I’ve been asking myself — why has the stock market recovered so quickly from historical falls (during March 2020), when all indicators in the wider global economy point to a downturn of a significant magnitude., possibly even an unprecedented magnitude?
My initial thought was that the market is predicting an equally unprecedented recovery in the real economy. That is, the market has ‘seen through’ a short and sharp shock to the system, to greener pastures on the other side. This is what would align to a typical correction and bounce-back. There may be some merit in this view. At least some level of activity will surely come back on line quickly when the health issue is back under control.
But I am just not convinced that the real economy is going to recover quickly in any meaningful sense. I cannot see how things can go back quickly to a level of activity that will justify the stretched valuations that were evident well prior to the COVID-19 outbreak.
If we look at indicators in the wider economy, things don’t look so rosy.
For example, the London Metals Exchange Index is not so bullish:
Neither is the CoreCommodity Index:
So what is potentially driving the recovery in the stock market?
My conclusion is that sheer terror about two related things are actually driving the recovery in stock prices:
- The likely depth and extent of the downturn, and how long it is likely to last; and
- In turn, the amount of money Governments around the world are going to print to try and get us out of it — and where that money will ultimately flow.
My view is that the ‘global wealthy’ have been sitting on a lot of cash prior to this crisis due to record profitability and stretched asset valuations. They are now extremely concerned about the impact on the value of this cash from the coordinated ‘printing of money’.
The question is now between two evils. Holding cash that is going to be massively debased, versus acquiring assets that are massively overvalued.
From a risk perspective, it seems that ‘hard’ holding assets that are beyond the reach of Governments (like shares in global and productive companies) seems the better bet.
So the wealthy are buying any asset they can at any price to get rid of all of their cash before the value of cash starts to rapidly fall in real terms (relative to other assets). For those able to calculate the arbitrage between the real ‘cost of debt’ and the likely ‘debasing of cash’, the strategy of leveraging into costly stocks probably also still makes sense.
In summary, my conclusion is that the stock market recovery does not reflect fundamental value, or a view about the future of the real economy (i.e. the discounted value of future profits), but rather a ‘relative value’ to what the wealthy think cash is going to be worth (i.e. nothing).
Predicting the direction of markets is a fools game, but at this stage I can only see two things supporting the value of stocks: a cycling of cash to assets, and a cycling of debt to assets. This trade has been encouraged by Government to varying levels for almost two decades. The longer it is supported, the bigger the ultimate bubble (both in terms of debt and assets).
Hopefully this folly bursts after the current health crisis, because what we don’t need now is both a real crash and a financial crash, followed by another real crash…
The information contained in this post is current at the date of publishing – 20 April 2020