Market could fall another 30pc, under one Macquarie scenario

Investors are starting to fear a GFC-like fall in corporate earnings, says Macquarie, as it models the COVID-19 fallout.

Macquarie examined three potential scenarios for markets as the pandemic plays out. Picture: AAP

Investors are starting to fear a GFC-like fall in corporate earnings caused by a “global pandemic and recession”, Macquarie has warned.

In a worst-case scenario the Australian sharemarket could fall a further 30 per cent on top of its 26 per cent decline from a record high of 7162.5 points four weeks ago, according to Macquarie’s Australian equity strategist Matthew Brooks.

A fall of that magnitude would imply a peak-to-trough fall of 48 per cent for the Australian sharemarket. That would be the biggest fall since the global financial crisis (GFC).

Australia’s S&P/ASX 200 has so far fallen 26 per cent from a record high of 7162.5 points to a four-year low of 5002 after undergoing its fastest ever shift from “bull” to “bear” market, defined as a fall of at least 20 per cent from a peak.

But the faster the US and Australia shut down their economies – as have China, South Korea and many European nations – to “flatten” the growth in COVID-19 cases, the less the risk of a worst-case scenario for the sharemarket, and greater fiscal stimulus will be more likely if the pandemic and associated economic outlook worsens, according to Macquarie.

Indeed, Mr Brooks has also outlined a less damaging “global slowdown” scenario and a more favourable “quick recovery” outlook.

“Australian stocks are already pricing in a global slowdown, but until day-on-day growth in US COVID-19 cases peaks and starts to trend down, we suspect volatility continues as markets price in scenario three (global pandemic and recession),” Mr Brooks said.

“Once we see the peak in daily growth in US cases, it will be a positive sign that we may be past the worst, and this should allow equity markets to form a bottom.”

The S&P/ASX 200 closed up 5.8 per cent on Tuesday as US stock index futures traded up by their daily limit of 5 per cent.

That follows a 9.7 per cent fall in the S&P/ASX 200 and a 12 per cent fall in the S&P500 on Monday, their worst days since the 1987 crash.

Macquarie’s Mr Brooks said the Australian sharemarket had “already priced in a material slowdown” in the global economy because of coronavirus but that “many investors are starting to fear a GFC-like fall in earnings”.

He noted that if Australian corporate earnings per share were to fall 31 per cent as they did during the global financial crisis in the GFC and investors were to demand an equity risk premium (the excess return over the 10-year government bond yield) of 7.4 per cent, the “fair-value” price-to-earnings ratio for the S&P/ASX 200 would be 13.5 times and the target price would be 3700.

From the peak in November 2007 to the trough in March 2009, the S&P/ASX 200 fell 54 per cent.

“Under this scenario, the ASX 200 could still fall a quarter from current levels,” Mr Brooks said.

But he sees an equal chance of a “quick recovery” where the index rises to 6600 points – about 30 per cent above Monday’s close.

In the quick recovery scenario, Mr Brooks assumes a 7 per cent fall in EPS - similar to the 2015-16 albeit concentrated over one-to-three months rather than 14.

“We assume a 4.4 per cent ERP, as the recent bear market could dampen equity sentiment for some time,” Mr Brooks said.

“With a 1 per cent bond yield, this implies a PE of 18.6 times and an ASX200 index of 6600.”

In the global slowdown scenario, he assumes a 16 per cent fall in EPS - half of what occurred in the GFC.

He also assumes that government bond yields fall to zero and that a higher equity risk premium of 5.9 per cent is needed to offset higher earnings volatility. Low rates support a fair value PE multiple of 15.6 times in that view, generating an index target of 5100.

“With the ASX 200 at about 5000, the market is already pricing a material global slowdown,” Mr Brooks said.

“We suspect the risk of scenario three is reduced the earlier the US and Australia shut down their economies like China, Korea and Italy so as to flatten the growth in COVID-19 cases.

“That said, we would expect materially more fiscal stimulus if scenario three becomes evident.”