Feature Stories | Apr 01 2020
A recession is a given, as is an eventual stock market recovery. But a recovery is entirely dependent on just how deep the inevitable recession will prove to be, and just how long its lasts.
-GDP forecasts plunge
-Australians have not had to deal with a recession for 29 years, hence some never
-Restrictions cannot be lifted prematurely
-When it’s all over, it will be a strange new world
By Greg Peel
As of the close of Tuesday’s trade, the ASX200 had recovered 17% from the intraday low set on Monday, March 23. From the intraday high set on February 21 to that intraday low, the index fell -38.5%. Noting that percentage falls are measured from the top down, and gains from the bottom up, a fall of -38.5% requires a recovery of 61.6% to return to the starting point.
Throughout this crisis it has been assumed that the bounce, whenever it comes, will be short and sharp. The reasons being (a) the drop to -38% down was the steepest in history and (b) the bear market is due to an exogenous shock with a foreseeable end, not a boom-bust cyclical downturn.
Of course, the “foreseeable end” remains the swing factor. How soon the world passes peak-virus will determine just how long the inevitable recession, which we are clearly now in despite technically requiring two quarters of data to prove it, will last. When the world first accepted the virus as a crisis, the assumption was one quarter of economic damage. As the case-count grew in both quantum and spread, that became two quarters. The jury is currently still out on whether it may bleed into three quarters.
Which means despite a 17% bounce looking pretty definitive, there is no guarantee the bottom has now been seen. While a recession typically marks the end of a bear market, not the beginning, the recession is when reality bites.
In technical terms (two negative quarters) the last recession in Australia began in the September quarter of 1990 and lasted until the September quarter of 1991 – five quarters. Given stock markets are forward looking, Australia’s stock market index (All Ords back then) bottomed in January 1991 but rolled over again into another bear market in 1992, until seriously marking a bottom and surging to 1994, when another -20% correction ensued.
Having worked through that period myself, in the stock market, I was surprised to revise my history and find the recession ended in 1991. If you’d asked me, I would have said 1994. It certainly felt like it at the time. Of course, “recession” is a technical term, not a description of sentiment.
On the assumption you would have had to have been an “adult” at the time to feel the impact of the recession, and assuming an “adult” is 18-plus, you’d have to be 47 today to have any experience of a recession in this country. That means a helluva lot of Australians don’t know what they’re in for. And moreover, nor does the bulk of today’s financial market workforce.
Of course, things are different this time. Yes I know, it’s the kiss-of-death statement, but consider the following:
Keating called the 90s recession “the recession we had to have”. Morrison is throwing everything the government has at it.
In September 1990 the RBA cash rate was 14%. Choke on that millennials, then give me an “Okay Boomer”. Today the RBA cash rate is effectively less than zero, if we add QE-style measures to 0.25%.
By September 1991 the RBA had cut to 9.5%, and in July 1994 the rate bottomed out at 4.75%. We might call that recession chasing. Before this current recession had begun, the RBA threw everything it had at it.
In 1990 there was no option to work from home. When you lost your job last time, you lost your job. End of story.
I don’t recall, in the '90s, there ever being a shortage of toilet paper.
And of course this recession will be different, if not unique in our time, for being brought about by a virus and not previous economic excesses.
In 2008, most Australian bank analysts made the glaring error of suggesting “banks are defensive” in economic downturns. The problem was their experience, and five-year average data, only went back to the 2000-2002 downturn, which wasn’t even a recession. By the time the banks had seen around -80% of their market caps wiped out, and were desperately raising capital, only then did the penny drop for said bank analysts.
How will experience inform today’s analysis?
To be fair to stock analysts generally, 2008-09 did not result in an almost blanket withdrawal of corporate guidance, as has been the case in Australia in the last two weeks in particular. Companies did not shut down in the GFC, unless they went bust.
While broker analysis is independent, it is heavy reliant on “guidance” as the guide to earnings forecasts. Often analysts will call guidance “ambitious” on the one hand or conservative on the other, but rest assured, a change in guidance almost invariably results in a change in analyst forecasts.
Without guidance, analysts currently are, by their own admission in many cases, just as in the dark as everyone else, as they sit in their lounge rooms. Economists now begin their reports with “I’m no medical expert, but…” No one can be held accountable for current forecasts.
Which is to a great extent informing updated recession predictions.
We also have to give analysts and economists some grace for the sheer speed of this crisis and the subsequent speed of response. Less than a month ago, Morrison was off to the footy. Today, only he and Frydenberg can publically gather, not one person more.
