16 Apr Why the economy might not be a sleeping beauty
Welcome to our latest investment update, which we have published a day later than has been our norm, as two trading days were lost to the Easter weekend.
Given that share prices appear to be displaying a bit more resilience and stability (more on that in a moment), we are proposing to throttle back and revert to fortnightly communication, meaning our next update will be on or around 29th April. As we have said before, the situation is extremely fast-moving so if anything emerges which impacts markets significantly, we will put out an update right away. Of course, if you do have any concerns or questions before then, please do pick up the phone or email your adviser.
Investors, particularly those with experience, will know that asset prices rise, reach a crescendo, plateau and subsequently fall, before the whole cycle starts again. Whilst the catalyst for a change in the trajectory might be economic or political, the cycle is largely governed by human behaviour, as the graphic below shows:
Many of our readers will have seen this before, or something very close to it. We call this the ‘rollercoaster of investment emotions’ and I make no apologies for bringing out such ‘warmed up leftovers’ because it is useful context for where we find ourselves right now. Though the graphic is presented as symmetrical, the reality is always different, but the emotions remain the same.
As you can see, the upswings tend to be associated with feelings of hope and euphoria but once this optimism fades, it gives way, first to dismissal (this fall is only temporary), then fear, panic and finally capitulation (maybe this investment just isn’t for me). Overlaying this with what has happened to the UK stock market, we can see that the FTSE100 returned investors around 250% from March 2009 to February 2020 but since then a gradual fall has steepened, with many investors reaching for the panic button at precisely the wrong time (point 1 on the chart).
The reason we mention this is the right hand side of the graphic perfectly reflects what we have been witnessing since the start of the COVID19 outbreak. Regular readers will have seen a chart similar to the one below, which we published a few weeks ago. At the time, share prices were falling, and rapidly, as fear and panic gripped investors. The question we posed at the time was not when prices would recover, but when they would stabilise.
Roll on three weeks and we can see that prices have tended to follow a very similar pattern to previous ‘shocks’ and are consistent with the rollercoaster graphic. At the risk of tempting fate, it does appear that the initial period of panic is over for investors. Of course, in the short term, investors are going to be very sensitive to news-flow on whether the virus is peaking and we need to be mindful that in 2008, there was one further lurch down before volatility dissipated. Whilst we cannot discount that happening again, we think there is grounds for optimism this time around.
Doctors are fundamentally different to economists. Clinicians can (and very often have to) place critically sick patients in a coma as a means of stabilising, before resuscitation. This is analogous with where we find ourselves currently with the world economy. If there is a fundamental belief that COVID19 infections are showing signs of plateauing (or in the case of the UK and US, will be), attention will start to turn to resuscitation of the economy. The problem is that the economy is not a sleeping-beauty, ready to wake up at the first kiss by central government. The longer the lockdown continues, the harder and longer the rehabilitation will be. We already know the economic data and the corporate profits which dovetail with them, will make extremely uncomfortable reading but we believe the stock market knows this too and has priced this in. This leads us onto why we see a different pattern emerging compared to 2008.
Stock markets do not like recessions and prices usually fall, but a rough rule of thumb is that stocks tend to hit rock bottom around 3-6 months before a recession. On the basis that economic activity will be at its weakest when restrictions are toughest, which is likely to be sometime between April and June, it is perfectly feasible that the worst of the slide in stock prices is already behind us. We have long argued that financial markets are notoriously forward-looking, and whilst it might appear premature to be talking about recovery, it will probably be evident in share prices long before the economic data looks visibly better.
So at the risk of sounding blasé, our message is simple. Financial asset prices, not just equities have fallen, denial has given way to panic and some investors will have thrown in the towel. The economic fallout is going to be ugly, but not as ugly as share prices would have us believe. We think prices are now starting to show some signs of stability and whilst it’s tough to make an argument that recovery is imminent, after stabilisation, recovery is the next logical phase in the cycle.
We will write again in a fortnight.
Dr Andrew Mann