UK Edition
Successful investing is about finding inefficiencies and errors in markets and waiting for them to correct – and there could be one staring investors in the face right now.
There is a growing divide between how markets are performing – American and British share prices are 25pc and 15pc higher than in March – and the economic data which points to a recession of historic proportions.
A weak economy leads to less profit, an idea that should be dragging markets lower. Yes share prices are down since the start of the year but the recent rises have confused experts. Fund managers and economists remain extremely pessimistic.
Unemployment has soared in Britain and America. If people are not working, then they are not spending and are not paying tax. The consequences for company earnings and of government income are clear.
More than two million workers will lose their jobs between April and July in Britain and unemployment will reach 10pc, according to the Office for Budget Responsibility. Estimates from the Institute for Employment Studies point to unemployment reaching its high during the 2008 financial crisis, as show in the chart below.
In America, 22 million people have filed for unemployment benefits in the past month. This has erased almost all of the jobs created during the ten-year economic boom since 2008.
Edward Park, of fund manager Brooks Macdonald said: “These are record numbers but markets have shrugged them off as they knew they would be bad. Investors are ignoring the data as they can see the exit from the shutdown.
“The rally in American assets, particularly in the technology sector, is out of step with what is happening in the economy," he said. Economic growth across the world has collapsed which will pile pressure on businesses that rely on exports.
The International Monetary Fund (IMF) said this year would be the worst global economic collapse since the Great Depression of 1929 and the global economy will decline 3pc. Britain would contract by 6.5pc and America by 5.9pc, which is in line with other major economies as shown below.
Simon Macadam, of consultancy Capital Economics, said: “When the global economy contracted by 0.5pc in 2009, pre-tax earnings of global non-financial companies plummeted by 45pc.
"We’re expecting a much higher decline, so there’s a good chance that earnings will fare worse than they did in 2009.”
Even when the economic shutdown is lifted, the chances of a V-shaped recovery – when an economy immediately bounces sharply back after a steep decline – are slim.
Markets are assuming a V-shaped recession but a U-shaped one – which is characterised by a very slow return to growth – is more likely, according to James Foster and Alex Ralph, of fund manager Artemis.
“The latest short term economic forecasts have been unbelievably awful. Hopefully the economy will recover quickly once lockdown measures are lifted, but our belief is that optimism about an instant recovery is misplaced.”
In a survey of fund managers, Bank of America found that half expected a U-shaped recovery compared to just 15pc for a V-shaped one. Cash positions rose to their highest levels since the 9/11 Terrorist attacks which is a signal investors expect markets to fall.
Why have markets risen so much?
One reason, according to Mr Park, is governments have unleashed unprecedented waves of money to stimulate the economy.
“We have had more fiscal and monetary stimulus in the past two months than in all of the financial crisis of 2008,” he said.
In Britain, Chancellor Rishi Sunak has attempted to insulate the jobs market from shutting down by paying 80pc of furloughed workers’ wages up to £2,500 per month. He also announced tax cuts and cheap loan schemes for businesses.
The American central bank said it was prepared to do whatever it takes to stabilise the country’s bond market and has gone further already than in 2008.
Another argument is that the number of deaths from the virus is beginning to plateau and economies are beginning to reopen, which will propel them into a V-shaped recovery. Andrew McCaffery, of fund manager Fidelity, said he is watching for a Covid-19 vaccine.
By tracking testing results of the virus globally, and observing how some economies have recovered once they have lifted the shutdown, he will be able to assess the outlook for stocks