Markets continue to defy gravity
As US and NZ share markets test new highs the data from around the world keeps getting worse. Later in this month’s discussion we will make a case for why share values may not be as overpriced as we all believe, but first let’s review the worsening news.
US Covid cases on the rise again
As President Trump continues to understate the rising risks of Covid infections in the US and States continue to attempt reopening to get some semblance of growth back in the economy, the daily new cases in the US continue to rise.
Doctor Anthony Fauci met with Congress in late-June to confirm that he was seeing a “disturbing surge” in infections in some parts of the country as some Americans ignored social distancing rules and States reopened without adequate plans for testing and tracing contacts. The 7-day moving average daily new cases for the US has continued to push higher into the end of June. This is not a second wave for the US but a continuation of the first wave.
7-day moving average of new daily Covid cases on the rise in US
Source: European CDC – Situation Update Worldwide – as at 24th June
This recent spike in US cases has already led to New York, New Jersey and Connecticut imposing a 14-day self-quarantine requirement on any interstate travellers from eight US states with the highest infection rates. These are Alabama, Arizona, Florida, North Carolina, South Caroline, Utah and Texas. At the time of writing this the 14-day quarantine period was voluntary.
In May 2020 the US monthly unemployment rate surprised everyone by dropping from 14.7% to 13.3% as they started to reopen and try to return to some sort of normalcy post the Covid-19 lockdowns. As shown below the last time unemployment was this high was the 1930’s global depression.
US unemployment rate 1929 – today
Source: National Bureau of Economic Research, FRED
Closer to home
Australia has been hailed as a global success story regarding their management of Covid infections with 7684 cases and 104 deaths as at the end of June. After it appeared Victoria had its daily cases under control in April, we are now also seeing what appears to be the early signs of a second wave of infections, with its 7-day average of new daily cases increasing.
This has again led to a wave of panic-buying as residents in Victoria stock up on essentials with “elevated demand” for the most valuable of all resources, toilet paper. The increase in daily cases has led to Victoria extending its lock down restriction and mobilising 1,000 army personnel to assist in testing. We hope that they can get the numbers down and wish our Anzac cousins all the best.
Australian states – total cumulative cases
Source: Coolabah Capital Investments June 29th 2020
International Monetary Fund (IMF) lowers global growth forecasts
The impact of Covid-19 lockdowns and slowdowns is being felt by the entire world. As at the middle of June over 92% of all the countries in the world were in recession.
Economic GDP forecasts around the globe are regularly being downgraded. At the end of June, the International Monetary Fund (IMF) revised down their forecasts again with the global decline in GDP now forecast to be -4.9% for 2020. This is down from an April forecast of -3% and a January 2020 forecast of +4.0%.
IMF global GDP growth forecasts
Source: IMF, ANZ Research
We have also seen all IMF individual country forecasts downgraded with the largest change being India which in April 2020 was forecast to grow by 2% in 2020. Due to rapidly rising infection rates in India the June forecast is now for a -5% reduction in GDP in India in 2020.
Governments and Central Banks around the world are attempting to flood the market with cheap money, increased welfare and lower interest rates to support their economies through the worst of the global slowdown.
The chart below shows that the total forecast level of support (monetary and fiscal stimulus) as at the middle of June 2020 is many times larger than what was utilised during the 2008 Global Financial Crisis.
Global Stimulus – 2008 Global Financial Crisis versus 2020 Covid-19 crisis
Share markets seem to be pricing in a different world
As at late June the S&P500 was around 0.9% away from the previous February 2020 high. The NZX50 was also pushing close to its February high trading at 7.66% below this level. How can share markets and economies be so out of alignment? There are many reasons being floated to justify these valuations. Some of these are:
The amount of stimulus will accelerate and fund economies through the dip in growth
As discussed above Governments and Central Banks are supporting the economies with record levels of stimulus. Investors are may be relying on this to continue and not only support but accelerate any recovery from the damage caused by global Covid lockdowns.
Some Central Banks are clearly signalling they are willing to increase their support as required. Indeed, several market commentators and economists are expecting the NZ Reserve Bank to increase their Large-Scale Asset Purchase program (LSAP) from $60 billion to $90 billion in the coming months.
Retail investors are supporting current valuations
As shown below, we have seen a marked increase in smaller traders (retail investors) purchasing shares, with very low levels of retail “shorts”.
Retail traders – marked increase in contracts
Source: OCC, WSJ Daily Shot
The decline in corporate profits will be short term so investors can look past the 2020 dip and focus pricing on the 2021 earnings rebound.
As expected, earnings forecasts have continued to be downgraded. The table below shows Yardeni Research Institutes (YRI) forecasts for the S&P500. They are forecasting a 25% drop-in earnings per share for the S&P500, from a pre-Covid forecast of US$160 per share to a new 2020 forecast of US$120 per share.
Like most analyst forecasts, earnings are then predicted to increase back to a new high per share of US$175 per share in 2022. YRI’s forecasts are one of the more pessimistic.
YRI S&P500 earnings per share forecast
Source: Refinitiv, Yardeni Research, WSJ Daily Shot
The discount rate on future earnings has reduced
A more technical reason for share market valuations can be found in a review of one method of valuing shares know as a discounted cash flow method. When calculating future earnings, the forecaster must discount future forecast earnings by the current market interest rate to reflect the “cost” of not getting those earnings until a future date.
When the discount rate (interest rate) is higher future earnings of a company are discounted by a larger percentage, hence less attractive in today’s dollars. When the interest rate drops to just above 0% however the future earnings see hardly any discount and hence are more attractive, justifying a higher share price.
