Are stock markets too optimistic about the economic recovery?
The first half of 2020 was quite a turbulent ride. The Covid-19 pandemic has slammed the global economy like a bulldozer, with the past six months having been the wildest we have ever seen. Here are some numbers; more than 10 million confirmed Covid-19 cases worldwide, more than 500’000 deaths caused by the coronavirus. According to the World Bank the global economy will shrink by more than 5% in 2020. Economists forecast a 25-30% decline in global merchandise trade and a 30-35% reduction in foreign direct investment. This leads to a sharp decline in working hours globally. The International Labour Organisation warned that 1.6 billion workers are in immediate danger of losing their occupations. Moreover, the organisation said that worldwide, more than 436 million enterprises face high risks of serious disruption.
Central banks and governments reacted strongly on the above-mentioned facts. Our estimations show that over USD 5 trillion (USD 5’000 billions) have been spent since the outbreak of the virus by the G20 governments to counteract the impacts of the pandemic. Central banks are increasing their programmes to sustain the economy and their balance sheets are projected to grow on average by 15-20% of GDP before the end of 2020. As an example, the US nominal GDP was USD 21.5 trillion in 2019.
These massive interventions were the reason why the financial market is still at an acceptable level compared to the beginning of the virus outbreak when global stock markets fell between 25% and 30%. With the lower prices in March, the volatility spiked sharply and the S&P500 suffered from the greatest single-day percentage fall since the 1987 stock market crash. With the interventions of central banks and governments, the market was flooded with liquidity and this has led to a very positive second quarter for stock markets. The US American market gained almost 20% in the months March to June and the European markets also developed well. Consequently, stock prices have moved even further away from fundamentals. While the economy still needs some time to recover, stocks have already done so.
Now the question is whether the stock market is too euphoric about the economic recovery or is the economic data too negative and are we returning to the growth path faster than expected? We are of the firm opinion that the shares are too highly valued and the market too confident and therefore we have currently a defensive positioning in the portfolios. Our portfolios include a substantial cash position, high quality stocks and a gold allocation. A look at the Price-Earnings levels confirms our view. The expected P/E for the US market is around 25, while the long-time average is 18. At the same time, the P/E for the Eurostoxx50 Index is trading at 21, which is almost at all-time high levels. The Price Earnings Ratio is the relationship between a company’s stock price and its earnings. The P/E ratio shows the expectations of the market and is the price you must pay per unit of earnings.
In this uncertain market environment, we recommend investing in companies with high quality. To find these companies it is important to analyse three factors. The business model, the management and the financials. Stocks of solid companies deliver above-average returns, especially in very volatile market phases, as shown during the market turbulence at the beginning of the year.
Along with high quality stocks, we recommend to invest in megatrends. Investing in megatrends gives investors the opportunity to have a long-term allocation in exciting topics such as demographic change, urbanisation, climate change or cyber security. It is difficult to find individual stocks in these topics, which is why we recommend buying a broadly diversified fund. Many reputable ETFs or funds replicate these topics.
In conclusion, we expect the second half of the year to be difficult for investors. The Covid-19 crisis will leave its mark and the economy will take longer to get back to pre-crisis levels. Therefore, it is even more important to invest in a stable and high quality portfolio.
Luca Carrozzo, 10th July 2020