Answers to pressing questions about stocks – Part 3

Senior Investment Strategist Talley Léger provides relevant information about coronavirus’ impact on equities.

1. Has the S&P 500 Index ever had a better 5-day rally as of Monday’s close? What have such rallies meant for US equities in the near and long term?

Yes, the best 5-day rally occurred at the end of 2008, a few months before the S&P 500 Index ultimately bottomed for the cycle. However, the recent 5-day surge is the second best in history.

As impressive as that sounds, it provides little information about the near-term outlook of the stock market. Even the best 5-day rally in December 2008 was followed by further significant weakness in share prices. In fact, it wasn’t until March 2009 that the S&P 500 Index finally completed its bottoming process. Such extreme upside and downside volatility are the hallmarks of recessionary bear markets.

That said, the longer-term outlook is a different story. 12-month forward returns from the best 5-day rallies of all time were remarkably strong and consistently positive.

In the current environment, virus-related uncertainty could continue to weigh on stocks until the number of cases peaks. However, near-term chaos can create long-term opportunities for patient investors.

2. Has market leadership changed meaningfully during this downturn? If not, what does that tell you?

No, leadership hasn’t changed convincingly yet. There has been some movement in the stock-to-bond and cyclical-to-defensive ratios, but not enough to call a decisive “risk-on” shift toward stocks and the cyclical sectors of the market (e.g., consumer discretionary, energy, financials, industrials, information technology, and materials). In other words, government bonds and the defensive sectors of the stock market (e.g., consumer staples, health care, telecommunication services, and utilities) remain in the performance pole position for now.

In terms of style investing, growth-oriented sectors like information technology remain the relative standouts. Meanwhile, value-oriented sectors, such as energy, financials, industrials, and materials, are at the epicenter of the pandemic.

Such persistent leadership suggests that while the broad market may be getting closer to a bottom, the process is incomplete.

3. Can we really get out of this crisis with a garden-variety recessionary bear market? Is it too optimistic to think that a peak-to-trough decline of 30% is enough?

So far, the 2020 coronavirus crash and the 1987 crash are a good comparison, meaning those two cycles are lining up well. Specifically, the S&P 500 Index fell over 30% from peak to trough in both episodes, followed by double-digit rebounds from the initial lows.

In the 1987 crash, the rally faded and stocks fell to new lows a couple of months later, which also seems to be re-occurring as we write. Indeed, stocks can head meaningfully lower in the days and weeks ahead.

As for a worst-case scenario, the 2008/2009 housing crash doesn’t line up with the 2020 coronavirus crash because the latter happened so fast.

In 2008/2009, banks were significantly over-indebted. Today, banks are better capitalized than they’ve been in years. True, interbank lending spreads had widened in recent weeks, but the Federal Reserve’s (Fed’s) massive injections of emergency liquidity have helped to narrow those spreads and reduce stress in short-term funding markets.

One wildly optimistic scenario is a v-shaped market bottom, which we enjoyed coming out of 2018, but they’re rare. In that upside case, the virus would be contained following a short, sharp decline in business activity and a symmetrical snapback in growth, while massive policy stimulus is hitting the economy. However, we’ve never experienced such a sudden stop in activity before, and so much has to go right from a public health standpoint in order for this scenario to play out.

An extremely pessimistic scenario is a deep global recession and prolonged bear market in stocks or, even worse, a global depression.

The middle ground is that this is simply mandated demand destruction, and much (but not all) business activity can be restored as quickly (or as slowly) as it was shut down. As a base case, we see a weak first half followed by a strong second half, and a good recovery heading into 2021.

4. Is it even possible to assign a fair value to the S&P 500 Index when there’s no clarity on earnings?

Admittedly, that’s a daunting task. Granted, this drawdown has been so fast and broad-based that it’s restoring value to US equities, meaning opportunities are emerging rapidly. Specifically, the S&P 500 Index has fallen faster than Wall Street analysts’ consensus estimates for future earnings, leading to a much lower price-to-forward earnings (P/E) ratio. Specifically, the forward P/E ratio has fallen from about 21x at its recent peak to roughly 15x, a near 30% compression in multiples. The opportunity to buy stocks at more reasonable prices is now evident.

In this environment of high uncertainty and low visibility, however, earnings estimates are suspect, making P/E multiples difficult to interpret. There are probably good deals to be found at the company level, but there will be winners and losers even in the bargain basement.

The price-to-trailing earnings ratio has its own problems. Indeed, earnings recessions and negative denominators (-E) create meaningless valuations and negative quotients (-P/E).

5. When we come out of this, what should we expect to lead? How long could that leadership persist?

Historically, equity portfolios with a cyclical, small-cap tilt usually outperformed for several years into recoveries. Said differently, sectors and size were roughly the same play on improving economic prospects.

