Whether the equity and credit markets have already achieved a trough on March 23 will only be obvious with the benefit of hindsight. In real time, investors will, quite rightly, remain concerned about the depth and duration of the recession, the effectiveness of policy stimulus and the magnitude of the second order imbalances and reflexive linkages. There are a few key points to note.

First, in most historical episodes, markets rarely make definitive lows this early in a recession. The key reason is that a multi-month period of contraction in growth and profits exacerbates the known stress points. However, they also contribute to new ones which can lead to further de-leveraging and declines in risk assets. As a few analysts have noted, one of the most prominent bear market rallies in recent history was the 25% gain in the S&P500 starting in October 2008 following the passage of TARP. That rally was more than fully reversed into the market low of March 2009 due to the catastrophic collapse in economic and earnings data that followed.

Second, the strongest argument against a re-test of the lows in this episode is that the fiscal and monetary stimulus has never been so large, broad and rapid this early in a recession. It is plausible that the veracity of the policy response shortens the negative reflexive feedback loop from catastrophic data to persistently weak markets. Overnight and at the same time as another shocking jobless claims report was released, the Federal Reserve announced a barrage of new initiatives aimed at everything from Main Street lending programs for small business to purchasing junk bond ETFs. The Main Street program seeks to purchase loans for firms with up to 10,000 employees or with $2.5 billion in revenue. That covers a large proportion of the Russell 2000 index and addresses the impact on small business that have been disproportionately impacted by the COVID-19 crisis. However, we are not convinced that the Fed ought to be buying junk bond credit. That is a slippery slope in capital allocation and moral hazard. However, the big picture point for equities and credit is that the size, force and speed of the Fed’s response has been unprecedented in this episode.

Third, the macro risk for equities is twofold; 1) a general risk is the probability of an even more severe than expected deterioration in the economic and earnings data in the March quarter reporting season over the coming weeks; and 2) specific to this episode whether infection and mortality rates decline sufficiently to allow meaningful relaxation of lockdowns and resumption of activity in late April or early May. In terms of the composition of risk asset performance, a rapid improvement is most evident in cross asset volatility, developed market equities, rates and G10 currencies (around 50% or more retracement of the peak to trough decline). US high yield credit also rallied sharply following the Fed’s actions overnight.

In contrast, commodities, and emerging market currencies have recovered only 10-20% of the decline. Within equities, value and cyclical sectors are still tending to lag growth and defensive sectors. That is a similar return composition to the regime over the past decade. The technology sector, in particular, has continued to outperform through this episode as a beneficiary of Fed liquidity, flat interest rate structures and genuine secular growth. That is a key relative preference for us over the coming months. As we noted recently, Chinese equities and commodity prices led the recovery after 2008 given China’s policy stimulus (around 12% of GDP) which contributed to demand for raw materials for infrastructure and real estate. US and developed market equities did not trough until March 2009. In this episode, the size and scope of the US policy stimulus could be equivalent to China’s response in 2008 and might therefore lead to US outperformance from this contraction.

In conclusion, while the headlines this week have primarily focussed on the improvement in global infection and mortality rates this week, the initial and ongoing catalysts for the recovery in equities and credit have been the broadest and largest combination of monetary and fiscal measures so early in an economic recession. That said, we continue to fear that the deterioration in the macro data and earnings is not fully reflected in broad equity valuation. As we noted yesterday, the S&P500 price earnings ratio based on 12 month forward earnings has already risen back to 19.4 times or the same level it was at the market peak in February. Put another way, the market is at peak, not cheap valuation. The key conclusion is that a re-test of the downside is still possible over the coming weeks. On the positive side, the Fed is clearly determined to underwrite most risk assets. The unprecedented policy measures, particularly the extraordinary balance sheet expansion and direct financing are probably most bullish for gold and gold mining equities, relative to fiat currencies (more on that to follow).