Column
Fundamental
Australia

General Market Update

12 May 2020
By
With the health crisis seemingly under control and markets well off their lows, where to from here?

It seems like a lifetime ago that markets began plummeting in response to the rapidly deteriorating health crisis facing the globe, but it is actually less than three months since the ASX 200 was at all-time highs of 7162 points. Since then we have seen a dramatic fall in less than a month of as much as 37%, followed by a steady but less linear rise of 18% from the lows. Despite the impressive recovery which has come because of the restrained spread of the virus in major countries around the world which has brought forward plans to re-open, the ASX 200 still remains 25% from its highs in February.

The commentary of most pundits seems to be: ‘the global economy is at a standstill, so why on earth are share prices rallying?’, but I think this misses a few obvious points. The first one is that the market overshot on the sell-down which, at the time when markets were still unsure about how effective shutdowns would be and when Scott Morrison is talking about a six-month hibernation, was a result of uncertainty which is a confidence killer. So, as the pandemic has become controlled in countries like Australia and South Korea, the worst-case scenarios were no longer appropriate to price into stocks. The stock market is always forward-looking, so once the likelihood of economies reopening became more likely, the stock market was always going to play catch-up.

Secondly, it is simply not the whole picture to say that the local market has rallied 18% off its lows. After the initial panic sell-down, the market has begun rewarding those companies that are either benefitting from the unique environment or who are well-placed to rebound quickly once things return to normal. But a vast number of stocks are still down in excess of 25% from their highs. And in the U.S., the gains have largely come from the big tech names such as Amazon and Microsoft which happen to be the biggest companies on the New York Stock Exchange. Australia’s stock market is dominated by financials and resources which are far more leveraged to a global recession.

Finally, while the pandemic and the forced economic shut-down are one-off in nature – and while we don’t know how quick a recovery will be, we can be confident there will be one – one change that will arguably have longer-term implications is the outlook for long-term interest rates. Governments around the world have all had to borrow significant amounts of money to keep these economies afloat while economic activity drops off a cliff, and it will be in everyone’s best interests to have lower interest rates for longer. On a discounted cash flow (DCF) valuation methodology which is a very common analysis used to value equities, long-term interest rates below 1% will ultimately lead to higher valuations for equities (on the assumption that future cash flows are more valuable in today’s dollars).

So, the important thing to remember is that a bad economy doesn’t always translate to a bad stock market. We are seeing long-term trends crystallised in a matter of months such as e-commerce, online team collaboration, the move towards a cashless society etc and those names will continue to be rewarded by the market. And we have stocks that were sold down on the fears of an even longer shutdown and the likelihood that many of these companies will see a return to normality in the not-too-distant future, and the reflection of this likelihood in their share prices. This could change quickly if we see a spike in local infections and a new shutdown, but for now the market seems to be going with the odds as at today: that we have seen the worst, and where we go from here depends on how quickly we recover.

SHOW COMMENTS / QUESTIONS (5)

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Keith E.

Not a word of this explains today’s slump!

Shannon Rivkin

Hi Keith,
The article wasn’t in direct response to yesterday’s market, but more a commentary on the current dynamics driving the market.
Regards,
Shannon

Riki S.

Remarkable equity turn around in the USA Shannon – other markets are not quite as optimistic. Don’t fight the FED… but can the FED save everyone? Maybe they can start buying stocks directly. It should be interesting to see how the corporate and now country debt issue plays out, with the real potential falling revenue and tax income is prolonged and in particular if we bake in a second wave, zero vaccine for 12 months, disrupted economic activity, cash hoarding and the significant risk associated with the White House push to open without the necessary testing regime in place…… a… Read more »

Shannon Rivkin

Hi Riki,
I agree with you that right now predicting the future has never been harder and that is a scary thing for markets. But there are things that can be predicted with more confidence (such as the continued explosion in online shopping) which is why portfolio construction will never be more important than right now.
Regards,
Shannon

Riki S.

Hi Shannon – couldn’t agree more.

Online/Digital good stocks have ahd their evolution sped up. Probably also a good opportunity to mix in a little gold, to offset the stagflation, although suspect there’s going to be a deflationary event before, which will make things a little tricky, timing wise. Maybe a small punt on a biotech spec, given the specific virus challenge and asymmetric upside.

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