversals make it difficult for investors to assess the chances of a sustainable economic recovery. The collective wisdom of markets is not very helpful to investors these days. While equity markets staged a powerful rally in the last weeks, partially offsetting the initial stock market losses induced by the Covid-19 outbreak, global stocks are again diving. The recent jumps in China and US coronavirus cases appear to stoke investor concerns.

According to Pascal Böni, Associate Professor of Finance at Tilburg University’s business school TIAS (Netherlands) and CEO of Switzerland based asset manager Remaco, “from a financial economist standpoint of view, the recent downturns ought to be the expectation and come as no surprise. His assessment is based on a study co-authored with University of Basel Finance professor Heinz Zimmermann. Using S&P 500 firm level factors from the well-known Gordon model, they find that implied growth expectations have dropped by a significant 10% within only a few weeks following the virus outbreak. “This drop indicates the Covid-19 downturn is of long-term rather than short-term character”, comments Zimmermann.

The research of Böni and Zimmermann thus points towards a medium- to long-term and not a short-term recovery of global equity markets. Such a significant drop in implied growth was observed the last time during the Global Financial Crisis (GFC), says Böni. According to him, additional other real economy indicators are set for a slow, rather than a fast recovery: Examples are the steep drop in the purchase manager index (PMI) to a level of approximately 43 points, or the observed downgrades in the US leveraged loan markets. The latter have outpaced upgrades by a rate of 43 to 1 over the past months. During the GFC, downgrades outpaced upgrades by a rate of approximately 18 to 1. Together with the new wave of volatility sweeping through the equity markets (the VIX Index spiked back to a level above 40 on Monday, June 15) there are not many signs for an immediate and sustainable market recovery.

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