Analysis takes time. Reports have to be written, sub-edited, complied and published. By the time they hit the market, the world has moved on to a new phase.
So with all of the above as a caveat of sorts, here we go…
Major Contraction
Longview Economics forecasts a -5% fall in US GDP for the year 2020, from 2.3% growth in 2019, followed by a 3% recovery in 2021.
For China, -2.0% in 2020, down from 6.0%, followed by +5.2%.
For Germany, -8%, down from 0.6%, followed by +1.5%.
For Australia, -6%, down from 2.2%, followed by +4.5%.
Looking at quarterly forecasts for the US, Morgan Stanley is (as at last week) assuming -2.4% for the March quarter (year on year), followed by a record-breaking -30% plunge in the June quarter.
On an annual basis, Morgan Stanley forecasts -2.3% from 2020, followed by a 3.3% recovery in 2021.
The broker expects the US to have lost -700,000 jobs in March (non-farm payrolls) and unemployment to rise to 12.8% in the June quarter. Real personal consumption expenditure in the June quarter will drop by -31% (year on year) on Morgan Stanley’s estimates.
Morgan Stanley expects global growth to dip to 0.9% in 2020, the lowest level since 2009’s -0.5%.
The broker expects Australia to fall into recession, but only for the requisite two quarters as a base case. That base case is nonetheless mired in uncertainty, of ultimate duration and impact, linked to labour market shocks and the ultimate success of policy responses.
Another source of uncertainty is how Australians will respond, given the length of time since the last recession, and given this is a health crisis and not a financial crisis. “Animal spirits” will be tested, the broker suggests.
Morgan Stanley expects ASX200 earnings per share to fall a net -20% in FY20 as a base case, and -30% as a bear case. The problem here, of course, is the near blanket withdrawal of earnings guidance across the market. Consensus forecasts will lag in catching up to reality, because there is little to go on. The real impact, or anticipated impact, may not be evident until companies begin to pre-announce result expectations, noting the result season is not until August.
The broker’s forecast for the ASX200 twelve months ahead has been lowered to 5800 as a base case, from a prior 6700. Note that the index peaked at 7162 in February and has since fallen through both the broker’s base case and bear case targets.
JP Morgan notes, from a US perspective, all recessions since World War average out at an 18 month time frame peak to trough. The biggest problem thus is not the size of the fall but the duration. While this particular bear market is unusual, arguably unique, and the -30% drop in a month broke records for speed, we still don’t know yet whether we can call a trough.
Even without the virus becoming “perennial”, suggests JP Morgan, the length of overall weakness could surprise if the US economy falls into a typical recessionary spiral between earnings, the labour market and final demand.
Controlling Duration
While the virus-led bear market has often been referred to as “unique”, as we are all aware much comparison has been drawn to the so-called Spanish flu of 1918, which actually started in America. It was called Spanish by the British but other names elsewhere, and certainly not in Spain.
Macquarie has delved into history to note the new virus emerged in March 1918, spreading across the US and then on to Europe and Asia over the next six months. Australia initially escaped the virus, as it was the only country to to enact strict travel bans, beginning in October.
A meeting was set up in November between those equivalent to today’s National Cabinet, and the Commonwealth Serum Laboratory, which was established in World War I and is known today as publicly listed CSL, already had an experimental vaccine developed in that year.
Despite strict measures, by January 1919 Melbourne had 50-100 cases.
It wasn’t until that January that the US government acted to limit the epidemic by the same measures we’re seeing today – closure of public events and spaces and compulsory wearing of masks – but given the incidence of the flu was low by comparison, most measure were lifted by March.
Then cases started rising again, so social distancing measures were enforced. These were lifted in May. Another wave hit, but this time no measures were reimposed. As Macquarie puts it, “This latter wave had a higher death rate, which may have been enough to change behaviour”. In other words, the public was so scared there was no need to enforce rules anymore.
The lesson? Social distancing works, but without an effective vaccine (still seen as at least 12 months off at best), if social distancing measures are removed too early more waves will hit. This brings into focus the Trump Administration’s desire to reopen the US economy as soon as possible, although already that goal has been extended.
It also explains why, to much horror, Scott Morrison has suggested Australia’s strict measures will likely be in place for six months, even if a “flattening of the curve” is apparent.
Evidence of the “flattening of the curve” is seen as a trigger for an ultimate stock market rebound, but extended lockdowns will only extend the duration of the recession, so such a bounce, expected to be swift, may prove premature.