The discussions above are only a few of the reasons currently being mooted as possible reasons for record high valuations on shares in the US and NZ. They are all viable potential reasons and may in hindsight prove to be correct.
The reality though is that when share markets are trading at record high valuations it is a time to be cautious. There is no time in history where share markets have reached record high valuations and then stayed there, but as the bulls are saying maybe “this time it’s different”.
A famous investor by the name of Sir John Templeton said, “The four most dangerous words in investing are “this time it’s different”. It was said in 1987 before “Black Monday”, in 2000 before the “Tech Wreck”, in 2008 before the “Global Financial Crisis” (GFC) and it is being said again today in discussions around 2020 share valuations.
So why not move to 100% cash? Firstly, this global slowdown is not like the GFC in that there are many sectors that benefit from the current environment such as healthcare stocks, tech stocks, and some consumer staple stocks. Also, no one knows if these valuations are suitable through the Covid-19 driven recession, but what we do know is that share market price bubbles like the one we are arguably seeing right now can go higher and last longer than anyone can forecast.
New Zealand out of lock down
Given New Zealand has come out of lock-down earlier than most of the world, the impact to economic growth, has been less negative than we are seeing in other economies.
Recently Standard and Poor’s stated that New Zealand was one of a small number of countries that had well-targeted stimulus plans, and good management of the pandemic. Other countries were China, Korea, Taiwan, Australia, Japan and Singapore.
Obviously, sectors such as tourism are going to be suffer more meaningful long-term damage, but the most recent forecasts are promising. S&P forecasts that NZ’s Gross Domestic Product (GDP) will decline 5% in 2020 before rebounding back 6% in 2021. S&P also forecast unemployment will peak at 5.8% this year which is much lower than the c.10% forecast by most local economists.
The chart below shows different approaches by country. Interestingly, this shows that New Zealand had one of the most stringent lock downs initially but has also now moved to the most relaxed level. This adds credence to the Prime Ministers catch phrase of “Go Hard & Go Early”.
Oxford Covid-19 government response stringency index
Source: Oxford Bloomberg, ANZ Research
New Zealand’s move out of lock-down and back to a more normal “open for business” environment has made headlines all over the world. It is possible that this in turn has made our share market an attractive place for global investors.
According to research from Forsyth Barr we have seen a large increase in foreign ownership in the NZX for the quarter ending March 2020, with foreign ownership now at a record high of 59%. A large percentage of the increase came from Australian investors who now own 16.7% of the NZX50. At an individual share level Kathmandu (KTM) and A2 Milk are respectively 52.2% & 50.4% owned by Australian investors.
NZX50 Foreign ownership – quarter ending March 2020
Source: Forsyth Barr analysis, Rifinitiv, Stats NZ
Given the support to borrowers with banks offering mortgage holidays, the government wage subsidies and the central bank pushing interest rates to record low levels it is still unclear how New Zealand’s economy and property markets will be impacted. However, we can be certain that the NZ economy will suffer a slowdown.
Westpac & ANZ economists are forecasting that NZ property prices will decline by around 7% & 12% respectively by the end of 2020, before recovering back to post-Covid levels by mid-2022. If this occurs, then this will be one of the quickest recoveries in modern times.
With the RBNZ pushing local interest rates lower and releasing the brakes on the number of high loan-to-value ratio (LVR) loans the NZ banks can write, the property sector will get support through this economic slowdown.
ANZ NZ property forecast
Source: REINA, Statistics NZ, ANZ Research
Westpac NZ property forecast
Source: Westpac Economics
NZ Government Debt to GDP
The NZ Government Debt to Gross Domestic Product (GDP) is forecast to rise from a globally low level of 20% to a still globally low level of 50% over the next four-years as the government attempts to provide the stimulus to support New Zealand through the coming recession.
The RBNZ has recently increased its forecasted level of Large-Scale Asset Purchase (LSAP) programme to NZ$60 billion with some commentators forecasting this will increase to $90 billion. The RBNZ purchases may see them owning more than 50% of all NZ government debt within the coming year.
Finishing on a brighter note, given New Zealand was able to get our Covid infections under control faster than anticipated ANZ has recently upgraded their forecast for NZ’s GDP decline and following recovery as shown below.
ANZ GDP forecasts
Source: ANZ Research, Statistics NZ
NZ Government Debt to GDP forecast
Source: Westpac Economics
We are currently living through a period that will make the history books. The disruption caused by the Covid-19 virus and global lock-down is unprecedented, as are the Government and Central Banks responses to this crisis.
We are now also seeing interest rates on government bonds that beggar belief. As an example, the Austrian government issued a 100-year bond in late June, which was offering investors only 0.88% gross p.a. Given the incredibly long duration of this bond if long term interest rates were to rise by only 1% this would mean the bond price would decline by 68%!
Given the very low yield on this bond and the high level of risk of capital loss we could sensibly expect there to be little interest from investors. Apparently, we don’t live in a world that thinks like that anymore as the bond was oversubscribed by a multiple of 10 times the sum Austria was raising.
Looking at the share markets on a traditional forward price to earnings measure prices now appear to be trading at expensive levels. Is this still the right measure for share valuations in a world where interest rates are now at historically low or negative levels?
The markets appear to be trading on short-term good news such as stimulus announcements or stories about a vaccine for Covid and ignoring the impact of the global recession.
We continue to monitor financial markets and remain cautious in general. The amount of negative economic data expected in the coming months could potentially see renewed volatility – however central banks have shown a willingness not to just sit on the side-lines if such volatility becomes extreme.