(June 12): Stock markets around the world have rallied hard from the lows in March, at the height of the Covid-19 pandemic-driven selloff. Since then, the Dow Jones Industrial Average and Standard & Poor’s 500 index have surged 45.5% and 48.2% respectively, and are now hovering just 8.7% and 6% below their all-time-high levels. Last week, tech stocks led the Nasdaq Composite to consecutive record highs.
Key bellwether indices in regional markets, including Singapore, Malaysia, Hong Kong, Japan, South Korea and Taiwan, have also rebounded, by between 18% and 52%, from their year-lows.
Certainly, the strength and durability of this rally have taken many by surprise.
Stocks have continued to rise despite dismal economic data and corporate earnings, political worries and street protests in the US, renewed US-China trade war tensions as well as pandemic uncertainties.
Where do we go from here? Can stocks continue to defy gravity?
Let’s start with a brief recap of the factors driving the current recovery rally from what has turned out to be the shortest bear market in history.
The quick actions of central banks and governments must be credited for backstopping the global economy from what could have been a devastating impact resulting from the Covid-19 pandemic. The injection of massive liquidity prevented financial systems from seizing and stimulus cheques helped tide over businesses and households.
Assured that the bottom is not falling out, investors grew confident in looking beyond the immediate aftermath, to the reopening of economies. And anecdotal evidence — such as Google’s mobility reports, which we highlighted last week — point to a quick rebound in activities.
Factories are resuming operations, workers are returning to offices and consumers — after being holed up for weeks — are raring to go out, releasing some pent-up demand fuelled by stimulus cheques and unemployment benefits.
The stream of positive news flow on vaccine and treatment developments further added to optimism that things would normalise sooner rather than later.
While the majority of professional asset managers and analysts are still sounding a cautious tone, retail investors are embracing this rally with both arms.
Brokers have reported sharp spikes in new account openings and trading activities. For example, trading volume on Bursa Malaysia jumped to a fresh all-time high on May 18, topping 11.3 billion shares, while the average daily traded volume last month was 2.8 times that in 2019.
The sudden jump in retail trading activities is underpinned, at least in part, by lockdown and restrictive movement measures — that left millions of people at home with time on their hands and few avenues for entertainment. Almost all live sports events around the world have been halted and there is only so much streaming media one can watch. Stock trading, on the other hand, offers excitement and — in the absence of sports betting, lotto and casino visits — a good substitute for those addicted to the adrenaline rush one usually gets from gambling.
Trading has been made simple and convenient, and commissions are low to zero for many online mobile trading platforms/ apps — a particularly appealing combination for the tech-savvy younger generation. For many of these millennials, stock trading is merely another form of competitive gaming.
And money has never been cheaper. With deposit rates falling precipitously, keeping money in the bank generates paltry returns By contrast, many would have already made much more in this rally.
Is this level of retail interest sustainable?
Interest rates are expected to stay low for a long while. Much of the prevailing investor confidence is based on the belief that central banks will continue to support financial assets by injecting unprecedented amounts of liquidity and creating the wealth effect to offset any income losses and keep consumer spending afloat. Indeed, the US Federal Reserve has pledged as much in its latest statement.
On the other hand, with economies reopening, people are going back to work — instead of sitting at home playing the stock market.
Gambling is going back to the way it was. Casinos are reopening their doors, number forecasts and lotto games are restarting and the world of sports is slowly coming back to life, and with it, sports betting.
Football matches in the Bundesliga resumed in mid-May while the La Liga and widely popular English Premier League are slated to restart on June 11 and 17, respectively. Serie A is scheduled to resume on June 20. Meanwhile, the PGA Tour is set to return in mid-June and the NBA is targeting an end-July start date. While Wimbledon has been cancelled, the French Open (one of the four annual Grand Slam events) has been rescheduled to September.
Hence, it is probable that some of the exuberance driven by retail investors will soon taper off. That should result in stock prices that are more reflective of economic fundamentals, maybe.
There has been no shortage of narratives predicting the path of the global economic recovery — a veritable alphabet soup of possibilities: V-shaped, W-shaped, U-shaped and L-shaped.
We think the recovery will be V-shaped but not all the way. This is also, incidentally, very similar to projections made by the US Congressional Budget Office (see chart).
