Equity market indices in the month of March witnessed the largest drop over the past decade and the highest one-day gains since the 2008 financial crisis. As equity markets seesawed their way through the month, the volatility Index hit a daily high of 82.69 and has remained elevated at past crisis levels throughout the end of the quarter.
Despite the bear market rally recorded towards the end of the month, equity markets closed in negative territory for the first quarter of 2020, with US equity index S&P 500 down 31 per cent from its peak and European equity index Eurostoxx 600 recording a 39 per cent drawdown from its February high. As risk aversion drove the market wide sell-off, the textbook defensive strategy yielded better return, on a comparative basis, during the first quarter. Investors positioned in the health care, utilities and consumer staples were less negatively impacted by the market downturn.
The health crisis has put on a spotlight on the pharmaceutical industry’s race towards developing a vaccine or treatment for covid-19, while nation lockdowns underpinned the surge in demand for food and staples, marking the only two industries which managed to return a gain during the month of March. Given the defensive nature of demand drivers for these sectors, the current economic headwinds are expected to have a relatively less negative impact on the companies’ earnings and are expected to continue to outperform in a bearish market.
The technology sector also managed to weather the storm despite having a cyclical nature. The pandemic has pushed forward the digital transformation of businesses worldwide, as employees connect remotely and distribution channels move online. The uncertainty over the duration of nation lockdowns and social distancing measures increased the urgency for companies to adapt to the current business conditions and increases the likelihood that some of the new business practices may stick around beyond the pandemic.
Technology giants, Amazon and Microsoft stood out as winners in the technology sector, having closed the first quarter of the year in positive territory. On the other hand, the energy and financial sectors were the hardest, as weaker fundamentals lowered the sectors’ earnings outlook. The expectations for lower global demand and the failure of oil producers to agree on a production cut led to the fall in oil price, which in turn lowered the earnings outlook for energy companies. Meanwhile accommodative monetary stimulus, including lower benchmark interest rates in the US, drove weaker earnings expectations for the financial sector.
Key catalysts to an inflection point in the market sell off depend on any signs of stabilisation of the outbreak across geographic regions and whether the policy measures to contain the economic impact will be effective in managing systematic risks triggered by contagion measures.
Over the past few days, pandemic statistics collected on a daily basis have shown tentative signs that new cases worldwide are beginning to stabilise. Three to four weeks following the government-imposed nation lockdowns, the daily number of deaths in Italy, France and Spain have slowed down.
Meanwhile, across the Pacific, US President Donald Trump’s warning on Sunday for the “toughest week” yet in the US, highlights the difference as to where the regions stand in the pandemic cycle. However, signs of economic stability remain bleak, as the longer contagion measures are left in place, the more investors question whether the fiscal measures announced so far are enough to bridge the economic fallout from the health crisis.
As we head into the first quarter earnings season, missed guidance and uncertain outlooks are expected and thus, a cautious investment strategy remains prudent until risk premiums start to decline. However, the market correction presents long term patient investors with an opportunity to reassess companies with strong balance sheets and healthy cash flows, which enable them to be in a better position to benefit from a recovery when the markets looks at pricing in beyond the negative scenario expected in the near term.
Disclaimer: This article was issued by Rachel Meilak, CFA equity analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.