Don’t believe the hype that markets have baked in a V-shaped recovery.
Analysts at Morgan Stanley note the sharp run-up in stock and corporate bond markets worldwide since March has led many to conclude that over-optimistic investors have already priced in a swift recovery from the coronavirus-driven recession.
But in a Wednesday note, they argue that there’s plenty of ways financial markets are reflecting a more bearish investor than the impressive rebound in risk assets might imply.
“If investors expect a robust economic bounceback, they have an odd way of expressing it,” said the team of Morgan Stanley’s cross-asset strategists led by Andrew Sheets.
Since plumbing its March low of 2,237.40, the S&P 500 SPX, +0.78% is up more than 40%. The Dow Jones Industrial Average DJIA, +0.68% had also gained around 40% since touching its March nadir of 18591.93. Both large-cap indexes were on track to record modest gains on Wednesday.
In global equities, an exchange-traded fund ACWI, +1.03% tracking the MSCI All Country World Index, a stock-market benchmark composed of equities from dozens of developed and emerging markets, was up nearly 44% from this year’s bottom.
Sheets lists out several ways markets actually reflect a deeper pessimism about prospects for a V-shaped recovery.
- The yield curve remains flat. The spread between the 2-year note and the 10-year note, a gauge of the curve’s slope, stands at 49 basis points.
- Long-term bond yields in the U.S. and Europe are near historic lows. The 10-year Treasury note yield TMUBMUSD10Y, 0.650% is trading at 0.65%, while the 10-year German government bond yield was at negative 0.48%.
- Investments sensitive to expectations for economic growth are underperforming. Shares of larger companies were outpacing their small-cap equities.
- The lowest rated investment-grade corporate bonds are offering much scantier yields than higher rated investment-grade debt.
- Growth stocks are trading at historically expensive levels compared to their value peers.
“Needless to say, all those represent wagers against a strong recovery, and instead, on a world where growth remains weak and uncertainty remains high,” he said.
Sheets conceded there has been a partial unwind of these longstanding trends since risk asset prices slid to their March bottom, with inflation expectations starting to rise, yield curves beginning to steepen, and equities in growth-sensitive areas playing catch up.
Even so, “valuations are still a long way from implying a normal recovery, and instead reflect a market that remains concerned about long-term growth,” he said.