Unlike past recessions, the recovery in activities this time should be quick and steep because the shutdown — the sudden brake to almost all economic activities — is engineered through mandatory lockdown measures, and not due to lack of demand. Thus, when these restrictions are lifted, businesses will reopen and suppressed demand/consumption will rebound — hence, the V-shape. The latest US labour market report showed a net addition of 2.5 million jobs in May, contrary to market expectations of more losses. This is in fact consistent with our expectations of a quick rebound in economic activities, and furloughed workers returning to their jobs.
However, we do not think the level of economic activities will immediately recover all the way back to where it was. The worst may be over but sectors will recover at different paces, some faster while others will stay weak for longer.
For example, the worst-hit travel- and tourism-related sectors — airlines, cruise operators, hotels, segments of retail, restaurants and entertainment — would experience an extended period of weakness.
Without an effective vaccine, the majority of people are likely to continue to social distance and avoid crowded spaces.
The job gains in May are the low-hanging fruits — these are the minimal required workers returning to their jobs to restart businesses.
Unemployment in the US fell to 13.3% in May, down from 14.7% in April. Nevertheless, this is equivalent to about 20 million fewer jobs compared with that in February, before the pandemic. To put the number into perspective, the US economy created a total of 22.4 million jobs in the entire decade since November 2009, after the Great Recession.
We think the recovery of jobs will continue — but it will be harder and harder to lower the numbers going forward. Some of the jobs lost may be permanent.
A second wave of lay-offs is now unfolding. Over the past few weeks alone, large companies, including The Boeing Co, Chevron, IBM, Virgin Atlantic, United Airlines, Rolls-Royce Holding and BP as well as technology companies such as Uber Technologies, Lyft, TripAdvisor and Airbnb, have all announced lay-offs.
Closer to home, lay-offs, including through early retirement and voluntary separation, are similarly expected to rise. According to the Department of Statistics Malaysia, unemployment could go as high as 5.5% this year.
We expect a wave of bankruptcies — and resulting debt defaults — over the coming months, especially from the small and medium enterprises ranks, which are also the single biggest employer in most economies.
This bankruptcy–unemployment–consumption–negative feedback loop will play out for a while, even as investments gradually normalise and new jobs are created over the next few years.
We believe full recovery will take at least one year — more likely two to three years — which is in itself an accelerated speed driven by massive government stimulus.
Case in point: Singapore unveiled a fourth stimulus package worth $33 billion, bringing total stimulus spending to $92.9 billion. Malaysia too has announced another RM35 billion ($11.4 billion) in fiscal spending to aid the country’s recovery from the pandemic. One of the key focus areas for both countries is expanding wage subsidy programmes, incentives for new job creation as well as retraining and upskilling for youth and the unemployed.
Even Germany, the previous poster child for fiscal restraint, is now planning to spend an additional €130 billion ($205.26 billion) in fiscal stimulus, designed to kick-start its economy. Its proposal includes cash handouts and a 3% cut to value-added tax.
Meanwhile, US lawmakers are discussing the next spending bill, on the heels of the US$2 trillion ($2.77 trillion) CARES Act.
In summary, the market is correct — in looking forward and anticipating the economic recovery. However, it is looking increasingly like prices have run too far ahead of the underlying economic fundamentals.
More recently, investors have been piling into cyclical stocks, such as housing and banks, which typically do well in a robust economy. We think there is still a long way to go before we reach this stage.
Market momentum tends to overshoot, on both upside and downside. After the massive rally, stocks are now more susceptible to renewed volatility and correction — if reality does not meet the prevailing lofty expectations on both the pandemic (new cases could rise as activities resume) and economic recovery fronts.
We are keeping the Global Portfolio fully invested, but shifting to a more defensive stance. We disposed of our entire holdings in homebuilder Lennar and acquired, in its place, biotech company Vertex Pharmaceuticals.
The Global Portfolio gained 3.1% for the week ended June 11, boosting total portfolio returns to 18.7% since inception. The portfolio is outperforming the benchmark MSCI World Net Return Index, which is up 13% over the same period.
The Boeing Co was the top gainer for the second straight week, surging 17.5%, despite some late profit-taking. Tech companies as a whole chalked up strong gains. The big gainers include Apple (+8.5%), Qualcomm (+8.2%) and Microsoft (+6.2%).
Shares in Adobe and ServiceNow hit fresh all-time highs. On the other hand, BMC Stock Holdings, Johnson & Johnson and Starbucks ended the week in the red.
