Second wave fears spark share wipeout

“Economic progress must back up the stockmarket surge, or severe pullbacks are inevitable.”

Australian shares, the dollar and bond yields hit fresh two-week lows on Monday after a second wave of coronavirus infections emerged in Beijing and Tokyo, and more US states reported a worsening case load.

Investors wiped $39bn off the local bourse, with the benchmark S&P/ASX 200 index diving 128 points, or 2.2 per cent, to close at a two-week low of 5719.8 amid sharp falls in the Asia-Pacific region.

Japan’s Nikkei 225 dropped 3.5 per cent and South Korea’s KOSPI plunged 4.8 per cent, while the Hang Seng index declined 2.2 per cent and China’s Shanghai Composite slipped 1 per cent.

S&P 500 futures fell as much as 3.2 per cent, pointing to another rough night on Wall Street.

European markets traded nervously with the Euro-Stoxx 50 index down 3.2 per cent in early trading.

After bouncing 41pc in three months in the fastest-ever bull market in Australian and US shares, the S&P/ASX 200 has now lost 7.1 per cent in its worst three days in the past three months. The falls follow a weak outlook from the US Federal Reserve and signs that the coronavirus pandemic isn’t under control.

“It still feels like there is still too much good news in the price in the face of a secondary outbreak,” OANDA global chief market strategist Stephen Innes said.

China reported 57 new infections — the most since mid-April, with 36 cases in Beijing — while Tokyo disclosed 47 new cases on Sunday, the most since May 5, and 22 US states reported higher cases.

“What appeared to be little more than a flesh wound last week could yet prove to be a mortal one by week’s end if the COVID-19 curve in the US does not revert,” Mr Innes said.

Meanwhile, the Australian dollar fell 1.3 per cent to US67.66c, West Texas crude oil futures fell 5.3 per cent to $US34.12 a barrel and London Metal Exchange copper futures fell 2 per cent to $US2.5430 a pound as investors shifted out of risk assets more broadly.

Among safe havens, Australia’s 10-year bond yield fell 5 basis points to 0.86 per cent, a two-week low, spot gold fell 0.7 per cent to $US1715.62 an ounce and the US dollar index was little changed.

Bell Potter head of institutional sales and trading Richard Coppleson said the current sell-off was “really important for the bears and those long cash” because it came after the index unexpectedly rose 41 per cent in the past three months.

“For now, buyers will continue to sit on the sidelines … so a drift lower is likely for most of the week,” he said.

“Second-wave talk will get plenty of airtime and volatility will see wild moves until there is ­clarity.

“The biggest risk for the bears is that this turns out to be just an 8 to 10 per cent correction, then stops. If that happens then those who are desperately for it to come back — so they can buy the dips — will move quickly and aggressively, but only once they perceive the fall has run its course.”

But for now, the sell-off could “easily accelerate as ‘hot money’ flows out of shares”, Mr Coppleson added.

The reality check in shares came after Australian market hit a record 12-month forward price-to-earnings valuation near 20 times and a record-low dividend yield near 3.3 per cent. Meanwhile, the US market hit its highest valuation since the early 2000s tech bubble at about 22 times.

Despite an unprecedented wave of fiscal and monetary policy stimulus — including unlimited asset purchases from the Fed — investors should not overlook weak economic trends, a lack of confidence, and the risk of permanent job losses, Citi head of US equity strategy Tobias Levkovich said.

Mr Levkovich noted that the S&P 500 Index was more closely correlated to forward earnings expectations and coincident income levels than the expanding money supply created by central banks.

In his view, this means that the “increased monetary supply must turn into profitability”.

That was particularly so now, he argued, since the value of the S&P 500 relative to the value of global sales by S&P 500 companies in the last 12 months hit a record high last week, and “the Street is anticipating a powerful move in earnings per share beyond 2021 estimates”.

“Economic progress must back up the stockmarket surge, or severe pullbacks are inevitable.”

While a record high S&P 500 value relative to sales could be appropriate if profitability were rising, the sales relationship is “quite stretched”, and Citi’s lead margin indicator is “not arguing for a major bounce-back” in profitability, Mr Mr Levkovich said, while commercial and industrial loan lending standards were tightening. US small business optimism remained weak and while small firms had access to capital thanks to the Fed, they were now reporting a poor sales outlook and weak capital expenditure and hiring plans.

Mr Levkovich said it was “challenging to come away with a sense that all is good and healthy out there … indeed, continuing jobless claims still show scary statistics versus past recessions”.

“We can understand why the investment community might pay more than 18 times the earnings per share estimate for 2021 given low interest rates and a feeling of no alternatives, but we do not think that the Fed has everyone’s back, as 10-15 per cent corrections are perfectly normal events and Mr Powell (the Fed chair) is probably quite happy with reversing a 35 per cent plunge, which would have had terrible economic feedback loops,” he said.

“Given that the number of stocks off 20 per cent or more from 52-week highs has come down substantively and high-yield credit spreads have narrowed substantially, we doubt that he is focused on insuring wealth effects for investors on a daily basis.”