We’re still a long way from a return to normal times

The astonishing rebound on stockmarkets lacks logic.

Lines of unemployed outside Centrelink centres point to problems ahead for the economy, and markets. Picture: Sam Ruttyn

The shutdowns and deaths from the coronavirus pandemic will leave an indelible mark on several generations, but it seems only a temporary mark is being left on stockmarkets to date.

From the February 20 high of 7162 the ASX 200 is down about 23 per cent. Importantly however, it is up about 22 per cent from its March 23 lows. In the US, the rally is even more pronounced, having gained 31 per cent from its low point to now be just 13 per cent off its all-time highs.

To better understand whether the rally in share prices is justified, it may be worth examining what is different and similar to past ­experiences.

Many aspects of the corona­virus crisis are different to any of those we have seen before. This may explain why some of the world’s most lauded investors aren’t convinced that it’s time to jump back in.

Billionaire US hedge fund titan David Tepper recently observed “valuations on some individual stocks on the Nasdaq are nuts”, while US real estate pat­riarch Carl Icahn advised he is “hoarding cash, shorting commercial real estate and preparing for the coronavirus to wreak more havoc”.

Indeed, S&P 500 one-year forward aggregate earnings estimates have declined 20 per cent. However, the S&P 500’s rally from the lows has seen the price-to-earnings ratio expand from a low of 13.5 times earnings to nearly 21 times. The P/E multiple for the S&P 500 today is now higher than it was at the market peak in January.

In Australia a similarly ebullient picture can be painted. The P/E ratio for the ASX 300 peaked at 18.75 times in January. Today that ratio still sits at 18.1 times earnings despite the fact that one-year forward earnings estimates have decline almost 27 per cent from their peak in June last year.

The optimism across markets reflects expectations of a V-shaped income, earnings and economic recovery, and the fact that with interest rates likely to remain at zero for an indeterminate period, discount rates used for ­equity valuations will remain ­supportive.

However, the recovery could be anything but V-shaped and, with the US Federal Reserve ­offering rescue packages to otherwise bankrupt corporates, it is likely investors are betting on a zombie economy.

It is worth remembering that while global supply chains recently came to a halt in a synchronised fashion, the world’s economic recovery is dependent on each country’s response to the virus and these will not be synchronous.

In their book This Time is Different, economists and authors Carmen Reinhart and Kenneth Rogoff noted that if a recovery is measured as a return to pre-crisis per capita incomes, it took on average four years to recover, following each of the post-war crises prior to the GFC. After the Great Depression it took a decade. With elements of the depression in this crisis, something between four and 10 years might be reasonably assumed, even with government and central bank support.

Of course, not everyone holds the same definition of a recovery as Reinhart and Rogoff. Most investors define a recovery as a return to trend rates of growth. In reality, there will be some months where spectacular growth rates will be recorded off a devastated base level, but it is vital to keep in mind that such rises don’t imply per capita incomes will be restored to pre-COVID levels.

The market is currently being led by names with very little debt. The technology or growth companies with good earnings momentum and minimal debt are finding favour with investors, but the optimism can only last if those few companies leading the market higher can justify their valuations in the medium term.

On that front a lot depends on the extent to which workers return to actual jobs. In Australia, April unemployment rose modestly from 5.2 per cent to 6.2 per cent as most of those who lost their jobs weren’t actively looking for work. And without the participation rate plunging to its lowest level in 16 years, from 66 per cent to 63.5 per cent, the rate of unemployment would have been greater than 10 per cent. All employees who received the government’s JobKeeper wage subsidy were counted as employed even if they didn’t work any hours.

However, JobKeeper has a ­finite life and, as our longest server treasurer Peter Costello noted recently, it’s going to take some time to get unemployment back to 5 per cent.

So while markets have decided the crisis is over, I don’t agree. We will recover off very depressed levels of economic activity and incomes, but what we come back to will look very different.

We’re not returning to the levels of incomes that we enjoyed before the pandemic hit. And that has major implications for the prospects for many businesses and therefore their valuations. On that front this time is very different indeed.

Roger Montgomery is founder and chief investment officer of the Montgomery Fund.

www.montinvest.com