The recent resilience of global stock markets has created a key talking point heading into the June quarter reporting season.

After a record-breaking rally in April, the ASX has held most of those gains through May and got off to another strong start this week.

Amid that backdrop, the Q2 earnings outlook is expected to be more illuminating than usual, given the majority of companies on the ASX200 either halted or withdrew earnings guidance completely in the wake of the COVID-19 pandemic.

For now, the price action on markets indicates that investors are betting listed companies will navigate their way through the worst of the crisis.

But for Seema Shah, chief strategist at asset management firm Principal Global Investors, while stock prices look good they don’t “feel good”.

Shah highlighted the ongoing disconnect between stock prices and the real economy, with US unemployment rising to its highest level since World War II.

In effect, the price action indicates markets are betting that while the pace of economic contraction was unprecedented, the rebound will also be equally fast once the health crisis subsides.

And in the meantime, record levels of stimulus from governments and central banks will be enough to hold the fort.


The low is in, but where will markets settle?

Shah said recent signs of green shoots in the US economy, such as gasoline demand and increased mobility in mobile phone tracking systems, suggest that “April likely marked the nadir for economic activity”.

However, investors will likely have to account for an uneven economic rebound, as well as the possibility of more uncertainty on the health side such as the potential for a second wave of outbreaks.

In that environment, Shah said investors should be wary of a negative feedback loop stemming from sectors which had been hardest hit, such as airlines and physical retail stores.

“Markets may be right to look through Q2 numbers and look forward to a Q3 recovery. But it is entirely possible that there will be a Q4 reckoning, where a second wave of job losses and prolonged period of business failures tests equity sentiment,” she said.

In other words, more of a “W-shaped” recovery, with a short-term rally followed by more headwinds. And until a vaccine becomes available, lingering economic headwinds from the health crisis are likely to reappear.

Think Big: V-shape, U-shape or L-shape? This economist is bullish about a quick US rebound

That was a view shared by US Fed chair Jerome Powell, who said over the weekend that a full recovery for the US economy could take until the end of 2021, and would probably require the introduction of a vaccine.

With central banks on hand to provide support, Shah said equity markets were “unlikely to re-test their lows”. However, she stopped short of advising a total shift to risk-on trading positions.

If major economies show signs of recovery into the second half of the year, it may warrant a “rotation away from defensives into cyclicals, and from large cap to small cap (stocks)”, she said.

But for now, capital should be allocated selectively to businesses with “strong balance sheets, positive cash flow, less leverage, and those that have a vision to benefit from new secular growth trends”, Shah said.