Australian - and global investors - seem to think the current share market rout is at an end and is already positioning themselves for the recovery. Photo / AP
Australian - and global investors - seem to think the current share market rout is at an end and is already positioning themselves for the recovery. Photo / AP
COMMENT:
Can you turn an economy on and off like a light switch?
Investors in Australian shares are hoping the answer is yes, judging by the way they have piled back into stocks after the initial coronavirus-related sell off in March.
If you eschewed the news media and tried towork out what is happening with the Australian economy by relying on the 20 per cent rise in its share market over the past three weeks, you might think the economic outlook was great. You might even think boom times are just around the corner.
Of course, no one gets their economic news from share prices. It is meant to work the other way – share prices are meant to be based on a company's projected future earnings. In the current environment, that's all about the economy. And we all know what's driving the economy right now.
With a bleak outlook for the Australian and global economies, there is a greater disconnect than ever between the share markets and the real world.
Let's look at what's happened so far with Australian equities.
Australia's benchmark ASX 200 share index fell more than 36 per cent in the four weeks to March 23 as the scale of the coronavirus pandemic became apparent. That seems entirely reasonable.
But as the Morrison government put the nation into shutdown effectively turning off huge parts of the economy, the market rallied by about 20 per cent.
True, the Government's containment measures appear to be working and it looks as if we will start to emerge from social distancing in four weeks or so.
But consider this – the ASX 200 is now trading on a price-to-earnings multiple of about 16.9 times, compared to its long-run average of around 15 times. (The price-to-earnings multiple is a way of measuring share values, by comparing their profits with the actual price of the shares. The higher the ratio, the more higher investors value the shares based on their expectations of a company's future earnings.)
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Having a PE multiple higher than the market's long-run average would logically suggest earnings are also going to be better than the long-run average.
How can that be?
The International Monetary Fund is forecasting a deep recession, with the Australian economy shrinking 6.7 per cent this year as the world suffers its worst economic downturn since the Great Depression of the 1930s. (New Zealand's economy, by contrast is expected to shrink by 7.2 per cent and rebound more modestly.)
Compare this the Australia's experience of the Global Financial Crisis, when economic growth was weak, but the country managed to avoid going into recession. Yet the ASX fell close to 55 per cent during the GFC and its aftermath.
Despite the IMF forecasting an economic crash this year, it expects the Australian economy will come roaring back next year with growth of 6.1 per cent. But even after the rebound, the economy will be smaller than it was in 2019.
And it is highly questionable whether the V-shaped recovery is a realistic scenario.
The V-shaped recovery is based on a quick end to social distancing measures. But as we have seen from Singapore in recent days, it might not be that simple. After being held up as the gold standard of coronavirus responses, Singapore is now suffering a second wave of the virus which is seeing new infections surge to record levels.
We simply don't know how this is going to play out. For instance, Australia's lockdown isn't as extensive as New Zealand's which could mean the Australian economy comes out of this health crisis harder and faster.
On the other hand, if NZ's harsher restrictions mean it doesn't get a second wave its economy will recover faster and Australia will lag.
In an environment where there are dozens of 'other hands', it is hard to justify the investor optimism.
Will everybody by ready to go once restrictions are lifted or will some companies be so damaged they won't be able to pick up where they left off?
It's also notable that it took close to a year and a half for the ASX 200 to hit bottom during the GFC.
It then took almost a decade for the market to regain its pre-GCF high.
Yet Australian – and global investors – seem to think the current share market rout is at an end and is already positioning themselves for the recovery.
On Friday, the ASX finished its fourth consecutive week of gains and is now just 23 per cent off its record high in February.
It seems that many investors have made the mistake of looking at current share prices, and, deciding that at 20, or 25 or 30 per cent lower than recent highs, they're cheap.
Lined up against what's likely to happen with the economy, they might well prove to be overpriced.
Re-starting the economy might prove a lot more difficult than flicking a light switch.
