Wall Street has rebounded on the back of massive stimulus and a reassessment of the distribution of risks. Going forward, the focus will entirely be on the outlook for corporate earnings, hence the importance of the debate on the shape of the recovery.
A first, straightforward factor is the massive easing of monetary policy. The Federal Reserve is in ‘whatever it takes’ mode and, in particular, its decision to buy corporate paper has been instrumental in reducing the risk of numerous corporate defaults, which in turn is beneficial for equity market sentiment. The decline of treasury yields works in the same direction. Moreover, QE can trigger portfolio rebalancing by investors which may support share prices.
A second possible factor is fiscal policy. Congress has provided support of about 14% of GDP. To quote Jerome Powell: “While the coronavirus economic shock appears to be the largest on record, the fiscal response has also been the fastest and largest response for any postwar downturn.” This should influence growth expectations, at a minimum by reducing the risk of extremely negative outcomes.
A third factor is specifically related to the distribution of risks. In the course of 2019 and at the start of this year, surveys showed that US CFOs considered there was a high risk of a recession in the foreseeable future. Considering the equity market declines during recessions, one can argue that risk was very much tilted to the downside: the likelihood of a big drawdown was higher than the possibility of an equivalent increase in share prices. Following the market decline due to the pandemic and given the reaction of monetary and fiscal policy, it can be argued that risk is now less asymmetric than at the start of the year.
