An event-driven bear market (Peter Oppenheimer, Goldman Sachs)

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When news of coronavirus first broke earlier in the year, Goldman Sachs Research’s Peter Oppenheimer warned that the markets were being too complacent. With the stock market’s latest plunge, we got in touch with Peter, based in London, to get his views on how severe the selloff could be and the key metrics and risks investors should watch.

Let’s get straight to it: How long will this turbulence last? Are we heading into a bear market?

Peter Oppenheimer: It’s difficult to say with any certainty, given how much is still unknown about the spread of the virus and the lack of historical precedent. We’ve never before entered a bear market because of a viral outbreak. But if you believe we haven’t hit the trough and we are in fact headed for bear territory, it’s useful to look to the history of bear markets to get a sense of their duration and intensity. There are three different types, each with different triggers and characteristics: structural bear markets, cyclical bear markets and event-driven bear markets. At this stage, we think the balance is still in favour of this being an event-driven bear market, suggesting that the rebound in equity markets will be swift. On average, these kinds of bear markets triggered by exogenous shocks have seen declines of 29% and lasted nine months, with markets regaining their previous levels within 15 months.

But there are few precedents for coronavirus. How does this factor into your analysis?

Peter Oppenheimer: That’s right. It makes us more cautious, and there are three important caveats to make about intuiting anything from the history of event-driven bear markets. Firstly, none of the event-driven bear market examples from history were triggered by a virus or other disease outbreak. They’re all different but typically it has been market driven, so a monetary response has often been more effective, whereas this time it’s not clear that it will be. This is partly because interest rate cuts may not be very effective in an environment of fear where consumers are forced, or just inclined, to stay at home. Secondly, none of the previous examples were in periods where the starting point of interest rates has been so low. This could raise the concern in markets that there is less room for an effective policy response. And thirdly, in previous periods when there have been viral shocks, such as SARS, the equity markets tended to rebound when the growth in infections slowed. While this may be true in China, it’s clearly not true in many other parts of the world, so the fear factor around the economic shock from preventative measures may push markets further down in the meantime.

Beyond monitoring the spread of the virus, what are the other key metrics to watch?

Peter Oppenheimer: We have two proprietary indicators that we are watching closely for signs that markets are approaching a buying point, particularly for longer-term investors. Our Global Risk Appetite Indicator has fallen below -2, a level which historically has indicated above-average S&P 500 returns over the next 12 months. In the depths of the global financial crisis this measure dropped to -2.96 before recovering, so to cap downside risks in the near-term, you usually require a perceived shift in growth momentum and/or policy response. The other measure we’re watching is our Global Bull/Bear Market Indicator. This is based off an assessment of six major factors. Encouragingly, the recent measures have come down from the peak levels that we’ve seen. This both suggests less room for downside risk and higher likelihood of stronger, longer-term returns. That said, the factors underlying this model are showing conflicting signals at present. Generally low unemployment, a flat yield curve and a high valuation are all pointing to vulnerability. On the other hand, low core inflation, a depressed level of growth momentum and strong private sector balances are a structural support for the markets.

Are there any other risks to be wary of?

Peter Oppenheimer: Credit markets will be in sharp focus in the coming days and weeks. With the collapse in oil prices, the risks in the high yield credit market increase. And the growing risks of a global recession—or even the risks that this is priced as a likely scenario—make credit look vulnerable. All of these things increase the risk that any event-driven shock will morph into a more entrenched cyclical bear market as investors price the probability of sharp falls in corporate profits into a recession. However, given other supports—including ultra-low interest rates and relatively healthy private sector balance sheets—our assumption is that any event-driven bear market will be associated with a swift recovery.

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