I was on a call with a reader talking about what direction global equity markets might go next. Obviously, not possessing a crystal ball, my thoughts were purely speculative but this reader had been a little spooked by the market decline in early 2020 and although they hadn’t sold everything wanted my opinion on what I think might happen next.
Clearly, economies around the world are facing enormous headwinds from the measures put in place to keep the coronavirus pandemic under control. With a huge swathe of the population not able to leave their homes and job losses on the rise, it doesn’t take a genius to see that economies and company earnings are likely to take a huge hit in 2020.
The initial reaction to the pandemic was fairly predictable – a precipitous collapse in equity indexes which deepened rapidly over the course of a few weeks as investors sold out of equities and fled to the relative ‘safety’ of cash, government bonds, and gold. What happened next was an unprecedented package of interventions by central banks who declared multi-billion pound purchase programmes of everything from government debt to corporate debt and even Exchange Traded Funds. The vast sea of cash poured into the markets which reversed course and began a storming recovery – returning to pre-crash values almost as quickly as they’d fallen.
As of July 2020, volatility remains higher than in 2019 but share prices have largely recovered and in some cases have continued to march upwards, regardless of the seemingly obvious economic catastrophe we’re living through.
In my opinion, most companies are facing significant loss of revenue as a result of the global lockdown and will continue to do so for the foreseeable future. Job losses in the tens of thousands will likely be registered across the majority of countries which will impact asset values, consumer spending and government tax receipts. National deficits will grow (and remain elevated), leading to increased national debts. Banks will face elevated defaults on loans and discretionary spending will decline as households tighten their belts due to incomes declining.
Taking this into account, how on earth can companies still be valued at the same price they were six months ago? Even if you believe that spending and investment will recover (which I do) then it won’t be immediate and earnings are bound to be impacted. Many companies will not survive at all.
So have markets lost their mind?
I don’t believe that this means that investors should shun the markets all together. There are deals to be had and some companies will continue to motor forward and grow over time. But pouring money into indexes or the biggest names at any price seems foolhardy to me. Sadly, so many investors are mindless ‘passive’ investors that they’ll buy any company at any price, so long as it’s part of an index they’re interested in.
Likewise, the tidal wave of central bank cash has vastly influenced markets – the Bank of England’s balance sheet is now valued at over £700bn (pre-2008, it wasn’t even £50bn). The US Federal Reserve’s balance sheet ballooned to over $5t (yes, that’s trillion…) in March and has continued to grow ever since.
This is going to be extremely difficult to unwind but is largely behind the rapid reversal of index values. It doesn’t come risk free, however. I’ve given up pointing out inflationary risks (after 12 years I begin to wonder if I’m missing something obvious) but this level of intervention in public markets is absolutely unprecedented.
Having said that, we’ve had interest rates at rock bottom for a decade. We’ve had central bank intervention for a longer. Much like income tax (a temporary measure legislated in 1799 to pay for the Napoleonic Wars), these things prove very, very difficult to get rid of once you start relying on them. Notionally, the right of the UK government to levy income tax expires once a year on April 5th but somehow, no one has stopped levying it in over 220 years.
For me, the bigger concern is that the stock market is not the economy. Tens of thousands of people around the world are losing their jobs; that means difficulties buying food, paying for mortgages, paying for school fees – real, important essentials of living. Governments can lock us in our homes (mostly successfully it seems) for months on end, but when people can’t afford to live, society begins to face much bigger, more immediate and dangerous issues than the notional value of a company.
Markets do seem a little disconnected from economic reality at the moment but I believe they’re responding in a fairly predictable manner to the major investment interventions by central banks. Ultimately, I believe that the pandemic will pass, and that the majority of lost jobs will return to the economy. There is undeniable evidence that equities should form a key part of any investor’s portfolio – but in the current climate, I feel caution should be the name of the game.