Exposure rates of the Dorval Asset Management Range – 9th April 2020

With the extremely severe but temporary shock on the economy, corporate earnings and dividends in 2020, investors are losing their bearings on asset valuations. As the first quarter 2020 earnings reporting season draws near, we sometimes hear said that current stock-market levels underestimate the reality of the slump. Yet this reasoning boils down to a considerable overestimation of the impact of an admittedly spectacular but inherently temporary shock, which seems unreasonable.

 

Let’s imagine a “lost year” scenario for just a moment, with all companies cancelling dividend payouts in 2020, before normalisation from 2021 onwards. Using some standard hypotheses (available on request), we show that this scenario would have an impact of barely 5% on the value of this group of companies, based on a discounted future dividends model (cf. chart 1), which is a far cry from the 30% or 35% plunges we have recently witnessed on stock-market indices.

 

Lost year on dividends would cost 5% for indices

Dividends for group of companies (e.g. S&P 500)
where dividends increase 5% per year under normal circumstances

Base 100 in 2019 / Baseline scenario (no shock) / Lost year for dividends scenario in 2020
Net present value of lost year scenario: -5% vs. on-shock scenario (calculation hypotheses available on request)

 

However, this scenario may appear both overly pessimistic – dividends will still be paid by several companies in 2020 – and overly optimistic as it assumes that companies will fully get back to their previous trend as early as 2021, which most investors are unwilling to believe at this stage (be they right or wrong). We have therefore developed two very conservative scenarios (cf. chart 2), both of which assume a 70% drop in dividends in 2020 – which is much more than the 25% decrease for the S&P 500 in 2009 – followed by a return to their 2019 level only in 2022. Scenario 1 assumes a partial catch-up thereafter, while the very pessimistic scenario 2 assumes no catch-up. These two conservative scenarios give declines of respectively 9% (scenario 1) and 18% (scenario 2) in the index’s value, so we can see just how excessive the share price nose-dives since the end of February have been.

 

Future dividend flows: two pessimistic scenarios

Dividends for group of companies (e.g. S&P 500)
where dividends increase 5% per year under normal circumstances

Base 100 in 2019
Baseline scenario (no shock)
Scenario 1: shock followed by partial catch-up, then return to previous growth levels
Scenario 2: shock then return to previous growth from 2022, but with no catch-up
Net present value of two scenarios :
Scenario 1 = -9% vs. no-shock scenario
Scenario 2 = -18% vs. no-shock scenario

2008-2009 scenario for S&P 500

 

Risk premiums dictate market movements much more than economic stats and the earnings reporting season that is soon set to get under way. These premiums have eased since the end of March on the back of active engagement from the public authorities, and in particular the central banks. However, these premiums will also – and in particular – continue to trend on the basis of predictable developments in the epidemic and the way it is managed. After full lockdown, a second phase when we very cautiously and gradually emerge from isolation (two steps forward, one step back) seems to be shaping up from May, pending confirmation that vaccines currently being researched by several large pharma companies will be effective and safe: it is this confirmation that will mark the end of the crisis and the normalization of share prices.

 

 

Download the weekly letter in PDF version: Exposure rates of the Dorval Asset Management Range – 9th March 2020

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