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The value of Canadian firms trading on the Toronto Stock Exchange fell in February and March 2020. The S&P/TSX Composite index dropped by 37 percent between February 19 and March 23, 2020—the date the index hit its lowest point during the COVID-19 crisis. This is a drop of around $1 trillion in the value of those firms, and it corresponds to about half of the annual Canadian domestic output the previous year. The reason for this decline is that forecasts for these firms’ future earnings plummeted as the pandemic evolved. Like most stock markets around the world, the TSX index had fallen ill, and its health deteriorated rapidly, adding to the stress of unprecedented uncertainty.
Surprisingly, global stock markets, including the TSX, have recovered most of their losses (Chart 1). By the end of August 2020, the TSX index showed a decline of around less than 10 percent since February. The V-shaped recovery pattern—resulting from the plunge followed quickly by the rally—is puzzling. Estimates from Statistics Canada show that the Canadian workforce shrank by around 3 million jobs between February and May 2020. Given the abrupt economic slowdown and the uncertainty around the future recovery, it is easy to wonder if the stock market rally is disconnected from the real economy. The signal sent by the stock market is also puzzling because the V‑shaped pattern varies across industries and even across companies.
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To read about this puzzle, we read on the costs of individual movements in the TSX index. The V -shaped episode then decomposes the replacement in the costs of individual movements in two parts:
First and is not surprising, we observe that the diving of business equity costs in February and March can be attributed to a building at the rate at which investors have long -term profits. This reduction rate has an update of buildings from 10 to 15% on average between shares. However, the reduction rate has returned to its point at the beginning of February to August.
Second, we note that the 8% drop in the TSX index between February 19 and early August 2020 aligns well with the drop in corporate earnings provided through inventory analysts Marketplaceplace. Although the lengthy run would likely prove analysts wrong, existing forecasts for inventory costs and profits seem in line. This suggests that the Inventory MarketPlaceplace is not disconnected from the economic situations that analysts are providing. We come to the same conclusion that we use the average or maximum pessimistic forecasts. We also asked if Shopify’s inventory spurs the TSX index’s recovery because it has seen significant gains in this period. However, Shopify’s exclusion from the research doesn’t replace our conclusion either.
We estimate the drawdown rate for long-term gains using:
The reduction rate we estimate is a measure of how much inventory of Marketplaceplace reimbursement that investors win by risk. We attach to the calculations and research used by Landalier and Besmar (2020) for the United States. The average reduction rate that we extract between inventory in the TSX The index increased from 10% to approximately 15% when the index sank (from February 19 to March 23). Table 2 shows that the reduction rate has returned since it was before the COVID-19 shock. This tells us that the reduction rates promoted market market fall and reviews to profit expectations did not seem to play a role at the beginning of the crisis.
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In fact, the giant swing in the reduction rates agrees with the data on the hazards of the revealed tail of the costs of the characteristics in the TSX index in this period. Table 3 shows that the probability of a wonderful fall in the price of the highest TSX index in early 2020, but slowly recovered since then.
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Corporations that are quoted in the stock market report the profits in terms of profits consisting of consistent with central (EPS). Analysts largely monitor corporate EPS, commonly known as “lower lens”, when corporations announce their profit results. Most analysts expect annual corporate EPs for several years in the Future. They publish and update these forecasts, which are collected through Refinitiv and are disseminated in the Database of the Institutional Dealer Estimation System (IBES).
Chart 4 shows that EPS forecasts for 2020 fell by 52 percent on average across the TSX index, starting in the second half of March 2020 (blue line). The decline is less pronounced for earnings forecasts for 2021 and 2022, which were revised down by 18 and 13 percent, respectively.
Looking back to history, we find that the reduction in earnings that analysts expected for 2020 is much larger than the earnings’ reduction they expected early in 2009, during the global financial crisis (Chart 5). However, the revisions in EPS forecasts for 2021 and 2022 are similar to the revisions for 2010 and 2011. This suggests that stock market analysts are projecting a lingering recovery for firms’ EPS, as they had in 2009.
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The decline in earnings forecasts largely explains the decline in the value of the TSX index we observe at the end of August 2020. Chart 6 compares average stock returns and revisions in EPS forecasts for different industries. Industries whose stock values plunged deeper were also those with the steepest revisions to EPS forecasts, on average. This gives us confidence that changes in earnings forecasts play an important role in the change to the stock market value between February and August 2020.
The power sector stands out: 2021 profit forecasts were revised to nearly 83% and the price of inventories fell about 43% on average between Feb. 19 and Sept. 10, 2020. Even though power corporations are excluded, positive data between inventory costs and earnings forecast revisions are widespread in other sectors.
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Table 7 breaks down the diversifications in the rate of reduction since the beginning of 2020 between threat remuneration (threat premium) and the minimization in long-term interest rates. The threat premium in August 2020 is about 1. 1% higher than the point it was before the CovVI-19 crisis. This building is largely offset through minimizing interest rates, which have been partly due to the Bank of Canada’s responses since the crisis began.
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Our effects comply with Kyeong’s (2020) that the price of the most delicate corporations to the economic slowdown results in a slow and superficial economic recovery, which contrasts with the sign we download from the price of the less delicate corporations. In fact, in Uninformed Effects, we note that the corporations most sensitive to the economic slowdown have suffered the biggest drop in profits so far. In general, there is a divergence after the Covid-19 crisis between:
Our conclusion is also robust. We repeat our calculations the maximum pessimistic gains for each corporate at all times. On average, the reduction rates that we obtain in this way are lower. For example, the peak is 13% in March 2020, or approximately 2 percentage problems under the estimate based on average forecasts. However, the market scale reduction rate at the end of our employer is still very close to the dominant point at the beginning of the year. This result implies that market evaluation in September is aligned with the average drop in acquisition forecasts among companies.
Finally, our effects are based on the long -term expansion estimates of each corporate beyond 2022, which correspond to the observed expansion of sectoral sales in the past economic cycle. These expansion rates have an average of around 3. 9% and a variety between 2. 8 and 4. 9%. However, we verify that our conclusions remain unchanged if we estimate this expansion rate by using other approaches (for example, the estimates of long -term expansion analysts).
The apparent disconnect between the economic outlook and high stock prices raises questions. But we find that the decline in the value of the TSX index between February and August 2020 aligns well with earnings forecasts by stock market analysts. This does not mean that that the analysts’ lower forecasts and the current market value are the best predictions of what is to come. Even more, it does not mean these forecasts will be right. In June, the International Monetary Fund said that the gross domestic product for advanced economies will be lower at the end of 2022 than it was at the start of 2020. The Bank of Canada painted a similar picture for Canada in July (Bank of Canada 2020). More research is needed to determine how closely analysts’ forecasts of firms’ earnings relate to projections for the Canadian economy.
We thank Guillaume Bédard-Pagdé, Hayden Ford, Tamara Gomes, Maxwell Knifton and James Kyeong for their comments and suggestions. Finally, we are grateful to Nicole Van de Wolfshaar and Colette Stoeber for editorial aid.
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