To describe recent market volatility as high is to understate the facts. Since the peak on February 19, the US market has registered the most rapid sell-off ever, its biggest three-day gain since the 1930s, the biggest one-day percentage gain since 1933 and the second ever largest one-day fall.
I received a call from a journalist mid-February asking me to comment on the ASX 200 breaching 7000 points. Just one month later I was asked to reflect on the index’s 28 per cent decline to below 5000 points.
There’s little doubt the panic would be worse than the pandemic. While it is indeed true that the pandemic is as bad as we thought it could be, prices have now also fallen considerably. Some of those stocks that were until now enjoying a period of profitless prosperity have fallen as much as 80 per cent.
When considering what happens next it is essential we reflect on prospects and value while remembering that we do so within an information vacuum with respect to the future. There are few, if any, precedents to guide us.
Ok, first the good news arguments
The bulls argue that while the news may indeed get worse before it gets better, the bad news will end relatively soon. The light at the end of the tunnel will emerge at any moment.
According to our COVID-19 data-tracking project much of Europe is now experiencing the slowing live Coronavirus case growth expected by the most bullish analysts. Countries including Switzerland, Germany, Italy and Austria are indeed tracking below five per cent daily case growth. And while the UK and the US are paying dearly for their tardiness, the early data is following a similar path to countries that began testing, identifying and isolating ahead of the US and the UK.
It does seem increasingly clear that the virus’s spread can be controlled with social isolation and lockdowns.
At the same time, central banks and governments have wasted no time throwing modern monetary theory at the problem. Helicopter money, cash injections, rate cuts, rent and mortgage deferrals, eviction bans and helicopter money, and even universal wages, have been implemented with scarcely a thought about the future and necessary unwinding.
But lockdowns and social isolation can only ‘flatten the curve.’ Investors might currently be enamoured with the idea that a flattening curve is a signpost for loading up again but a flattening curve is not tantamount to victory over the virus. The virus hasn’t vanished and the population isn’t immune. For that to happen new cases must cease and all existing cases must recover and be clear of the virus.
While the health crisis can be controlled, no ‘back-to-normal’ scenario can be contemplated yet. And the idea that herd immunity can be achieved by quarantining the vulnerable and allowing the remainder of the population to contract the virus, ignores the untold illness and death that would result as well as the crushing blow to health services.
A return to normal life in the short term is therefore not possible. A v-shaped recovery is a pipe-dream. At least not until a vaccine is developed. And if a vaccine is developed in the 12 or 18 months being proffered, it will be the fastest-developed vaccine in history.
Investors are currently betting that the crisis will all be over pretty quickly or that the trillions being thrown at the economy is enough to maintain a stable holding pattern ahead of a rapid return to normality.
How realistic is that assumption?
Put an economy into hibernation (for even a short time) and it can only wake with a serious hangover and a grogginess that will take time to shake off. The adage ‘hire slow and fire fast’ is worth noting at this point. Thousands have been ‘let go.’ Rehiring thousands takes a lot longer and that assumes the same businesses exist and are in a position to hire aggressively. That seems pretty unrealistic and optimistic.
I am also concerned about the government’s recently announced changes to corporate insolvency laws. Those changes effectively suspend a creditor’s rights, and creditors include employees. Companies previously had 21 days to respond to a creditor’s statutory demand for payment. Those creditors must now wait 180 days. And even director’s liabilities for insolvent trading have been suspended for six months. Has the government effectively legislated a company’s right to steal from its creditors? ASIC won’t be able to cope with the number of claims for dishonest and egregious fraud. I suspect in their rush to save the economy, the government has created a legislative game of Twister that will take decades to unwind.
The market’s rally this week has all the hallmarks of the bear market rallies that pepper every correction.
Looking at the US data, the headlines are going to get worse
Hearing governors describe lockdowns as ‘un-American’ or ‘illegal’ smacks of a country suffering from an auto-immune response. A country fighting itself. The land of the free is populated by individuals unwilling to make the sacrifices necessary to save the whole. The body cannot survive without the brain. The US is dysfunctional.
Meanwhile US investors haven’t realised that even if the country agrees to lockdowns, it doesn’t stop the virus. And while they work it out, millions will lose their jobs and thousands of businesses will close. And that’s before we consider the record indebtedness of US corporates who have borrowed to pay dividends and buy back stock. Those same business that bought back their stock at the highs, will be soon announcing capital raisings at the lows. The destruction of equity for existing investors will be tantamount to a permanent loss of capital. While it’s a little late for many investors now, it really is worth paying attention to the tenets of value investing after all.
The US economy will contract at a pace that will rival the 10 per cent slump in the first quarter of 1958. A recession is inevitable. And remember the US economy in 2019 was already growing at below two percent.
The recent market rally appears to assume lockdowns end in a few weeks or maybe a month, low interest rates and oil prices fuel a rapid return to economic and earnings growth.
Perhaps that would be true if people were only worried about the economy. This time they are worried about their health and safety.
Will people return to normal patterns of behaviour even if their governments tell them it is safe to do so? Perhaps they do. But even then, what will be left to return to? A V-shaped recovery is a long shot. I’d rather bet on the possibility the negative implications stay with us for some time. A U-shaped recovery is more likely and that means the market is still vulnerable, especially after this week’s rally.