How the economy will play into the hands of investors in bank shares

Founder and Publisher of the Switzer Report
Print This Post A A A

As investors, we’re always trying to cope with uncertainty. Most of you would’ve realised that I try to stick to consistent rules of investing that reduce the chances of being smashed by the stock market over the long run. It’s why I invest in quality companies, especially when the stock market goes panicky on me.

I’d love $1,000 for every time over the past 10 years I’ve recommended buying the dip on the stock market. I make this call because it’s a part of my consistent investment strategy. Now with so many companies unfairly smashed, if you have a longer-term take on a business, it’s stock-picking time.

In 2019, when so many great companies looked fully-priced, I was investing in the Index via ETFs.

S&P/ASX 200

That worked out pretty well until late February when the world was told the “China virus” (as Donald Trump likes to call it) was declared a pandemic by WHO, which until then was playing down the threat. How do I know that? Well, I was writing it and was curious why the stock market was not more rattled than it was in early February.

There’s no use crying about spilt milk so it’s onwards and upwards. That’s been the case for the S&P/ASX 200 Index since the low for stocks on March 23, though our bounce-back has been disappointing compared to the US. We’ve comeback 13.5%, while the Yanks have regained 32%!

A big part of that rise is because the US market has the FAANG stocks — Facebook, Apple, Amazon, Netflix and Google (Alphabet) — which are huge companies in the US indexes. And most of their share prices are at 2020 highs! Meanwhile, banks are huge in our indexes and we know they’ve been smashed by the Coronavirus closures and Government-powered rescue plan.

When the economy recovers, so will bank share prices and the local Index will start playing catchup on the S&P 500 in the States.

What’s my best guess on the economy? And because of the non-economic curve balls of the virus and its potential to bring a second wave of health and wealth problems connected to future economic closures and lockdowns, this is the toughest forecasting challenge of my life.

Knowing my limitations, I’ve developed the competitive advantage of knowing which economist’s work is reliable, so I’ll use the consensus of their views, along with my own set of dependable indicators to do OK in guessing our future.

In 29 years, I only used the R-word (and even then it was tentative) during the GFC. Now I know I get accused of being a perma-bull but I’m sure we’re in a recession now. Though there have been some economists who think statistically we could miss out on a technical recession.

That would happen if the March quarter, which was heading towards positive growth, was only just positive because the month of March wasn’t bad enough to take us negative for the quarter.

Of course, the June quarter will be a big, bad negative for growth but the JobKeeper policy, which was aimed at reducing the severity of the economic collapse, would’ve softened the drop. That said, it still should be a shocker.

Then we come to the September quarter made up of July, when most of us will be back at work, even if a lot of us spend more time working at home. More normalcy should be achieved in August and ditto for September. This could be a marginally positive month for growth.

On this scenario we might only see negative growth in the June quarter and therefore no technical recession. But the June quarter is a recession in reality, even if it can’t pass the economist’s definition of one.

Of course, this is the best-case scenario and we could actually see negative growth in the March, June and September quarters because we don’t rebound our spending when things progressively get back to normal. Confidence will be critical and what we do with it is even more important.

The one economic reading I’ve been watching and taking seriously, as a possible guide for the future, has been the ANZ/Roy Morgan weekly consumer confidence reading. This has to tell us something about how the lockdown, the social restrictions and the virus updating is affecting our willingness to be as normal as we were before anyone uttered that damn word — Coronavirus.

On the latest reading (last week), the ANZ-Roy Morgan consumer confidence rating rose by 2.2% to 92.3 points. That means that sentiment has lifted for seven straight weeks and is up 41.4% since hitting record lows. On March 29, after the stock market hit its low, the index went to 65.3, which was the worst reading since 1973, when Gough Whitlam was PM.

