The financial markets will eventually recover, but what letter shape will it resemble?

When COVID-19 started making a significant impact in the U.S., some market pundits were calling for a V-shaped recovery. As the situation worsened, the consensus forecast seemed to shift to a U-shaped recovery. And now that the virus has effectively shut down the nation for an indeterminate period, some are positing an L-shaped trajectory which, based on the horizontal bottom line of the letter “L,” does not denote a recovery anytime soon.

UBS laid out three COVID-19 market scenarios in its April investment strategy guide, with each scenario respectively corresponding to one of the three above-mentioned letter-shaped profiles.

Upside Scenario/V-Shaped
Strong compliance with social-distancing measures, coupled with viral seasonality (i.e., if the virus spreads more slowly in warmer temperatures) and/or pharmaceutical breakthroughs, could enable the U.S. and Europe to see infections peak by mid-April. If so, sheltering mandates could be relaxed starting in early May, meaning that government stimulus would be sufficient to prevent lasting economic damage.

That could provide the backdrop to a V-shaped recovery in this year’s third and fourth quarters, with the S&P 500 Index ultimately trading at roughly 2,900. (It finished Friday’s trading at nearly 2,305, and it ended last year at almost 3,231.)

Central Scenario/U-Shaped
Much like in the upside scenario, new virus detections peak in mid-April and sheltering restrictions loosen in early-May. But the virus isn’t completely eradicated, and sheltering restrictions are reimposed when needed in certain countries throughout the year. UBS expects “softer” restrictions to be in place for the rest of the year. While coordinated monetary and fiscal responses from central banks and governments will provide necessary funding to support affected businesses and industries in this scenario, it will arrive too late to protect all of them.

This would produce a U-shaped recovery that takes hold in the fourth quarter, putting the S&P 500 at about 2,650 by year end.

Downside Scenario/L-Shaped
Containment measures are too late and new virus infections keep rising in the U.S. and Europe into May and June, keeping most sheltering restrictions in place until June or July, and possibly intermittently for the rest of the year.

“In this scenario, government policy would not meaningfully offset the lengthy demand shock, leading to a sharp rise in bankruptcies and joblessness,” according to the UBS report. “Companies would forgo significant revenue, and losses would be borne by shareholders, creditors, and banks.”

If that happens, UBS foresees an L-shaped growth profile for the remainder of the year and the S&P 500 trading at roughly 2,100 by year end. But if past bear markets are a guide, it could close lower at between 1,650 and 1,950. 

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