Officially we are in a bull market again as there has been a 20% gain from the March lows. You could be forgiven for thinking the worst of COVID-19 is over, at least in regards to the sharemarket.
However I don’t think this is a prudent position to take.
History tells us that the recent rally should not be viewed with optimism.
The below chart, from my GFC-era communications to clients, captures the peak in November 2007 to the trough in March 2009 (ignore the horizontal lines).
I have highlighted three examples of when there was a recovery.
Period 1 – 5,250 to 6,000 = 14% in 1 week
Period 2 – 5,200 to 6,000 = 15% in 8 weeks
Period 3 – 3,750 to 4,300 = 14% in 2 weeks
(please note that above figures are approximations based on the chart)
Below is the US chart for the Great Depression.
Period 1 – 198 to 293 = 47% in 20 weeks
Period 2 – 211 to 245 = 16% in 10 weeks
Period 3 – 157 to 194 = 23% in 8 weeks
And lastly, our current market:
Period 1 – 4,564 to 5,530 = 21% in 4 weeks
By posting these charts, I do not claim that the COVID-19 crash should be likened to the GFC or the Great Depression, however I find it almost hard to believe that the share market low has been reached, and consider it more likely that we will lose the recent gains and the markets will travel even lower. The GFC and Great Depression had waves of downwards movements, and I believe a ‘V shaped recovery’ for the “Great Lockdown” seems illogical when you consider the following:
- Early Super withdrawals – Australians (who are either unemployed, made redundant, eligible for some government payments or have had their working hours reduced by 20% or more) will soon be able to withdraw $10,000 from their super, and another $10,000 next financial year. The Federal government forecast 1.5 million people will apply, and $27 billion will be withdrawn. Others, including myself, believe over $40 billion will be withdrawn. A significant portion of these funds would currently be invested in the sharemarket, and will necessitate sell-downs from super funds in order to funds the withdrawals. This will place downwards pressure on share prices.
- Lack of inflow – Compounding the above point is the fact that inflows to super funds would have reduced dramatically. The unemployed do not receive Superannuation Guarantee payments, and the self-employed would likely not be diverting precious cash into super in order to benefit from a tax deduction.
- GDP – Between 1929 and 1932, worldwide gross domestic product (GDP) is estimated to have fallen 15%. During the GFC worldwide GDP fell by less than 1%. The IMF is predicting a 3% GDP fall during the Great Lockdown. China released their GDP at negative 6.8%; economists had predicted somewhere between 6.5% and 16%. The UK’s Office for Budget Responsibility (OBR) warn of a potential 35% fall in the UK’s GDP.
- Unemployment – We have an idle workforce and an idle economy. Especially in the Eastern States where the lockdown laws are more harsh. People who were producing, are now receiving. During the Great Depression, US unemployment hit 23%. It is now suggested it could hit 15%.
- Immigration – Successive Australian governments have relied on immigration to provide the illusion of a growing, healthy economy. It is predicted that “300,000 people could leave the country to return home by the end of the year, which economists warn could further erode consumer demand and cause a slump in the rental and housing markets.” And that “we could be on the verge of the biggest percentage and absolute decline in our population since 1788”. It is unimaginable that immigrants, visa holders and/or tourists will be able to come to Australia any time soon.
- Government – The spending is simply unprecedented. The ramifications will last for generations. In addition, I remain concerned that worrying levels of inflation is a risk due to the lack of production, and the massive “printing” of money. Despite these government hand-outs, if Amazon and ebay are the only places to spend the money, one wonders how Keynes’s theory of fiscal stimulus is meant to work. There will be no “snapback” as Morrison and Frydenberg claim.
- No end in sight – A vaccine, if there is to be one, could still be 12 to 18 months away. Even if COVID-19 disappeared overnight, it is fanciful to imagine the economy will simply bounce back as if nothing happened. The sharemarket is probably where it should be if there was no COVID-19; I can’t see it deserving to be where it was two months ago.
I therefore believe there is limited upside potential, but the potential for further weakness.
There is no question that, in time, this period will pass and new sharemarket highs will be reached. Those with sufficient cash may choose to ride it out, those who are inclined to get worried over declining portfolio values may want to re-consider their asset allocation with a view of increasing cash.