What made us more scared in 1973? That was the year the oil crisis began in October “when the members of the Organization of Arab Petroleum Exporting Countries proclaimed an oil embargo. By the end of the embargo in March 1974, the price of oil had risen nearly 400%, from US$3 per barrel to nearly $12 globally; US prices were significantly higher.” (Wikipedia)

The chart below shows the slump and rebound in consumer confidence. Note how it was around 109 in mid-February, which was a three-month high, so being 92.3 points is heartening. My best guess is that if the reopening of the economy works out, then the weekly confidence reading will beat the 100 level, where optimists outnumber pessimists.

I loved this heading from CommSec’s Craig James, who has been a good predictor of the economy over time: “Green shoots of recovery?”

But we need more positive numbers before we say the worst is over for the economy and the stock market.

Remember, if we get economy calls wrong (it would likely be linked to a virus-problem), then we’ll see a second leg down for stocks. And this would mean chaos for the economy and a short-sharp recession that becomes a V-shaped recovery would be totally ruled out.

We could end up with a 12-month recession, which some economists call a depression. And the second leg down for stocks could be worse than the first! That has been the pattern for stock market crashes, with the second drop being the worst.

OK, that’s the worst-case scenario. Right now, the stock market, which is a forward-predicting machine, believes second-wave problems will be small or manageable. It expects businesses and consumers will gradually return to normal, albeit with a slowness in believing the worst is over. That’s why we haven’t seen the market approach pre-COVID-19 levels, though you have to ask what the Americans are smoking? Have a look at the S&P 500 rebound below.

The key US Index is now down 14.5%, so the overall market is out of bear market territory. But it has still had a serious correction. There’s also a fair bit of positive expectations about a virus vaccine or treatment to be a positive game-changer for the world, the crushed economies and the ‘infected’ businesses, consumers and investors who’ll determine our material future.

When they’re optimistic, normalcy will return with a vengeance. But if a second-wave problem emerges, then I just don’t want to contemplate the alternative.

The best recent drug news came from the USA’s top Coronavirus medico, Anthony Fauci, who said over the weekend: “I think it is conceivable, if we don’t run into things that are, as they say, unanticipated setbacks, that we could have a vaccine that we could be beginning to deploy at the end of this calendar year, December 2020, or into January, 2021.”

That’s the best virus news recently. But what about the best economic scenario?

A few weeks ago, I referred to Morgan’s chief economist, Michael Knox, who I rate very highly. Michael has analysed the work of the Congressional Budget Office (CBO), who has access to some of the brightest economic forecasters in the world.

Knoxy, some years ago, created a shortlist of America’s best economists. One of those, Kevin Hassett, who chaired the Council of Economic Advisers in the US and is now the Senior economic adviser to the White House, recently said he puts more credibility on the forecasts of the CBO than any other predictor.

This meant that Knoxy had to delve into what the CBO had to say. And the June quarter news is shocking, as the following shows:

  • Economic growth down 12% in the June quarter. This would annualise to a huge 40%!
  • Unemployment tops out at 14%.
  • By year’s end, the US federal budget deficit will be US$3.7 trillion!
  • By year’s end, US federal debt hits 101% of GDP!

But it’s not all bad news.

“The CBO believes that after a terrible second quarter, rapid recovery will begin in the US economy in the third quarter. Unemployment peaks in the third quarter and then begins to decline.”

Knox has suggested before if a quicker-than-expected recovery emerges, then all of the world’s government stimuli and unbelievably low interest rates could set us up for a Roaring 20s remake in the 21st century!

If that works out, then you can rule out another big second leg down for stocks. And investing in banks now for a pay-off over the next decade looks like a good play.

And by the way, Knoxy isn’t the only economist who thinks the three months to September will be a rebound quarter. As I pointed out on Saturday, Scott Wren, senior global market strategist for Wells Fargo Investment Institute, told CNBC this week that his team is factoring in an “out of recession” scenario for the US sometime in June.

He says we have a three-to-six week wait and virus news has to keep on improving. The reopening phase for the US and worldwide has to add to positivity.

Wren said “halfway through a recession, you start to see financials doing better, small caps doing better…” And that’s what Wall Street is starting to see.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

Also from this edition