The coronavirus crisis has had huge implications for the economy and markets alike since the initial outbreak in China became a global pandemic. 
Lockdown conditions imposed by governments around the world effectively closed down large parts of the economy and saw citizens confined to their homes.
The uncertainty of the duration and the severity of the pandemic saw market sentiment turn negative after an equity bull market that had lasted for more than 10 years.
Nevertheless, with many countries now appearing to be past the peak in death rates and seemingly having brought infection rates under control, some economies are beginning to emerge from lockdown.
Yet it remains to be seen what the longer-term recovery will look like.
Verbraken, an executive director at MSCI Research, and senior associate Sampieri modelled four different growth scenarios to see how markets could perform as the world begins to emerge from lockdown.
“Although the initial market turbulence subsided, there is still great uncertainty about how the Covid-19 public-health crisis will unfold,” they said.
“With the gradual release of fresh economic data and revised growth projections, it has become clear that the Covid-19 pandemic and its resulting lockdowns will have a significant impact on this year’s GDP numbers.
“What is not necessarily clear, though, is what the medium- to long-term implications will be. Will real economic output revert to pre-Covid levels, or could more persistent changes impact trend growth for the years to come?
“The reality is it depends to a large extent on how the public-health crisis evolves, and there is significant uncertainty around that.”
As such the pair considered four scenarios – V-shaped, L-shaped, ‘swoosh’-shaped and U-shaped – using the International Monetary Fund’s growth assumptions to assess how markets would perform.
The V-shaped – the most optimistic of the four – suggest a sharp contraction followed by a fast recovery. An L-shaped recovery – the most severe – would signal a sharp contraction with a long period of flat or no growth.
A ’swoosh’-shaped recovery is one in which a sharp contraction is followed by a fast recovery and so called for its likeness to the Nike ‘swoosh’ symbol. Finally, a U-shaped recovery would see a sharp decline followed by a gradual rise to its previous peak.
Source: MSCI
Combined with the assumptions for equity risk premium and real interest rate, the index provider’s scenarios have allowed it to estimate the impact on the US equity market.
Verbraken and Sampieri said their models show the equity drawdown could range from a fall of 13 per cent to one of 45 per cent from pre-crisis peak levels.
“The V-shaped scenario assumes an annualised 2.15-percentage-point contraction in the US economy over the next two years but no persistent impact,” said the pair.
“On the other end of the spectrum is a pessimistic L-shaped scenario in which outbreaks and lockdowns occur well into 2021; this scenario assumes not only a severe short-term contraction, but persistent effects — with annualised growth five years from now 1.6 percentage points lower than the pre-Covid baseline.”
They added: “The exhibit below shows that the current level of the US equity market is close to our V-shaped scenario, although, at the market trough in March, it was in line with our ‘swoosh’-shaped scenario.”
US equity performance vs four Covid-19 scenarios
Source: MSCI
Verbraken and Sampieri warned that the chart is not meant as a market-implied forecast of the most likely scenario. Nevertheless, the shape of any recovery will have significant implications for portfolios, particularly if there are further potential market shocks.
“Sovereign yields, oil prices and the EUR/USD exchange rate could revert partially toward mid-February levels under our V-shaped scenario,” they said.
“Under our most severe, L-shaped scenario, we assumed further downward pressure on the US and German sovereign yields, whereas concerns about European peripheral countries’ debt could increase their spreads and weaken the euro.”
And there could be a further impact for traditional asset allocation.
While the end of the 60/40 portfolio – an equity/bond split – has been forecast for some time, it remains a model for many investors to follow.
Potential implications for a hypothetical 60/40 equity/bond portfolio
Source: MSCI
Under the four MSCI scenarios, such a portfolio could slightly gain in a V-shaped scenario or lost a further 24 per cent in a L-shaped recovery.
Hover, they warned that “although the initial market turbulence subsided, there is still great uncertainty about how the Covid-19 public-health crisis will unfold”.