Investor optimism contrasts with economic uncertainty

While equity markets exhibited mostly positive sentiment throughout the week, reports published on Friday put market performance since the pandemic in context and provided forecasts for the near term.

In a report on financial market stress, TD Economics noted that, while market volatility in March was the second highest ever recorded (1987 takes the cake), this year’s market decline stacks up as average when compared to other recessionary periods.

Since World War II, the average S&P 500 decline (peak-to-trough closing value) during recessions is 29.5%, the report said, while 2020’s drop is about 34%.

In comparison, in 2001 and 2008, the S&P 500 dropped 49.1% and 56.8%, respectively.

Despite this year’s dramatic volatility, the markets’ performance “likely has to do with the massive injection of central bank and government support this time around, which has been far more proactive at the onset of the stress than past cycles,” the TD report said.

Since the lows of March 23, North American stock indexes are up about 30%.

In addition to central bank support, investor confidence is supported by reopening plans announced by various governments, said an outlook report published on Friday by Desjardins.

However, the optimism contrasts with the “spectacular plunge in economic activity in the first half of 2020, which is hitting global demand for oil hard, among other things,” the report said.

With economic uncertainty ahead, “the potential for further gains by the stock markets seems fairly limited over the near term,” the Desjardins report said.

Still, if a gradual economic recovery materializes in the coming months, as Desjardins forecasts, “stock markets and the Canadian dollar could still end the year a little higher than where they are now,” the report said.

Loonie’s outlook

Monetary policy helped the loonie appreciate more than 2% against the U.S. dollar in April, despite plummeting oil prices.

The Fed’s expansive asset purchase program was key to the appreciation.

While the Bank of Canada’s quantitative easing program is capped, the Fed’s is open-ended, with no limit on how much can be purchased, said Krishen Rangasamy, economist at National Bank, in a note on Friday.

“A busier printing press in the U.S. implies a bias towards Canadian dollar appreciation,” he said. The bank accordingly updated its foreign exchange forecast slightly, he said. The bank’s outlook for the loonie in the second quarter is $1.43 relative to the U.S. dollar.

Rangasamny warned, however, that the loonie could see a near-term correction.

“An argument can be made that the Canadian dollar may have risen a bit too much, too fast,” he said.

Plotting the loonie’s value against the benchmark price for oil, Rangasamny found that, for the first time since September 2017, “the loonie now seems a bit overvalued relative to what would be expected from current oil prices.”

For full details, read the reports from TD Economics (provides tables showing historical volatility and market declines), Desjardins (provides tables of market forecasts and economic indicators) and National Bank.