Here’s the conundrum – the June quarter of 2020 witnessed the worst economic slump since the 1930’s great depression, yet at the same time recorded the biggest jump in share indices for any quarter in more than two decades.
The answer to this riddle lies in a simple truth – share markets don’t reflect the present let alone the past but try to anticipate the future. Since the nadir of this crash on the March 23, the prevailing view is that the worst of the pandemic is over for the global economy. Yes, there might be second, third or fourth waves, but these should be better contained and won’t stop industry reopening. For instance, US manufacturing is rebounding quickly. See charts below.
The latest IMF world economic outlook is that this year will be the worst since the great depression of the 1930s, but thanks to official stimulus measures and pandemic controls global activity will bounce back in 2021. This view is also shared by local economists who in a recent newspaper poll thought the worst would be over by the June quarter 2020.
This assumes any future lockdowns will be localised. Foreign arrivals in quarantine will be guarded by police or soldiers, not lax security guards. Social isolation will be left to retirees who collect dividends, but don’t generate earnings.
As long as intensive care units are not overrun with COVID-19 patients there will be no general shutdown, though strict social distancing will be enforced and the wearing of masks on public transport and in lifts may become mandatory. Like the flu (that each year hospitalises about 18,000 and kills 1,500 to 3,000 Australians) we will have to live with COVID-19 until a vaccine is found, which could be 18 months or longer off.
In the meantime, any industry dependent on immigration or foreign tourism is listless. Instead domestic tourism will boom. We will all get to know the Australian outback and coastal regions better.
Financial year 2019/20 posted the worst market return since 2012. The All Ords share price index between Friday 28 June 2019 and Tuesday 30 June 2020 fell from almost 6,700 to 6,000; a drop of 10.4%. The flash crash from its high of 7,155 on the 20 February to its low of 4,464 on the 23 March wiped 36.2% off its value. The All Ords index as of last Friday had recovered 62% of the ground it lost in the crash.
Note also that the recent market crash and rebound demonstrated the greatest market volatility in the 50 year history of the All Ords index.
On a short to medium-term perspective, the All Ords came close to going bearish at the start of last week, but then picked up momentum to reconfirm the rally it’s enjoyed for the last 15 weeks. Note the red 10-day trend line continues to surpass the blue 30-day trend line and the index’s momentum while still negative is now green and improving.
On a medium to long-term horizon, the All Ords is still in a bear market. Observe that its 30- day trend line (red) remains below its 300-day trend line in blue (though the gap is narrowing) and its Coppock momentum oscillator (green) is still heading south and in negative territory. Until the Coppock reverses direction and heads north we can’t be sure the bear market is over.
As for July it’s typically the best month of the year for share markets. See chart below which shows the seasonal pattern for America’s S&P500 share price index since 1928.
This monthly pattern is also true for the Australian All Ords index over the last twenty years as shown by the chart below.
The next chart shows that over those two decades the All Ords did better than the S&P 500 between June and August.
Reinforcing the market’s rally is the fact that the US Federal Reserve is leading the charge to reflate asset markets. The chart below shows that its balance sheet will expand by more than QE1, 2 and 3 combined. In other words, digital printing of money is happening on an unprecedented scale. Little wonder modern monetary theorists are advocating the scrapping of taxes since money creation is easier and less painful.
But monetary hawks are warning that with production supply lines disrupted by the pandemic and trade tensions with China worsening the world is on the cusp of stagflation – too much money chasing too few goods and services. In other words low economic growth combined with increased price inflation.
Most economists don’t buy this argument because inflation so far has remained subdued notwithstanding a decade of QE (“quantitative easing”) by the world’s major central banks (USA, Europe, Japan and Britain).
Global Annual Consumer Price Inflation Rate % (IMF DataMapper)
If the future is stagflation, that would be bad for stocks. The last time that happened was the 1970s when the CPI went up by over 100% and the S&P500 stock index swung sideways for a decade. See chart below. Only health care, food, energy, utilities and gold thrived in this period.
Should stagflation be around the corner we are not there yet. Indeed the immediate threat to Australia is deflation as income support measures (JobKeeper, Job Seeker) and repayment deferrals (business loans, home mortgages, retail and dwelling rents and utility charges) expire in late September. Hopefully the Federal Treasurer’s economic and fiscal update on the 23rd July 2020 will abate fears of an economic cliff awaiting Australia.
Bull versus Bear
Lance Roberts of Real Investment Advice sums up the Bull and Bear cases as follows:
As I have said before Lance Roberts has been bearish since the market started recovering in late March. On fundamentals he is correct, markets remain overvalued notwithstanding most still being well below their highs of 20 February, 2020. But the clarion call of brokers is “there is no alternative” since Australian shares still deliver average dividends of 4.2% (with a forward estimate of 3.2%) whereas bank term deposits and government bonds yield at best only 1.0%. That’s what’s driving retail investors into shares.
As for whether the market is safe or dangerous I will continue to watch its actual trend and momentum rather than engage in a guessing game between bulls and bears. As stated above the current short to medium-term pulse of the market is bullish whereas the medium to long-term position remains bearish.
As always this is economic and market analysis, not trading or investment advice.
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