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Thomas Verbraken

Thomas Verbraken

Executive Director, MSCI Research

Juan Sampieri

Juan Sampieri

Vice President, MSCI Research

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Four COVID-19 Scenarios: What Might Happen Next?

  • As countries have started relaxing lockdown restrictions there is uncertainty about how the COVID crisis will unfold. We explored four potential market outcomes based on IMF scenarios for GDP growth.
  • Based on our analysis, the current level of the equity market is in between our V-shaped and U-shaped recovery scenarios, although closer to the former.
  • Compared to this week’s levels, a hypothetical diversified 60/40 portfolio of equities and bonds could gain 1% under our most optimistic V-shaped scenario but lose 24% under a severe L-shaped scenario.

Financial markets partially recovered from their late-March lows, but the U.S. equity market was still 15% below the mid-February pre-COVID-19 peak, as of May 19. What economic scenario do markets currently reflect? We explored four potential financial-market outcomes based on International Monetary Fund (IMF) scenarios for GDP growth, ranging from a swift V-shaped recovery to a pessimistic L-shaped scenario, in which outbreaks recur and lockdowns return well into 2021. Our analysis suggested that, based on the May 19 level, the U.S. equity market is closest to our most optimistic V-shaped scenario. Under the most pessimistic L-shaped scenario, equity markets could lose another 24% compared to May 19 levels.


Our Four Scenarios — from Muted to Severe

With the gradual release of fresh economic data and revised growth projections, it has become clear that the COVID-19 pandemic and its resulting lockdowns will have a significant impact on this year’s GDP numbers.1 What is not necessarily clear, though, is what the medium- to long-term implications will be. Will real economic output revert to pre-COVID levels, or could more persistent changes impact trend growth for the years to come? The reality is it depends to a large extent on how the public-health crisis evolves, and there is significant uncertainty around that.

We propose four financial-market scenarios with varying degrees of severity, based on those proposed by the IMF.2 The first, V-shaped, scenario assumes an annualized 2.15-percentage-point contraction in the U.S. economy over the next two years but no persistent impact. On the other end of the spectrum is a pessimistic L-shaped scenario in which outbreaks and lockdowns occur well into 2021; this scenario assumes not only a severe short-term contraction, but persistent effects — with annualized growth five years from now 1.6 percentage points lower than the pre-COVID baseline. In between these two extremes, we also modeled U-shaped and swoosh-shaped scenarios.3 The exhibit below shows the potential real-output paths under various scenarios.


The Market Impact of Short- and Long-Term Growth Shocks

We modeled the macroeconomic scenarios using MSCI’s macroeconomic model, staying as close as possible to the IMF’s GDP scenarios.

Combined with assumptions for the equity risk premium (ERP) and the real interest rate, these scenarios allowed us to estimate the impact on the U.S. equity market using MSCI’s macroeconomic model. The below exhibit shows that the equity drawdown could range from -13% to -45% compared to the pre-crisis peak.

Macroeconomic and Market-Scenario Assumptions

Scenario (shocks relative to Feb. 19, 2020) V-shaped U-shaped Swoosh-shaped L-shaped
Annualized two-year growth shock4 -2.15% -3.15% -4.55% -6.25%
Annualized long-term growth shock5 +0.00% -0.40% -1.00% -1.60%
ERP shock +0.75% +1.25% +2.00%  +3.00% 
10-year Treasury real rate (level) -0.15% -0.20% -0.30% -0.40%
Implied equity returns (%) -13% -22% -33% -45%
10-year Treasury yield (level) 1.20% 0.90% 0.70% 0.50%
10-year Bund yield (level) -0.30% -0.50% -0.70% -0.90%
10-year Italian sovereign yield (level) 1.40% 1.70% 2.30% 3.50%
US IG bond spread shock (bps) +120bps +200bps +310bps +420bps
US HY bond spread shock (bps) +255bps +440bps +685bps +925bps
Oil price (level) $45 $35 $25 $20
EUR-USD (level) 1.12 1.09 1.05 1.00
Implied inflation (level) 1.35% 1.10% 1.00% 0.85%

Macroeconomic and financial-market assumptions for four COVID-19 scenarios of varying severity. GDP shocks are based on IMF scenarios. Financial-market shocks are based on a combination of MSCI’s macroeconomic-model output, IMF scenarios and analysis of historical data.