China hit peak cases in early February, with new cases now said to be imported. The government’s strict quarantine measures appear to have been successful, and the Chinese are now quietly getting back to work, but without a vaccine, there is still a risk of a second outbreak.
Technology may be more advanced now than in 1918, Macquarie notes, but that’s no reason to throw caution to the wind. The Spanish flu was still impacting the world two years later.
A New Dawn
When we do pass peak-virus, and when restrictions are ultimately lifted, will we soon return to life and an economy as we knew it this time last year? Consensus says no.
Let’s start with the travel industry. Hands up, who’s looking forward to the opportunity to book a cruise? Thought so.
It will likely be a long time before cruise lines return to normal business. As for airlines, these too will be dependent on just how gun-shy potential travellers will remain, and for how long. And that’s just for tourism. It is rapidly becoming accepted that business travel will never be the same again, now that companies have discovered they can actually run their meetings and their day-to-day operations quite efficiently over the internet.
As for tourism in Australia, the collapse in the Aussie dollar makes offshore travel too expensive now anyway, unless the Aussie happens to flay back up again. Given the debt we’re taking on that’s unlikely, but then it’s all relative. And let’s not forget the government was already bailing out the tourism industry before the virus became an issue, given American tourists were being warned to stay away lest they be fried by a bushfire while climbing the Harbour Bridge.
We were also being encouraged to, and we were responding to such encouragement, to support regional areas badly impacted by fire, pre-virus. Such travel may ramp up again post-virus once we’re ready to leave the house, but the Barossa, for example, may remain unpopular for a while, and perhaps even Bondi Beach.
It is unlikely the tourism/business travel industries will ever be the same again.
Working from home works, it appears so far. For a long time pundits have been suggesting more working from home where possible simply to relieve traffic congestion and public transport strain. Fewer cars on toll roads?
Forced isolation has meant many Australians have had to take a crash course in cooking. Will they decide it’s not that hard and cut down in future on expensive restaurant bills?
Will the supermarkets, post-virus, sell another roll of toilet paper for twelve months?
Looking at the wider picture, Australians who once assumed their job was completely secure have now found it wasn’t, and they are finding that living a subsistence lifestyle on minimal government handouts is a severe economic and emotional strain.
Australians thus will think twice in future of making unnecessary discretionary purchases and leveraging up to unsustainable levels of mortgage payment to income ratio.
Even before the virus, Australians had stopped spending, constantly being reminded of the country’s record household debt. Interest rates were already at historic lows. Now lower still, will it make a difference? Or will Australians take a long time to return to “normal” spending patterns, if ever.
All of the above suggest not only could the recession go on for longer than assumed after peak-virus, some parts of the economy may recover very slowly, and some never.
Looking ahead, we must also consider just what austerity measures will be needed to be implemented by this or successive governments in order to repair a shredded budget. Surplus? Only in text books.
Once in a Lifetime
It is a truth universally acknowledged across the equity investing world that covid-19 will ultimately provide a once in a lifetime investment opportunity. But when to buy, and what to buy?
As noted in What Does History Tell Us? ( https://www.fnarena.com/index.php/2020/03/25/what-does-history-tell-us/ ) bear markets almost invariably do not end with a V-bounce, and while the first bounce might be swift and sharp, a second decline almost invariably follows at a latter date, perhaps even a third.
Yet history also shows that if you move too slowly, you will miss the bulk of once in a lifetime returns on offer.
Stock markets are forward-looking, and the current theme among stock analysts now is to identify stocks offering value on a “look-through” basis, even as guidance is unavailable. In this particular event, it is no stretch to assume the virus itself may have sparked phase one but it will be the recession that sparks phase two, even after we pass peak-virus.
Not whether or not there will be a recession – we’re already in it – but one of underestimated depth and duration.
Respected US (billionaire) investors have been lining up on US business television to reveal they are nibbling away to take advantage of the opportunity presented, but are expecting such an opportunity to last for a while yet. All assume at least one more leg down, whether to a higher low, a retest of the low, or a lower low.
No one claims to know the answer.
And what to buy? Well all of the above loudly signals that while some companies now look cheap because they were unnecessarily caught in the panic, other companies that look very cheap will likely remain so, if they remain at all.
All equity strategists are currently highlighting balance sheet as the primary consideration in bottom-picking, and asking the question as to whether the company you’re considering investing in will ever return to “normal”.
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