As we approach the end of May, the S&P Index looks set to post a gain of 4% for the month, with various stock market indices across the globe in sync with this trend. Meanwhile, in the US, 36 million Americans have filed unemployment claims and GDP has contracted by 4.8% in the first quarter of 2020.
This widening disconnect between equity market pricing and economic reality has been a theme of ours over the past number of weeks, and can be explained by the following five factors, using the US, the globe’s largest economy, as an example:
- Markets are forward-looking and although S&P earnings are forecast to be 25% lower this year, forecasts for 2022 are only around 11% lower than they were at the start of the year.
- The huge stimulus packages released by the US Federal Reserve combined with a large fiscal response, have supported investment-grade corporate debt, money transfers to small businesses, and an expansion of unemployment benefits.
- Lower interest rates are generally supportive of stock market prices, as they increase the present value of future earnings and reduce the opportunity cost relative to holding cash and bonds.
- There is also the factor that the S&P Index, by its nature, is weighted by the market capitalisation of its underlying components, whereas smaller firms, many of which are unlisted, represent 44% of US GDP. Small businesses are likely to suffer more from the economic shutdown because they typically have smaller cash buffers to draw upon compared to large businesses, and have difficulty accessing cheap credit.
- There have been very disparate performances across various sectors and companies within the S&P Index, with stocks such as Amazon and Microsoft actually having experienced increased profitability within the Covid-19 environment and representing high weightings in the Index.
With due consideration to the above points, one may argue that this broad disconnect is justified. However, in our view, this positivity needs to be tempered in that there will surely be structural changes to the global economy, even post Covid-19. Consumer behaviour and confidence levels will shift, and we need to remain mindful that the globe is still in the midst of an unprecedented economic response to a pandemic, where the possibility of a new wave of infections cannot be ruled out. The ‘elephant in the room’ in terms of market risk, being the China – United States trade war, also remains. Lastly, massive stimulus packages from central banks across the world have supported economies and financial markets, and the cost hangover of these programmes will still need to be understood and quantified.
- China has approved sweeping national security laws in Hong Kong. Democracy advocates in Hong Kong are concerned that this will allow Beijing to suppress freedom of speech, freedom of assembly and the free press.
- China’s approval of the above is in direct defiance of the US and increases the strain on the already tense relationship. Larry Kudlow, President Trump’s top economic adviser, said in response that China will be “held accountable” and that it had made a “huge mistake”, it remains unclear what the ramifications will be in terms of sanctions.
- Prime Minister Johnson has been placed in hot water this week after revealing his lax attitude towards a top aide not following the UK’s lockdown rules. In contrast to this, Prime Minister of the Netherlands, Mark Rutte, had not visited his 96-year-old mother in a nursing home in the weeks before her death, in accordance with Dutch lockdown rule. Even Rutte’s critics have said that this matches his “no-frills” personality and his belief in playing by the rules.
- European Central Bank President Christine Lagarde gave a gloomy outlook for the region’s economy this morning, predicting output will likely shrink 8% to 12% this year, adding that estimates for a mild slowdown are “out of date.”
- The week, the US reached the grim milestone of more than 100 000 deaths from Covid-19, giving it the world’s highest death toll from the virus. This is more American deaths than those suffered in the Korean and Vietnam wars combined.
- Safety concerns have caused the World Health Organisation to stop using hydroxychloroquine in a large trial on Covid-19 patients. The Lancet reported that patients receiving the drug as a treatment had increased death rates and irregular heartbeats. The organisation has said it will review the evidence by mid-June to make a final decision on the harm, benefit or lack of benefit of the drug.
- In last week’s News Flash, we shared a link to Professor Glenda Gray’s article, which criticised the lockdown regulations established by the South African Government. Since then, a letter was sent by Acting Director-General of the Health Department, Anban Pillay, requesting that Gray’s conduct be investigated. In response to this, 250 of South Africa’s top academics and scientists signed a petition supporting Gray’s right to express her opinion in public.
- All of South Africa will be moving into lockdown level three from 1 June 2020. Relaxations include: the sale of alcohol will be permitted from Monday to Thursday, 9:00 to 17:00; the time restrictions on outside exercise will be significantly extended; all construction activities can continue; and places of worship will be allowed to open on a limited basis. Follow this link for more details.
- The sale of tobacco products remain banned: Follow this link (covered in our News Flash dated 15 May 2020), for Dynasty-bespoke analysis as to the possible political motivations underpinning this decision.
Sources: Dynasty, Reuters, Bloomberg Markets, The New York Times, Daily Maverick, and Moneyweb, etc