It is interesting to compare where markets stand now relative to the four COVID-19 scenarios. The exhibit below shows that the current level of the U.S. equity market is close to our V-shaped scenario, although, at the market trough in March, it was in line with our swoosh-shaped scenario.6


US Equity Performance Versus Four COVID-19 Scenarios

U.S. equity-market performance is represented by the MSCI USA Index.


Implications for Multi-Asset-Class Portfolios

To assess the potential impact on global multi-asset-class portfolios, we created a stress test using MSCI’s predictive stress-testing framework to propagate our main assumptions to all other risk factors impacting portfolio returns.7 We complemented the scenarios with further potential market shocks, as shown in the table above. Sovereign yields, oil prices and the EUR-USD exchange rate could revert partially toward mid-February levels under our V-shaped scenario. Under our most severe, L-shaped scenario, we assumed further downward pressure on the U.S. and German sovereign yields, whereas concerns about European peripheral countries’ debt could increase their spreads and weaken the euro.

Applying these scenarios to a hypothetical 60/40 portfolio of equities and bonds indicated that such a portfolio could slightly gain under our V-shaped scenario or lose a further 24% under our L-shaped scenario, net of what had been priced in since mid-February.


Potential Implications for a Hypothetical 60/40 Equity/Bond Portfolio

Further portfolio impact of the scenarios, net of what has been priced in based until the week of week of May 11-15. U.S. Treasurys and high-yield bonds are represented by Markit iBoxx indexes. The equity market is represented by the MSCI ACWI Index and U.S. investment-grade corporate bonds by the MSCI USD Investment Grade Corporate Bond Index. Based on May 19, 2020, market data. Source: IHS Markit, MSCI.

Although the initial market turbulence subsided, there is still great uncertainty about how the COVID-19 public-health crisis will unfold. Our four coronavirus scenarios for financial markets can help investors compare a range of outcomes, from an optimistic V-shaped recovery to a pessimistic L-shaped scenario.

The authors thank Chenlu Zhou and Dániel Szabó for their contributions to this blog post.



1See, e.g.: Wheatley, J. “Global economic outlook still worsening, says IMF.” Financial Times, May 12, 2020.

2“World Economic Outlook: The Great Lockdown.” International Monetary Fund, April 14, 2020.

3A swoosh represents a steep decline followed by a slow recovery.

4Represents the annualized two-year drawdown in real output compared to the pre-crisis projection. This may include a partial recovery within the two-year period. Note that comparing the pre-COVID-19 (January 2020) growth forecast of the Congressional Budget Office with the March forecast shows a 3.5-percentage-point drop in annualized two-year growth rate.

5Calculated as the annualized shock to the growth rate at the five-year horizon compared to the pre-COVID baseline.

6This is not meant to provide a market-implied forecast of the most likely scenario. Rather, it is meant to help investors orient themselves relative to scenarios of varying severity. Note that different asset classes can indicate other scenarios to be priced in.

7The results shown in the exhibit below are generated based on this methodology, using MSCI's BarraOne®, whereby we used current correlations to propagate the shocks to a hypothetical multi-asset-class portfolio. MSCI clients can access these scenarios on MSCI's client-support site. These scenarios will be updated regularly to reflect the market environment and can be used in MSCI's BarraOne® and RiskMetrics® RiskManager®.



Further Reading

Coronavirus and financial markets

How could coronavirus impact credit markets?

What scenarios has the US equity market priced in?

A coronavirus stress test for global markets

The coronavirus epidemic: Implications for markets