How Much Bad News Is Priced Into The Market?

Authored by Michael Msika, macro commentator at Bloomberg

We’re starting to get a glimpse of the scale of the economic damage wrought by the pandemic. Data yesterday that showed the U.K. plunging into recession in March begged the question: how much worse was April, when the lockdown was in place throughout the month? GDP reports for the euro-area and Germany due tomorrow will offer more clues on the extent of the bleakness, and whether or not it’s priced in already by equities.

European stocks have bounced from a March low despite a further deterioration in the macro data, with investors focusing on stimulus measures and easing lockdowns even as the Citi Economic Surprise Index hit fresh lows in May. One could argue that stock markets fell earlier in anticipation of such economic impact, and indeed, the Stoxx 600 is still down 20% for the year. But while most market participants see a recession as likely, predictions vary as to how bad it will be.

“For our understanding of the relationship between the macro and market dimensions one element is key: if the macroeconomic conditions do not deteriorate further, it is usually time to at least neutralize the negative stance for growth assets,” says Florian Ielpo, head of macro research at Unigestion.

Central-bank stimulus has certainly helped, while huge fiscal and spending packages announced by major governments have provided another pillar of support to ravaged economies. France and Germany have pledged roughly 5% of their GDP in fiscal stimulus, while the U.S. and Japan’s packages amount to 11% and 21% of their respective GDPs.

One section of the market to watch closely is cyclicals, as government spending usually bodes well for these stocks. They have lagged the market bounce, and expectations of some improvement in PMI could drive shares higher.

Historically, buying them when PMIs are depressed has been the better strategy, as flagged by Barclays Plc and Bank of America Corp. strategists recently. Not everyone is as bullish though -- peers at Citigroup expect the gap between cyclicals and defensives to widen further.

With the rebound starting to stall, any data surprising positively may provide fresh impetus. An unexpected rise in Chinese exports last week was a boon for European stocks, and more reassuring data may reverse the current uncertainty and start to be a real support to markets, according to ActivTrades technical analyst Pierre Veyret.

U.S. payrolls also appeared to offer a silver lining, as the majority of job losses were said to be “temporary,” but Federal Reserve Chairman Jay Powell yesterday warned of long-term harm from the virus. Additional fiscal support could be costly, but worth it if it helps a stronger recovery, he said.

In Europe, more pain could be on the cards. The U.K. March GDP figure may have come out better than initially expected, but it was still “horrific,” as it only included one full week of lockdown, said Rob Scammell, senior portfolio manager at Kempen Capital. “Assuming GDP was stagnant before the lockdown, the drop in the last days of March is equivalent to a 21% fall in GDP. As such, April’s number will be much, much worse,” Scammell said.

The euro area first-quarter GDP data tomorrow will shed more light on the damage, as most countries began locking down before the U.K. Forecasts look particularly gloomy for France and Italy. Data from Germany, Europe’s biggest economy, will also be closely watched.

As of now, share prices haven’t decoupled worryingly from real economic development, according to Francois-Xavier Chauchat, member of the investment committee at French asset manager Dorval. Comparing global share prices with the global GDP, the manager sees valuations as largely justified despite some uncertainties.

Beyond macroeconomic reports for the months gone by, user mobility data is turning out to be an unconventional early indicator for investors hungry for real-time information as lockdowns start to ease.