While the value-oriented style of investing was another leader coming out of the early 1990s and 2000s recessions, that wasn’t the case following the 2008/2009 recession. Indeed, this cycle has generally been frustrating for value investors, owing largely to a constrained financial sector and associated hostile and costly regulatory and legal environments.

Contrastingly, the growth style of investing and the information technology sector have been outperforming for 13 years—the longest growth cycle on record. Excessive growth and tech positioning raise further questions about the next potential shift toward value and financials.

Both our strategic start-of-cycle dashboard and tactical list of market-bottom indicators argue that it may be too soon for a new business cycle to begin and, thus, for value to outperform.

Importantly for Financials, the yield curve—a market proxy for bank net interest margins—has steepened, but not enough to be consistent with past major stock market lows.

6. US equities have led for the past decade or more. Would you expect that to continue going forward?

In many ways, we’re witnessing the environment change and evolve in real time. From a market perspective, perhaps the twin external shocks from the coronavirus and plummeting oil prices will prove to be the catalysts for changing leadership across regions and countries.

Let’s use China and the US as the “poster children” for the emerging and developed markets, respectively.

China was the first to implement draconian social-distancing controls and mass shutdowns to contain the coronavirus. The result was a symmetrical flattening of the case curve, whereas the US continues to witness infection rates on an exponential scale.

Such extreme, yet effective, measures in China came at a steep cost—Beijing sacrificed near-term economic growth, which plummeted to its worst levels on record. Nonetheless, China’s economic activity is rebounding in v-shaped fashion, as evidenced by the roundtrip of its Purchasing Managers Indices (PMIs) from expansion territory to record lows and back again.

By comparison, accelerating infection rates in the US likely mean that the worst of the economic damage is yet to come.

One major risk to emerging markets is the US dollar liquidity shortage and associated upward pressure on the currency. However, it looks like the Fed’s efforts—together with a host of other major central banks—to boost US dollar-based liquidity has helped weaken the currency.

Importantly, Chinese stocks have been relatively resilient, outperforming in a challenging environment. Indeed, US equities have dropped precipitously while Chinese share prices have been relatively stable since the start of the year.

See Part 1 and Part 2 for more answers to the FAQs we’re hearing from investors and advisors.

All data is sourced from Bloomberg L.P. as of 3/31/2020 unless otherwise stated

Important Information

Credit: Tetra Images/ Getty

Past performance is no guarantee of future results.

All investing involves risk, including risk of loss.

Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.

Stocks of small-sized companies tend to be more vulnerable to adverse developments, may be more volatile, and may be illiquid or restricted as to resale.

Many products and services offered in technology-related industries are subject to rapid obsolescence, which may lower the value of the issuers.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

 The 12-month forward returns are the returns on the S&P 500 in the 12-month period after record 5-day rallies.

The yield curve refers to the difference in yields from very short-term bonds to long-term bonds.

The price-to-earnings ratio, also known as P/E ratio or P/E, is the ratio of a company’s share (stock) price to its earnings per share. A trailing P/E uses the company’s actual earnings per share over the past year, rather than a company’s guidance on future earnings.

The S&P 500 is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States. It is not possible to invest directly in an index. Past performance is no guarantee of future results.

A credit spread is the difference between Treasury securities and non-Treasury securities that are identical in all respects except for quality rating.

A Purchasing Managers Index (PMI) is a diffusion index that measures the output of the manufacturing and/or services sectors of an economy.

The opinions referenced above are those of the authors as of April 2, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations. This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Talley Léger is an Investment Strategist for the Global Thought Leadership team. In this role, he is responsible for formulating and communicating macro and investment insights, with a focus on equities. Mr. Léger is involved with macro research, cross-market strategy, and equity strategy.

Mr. Léger joined Invesco when the firm combined with OppenheimerFunds in 2019. At OppenheimerFunds, he was an equity strategist. Prior to Oppenheimer Funds, he was the founder of Macro Vision Research and held strategist roles at Barclays Capital, ISI, Merrill Lynch, RBC Capital Markets, and Brown Brothers Harriman. Mr. Léger has been in the industry since 2001.

He is the co-author of the revised second edition of the book, From Bear to Bull with ETFs. Mr. Léger has been a guest columnist for The Big Picture and for “Data Watch” on Bloomberg Brief, as well as a contributing author on Seeking Alpha ( He has been quoted in The Associated Press, Barron’s, Bloomberg, Business Week, Dow Jones Newswires, The Financial Times, MarketWatch, Morningstar magazine, The New York Times, and The Wall Street Journal. Mr. Léger has appeared on Bloomberg TV, Canada’s BNN Bloomberg, CNBC, Reuters TV, The Street, and Yahoo! Finance, and has spoken on Bloomberg Radio.

Mr. Léger earned an MS degree in financial economics and a Bachelor of Music from Boston University. He is a member of the Global Interdependence Center (GIC) and holds the Series 7 registration.

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