Is the stock market ignoring the economy?


Cht 1

THEY say that stock markets tend to run ahead of the economy.

Past trends have shown that the stock market has often risen months ahead of an economic recovery, and fallen before a downturn.

So, with the recent strong gains in global stock markets, led by the United States, talks have emerged over whether the “V-shaped” market rebound is telling us that the economy is also headed for a similar recovery soon.

Or is it just what some call a “dead-cat bounce”, or a short-lived recovery before a steeper fall sets in?

Could the market be underestimating the economic damage from the coronavirus (Covid-19) pandemic, and overestimating the speed of recovery?

There does not appear to be any consensus view on the recent behaviour of stock markets.

Most economists and analysts prefer to be on the cautious side.

The Covid-9 pandemic has pretty much shut down global economic activities, as countries go into various forms of lockdown to contain the spread of the virus, which has to-date infected more than three million people and killed more than 200,000 people worldwide.

With soaring unemployment, declining corporate earnings and increasing number of business closures, it is difficult to be optimistic. The world is facing an unprecedented crisis, and no one knows how deep and how long this pain will last.

Greed over fear

Stock markets have suddenly reversed course in recent weeks after suffering a meltdown and hitting their multi-year lows in mid-March due to the Covid-19 pandemic and collapse in crude oil prices. For instance, the US stock market, as measured by the Dow Jones Industrial Average, has surged by as much as 33% after hitting the bottom on March 23. The same applies for the S&P 500 and Nasdaq Composite Index.

In the United Kingdom, the FTSE 100 has risen about 18% from its March 23 bottom, while Japan’s Nikkei 225 has gained about 20% after hitting the bottom on March 19.

Back home, the FBM KLCI has also rebounded sharply after falling to its multi-year low of 1,207.8 points on March 19.

In what looks like a V-shaped recovery, the benchmark index has since gained 16.6% to close at 1,407.8 points on Thursday.

Year-to-date, though, the FBM KLCI is still down 11.4%.

Noting the efficiency of stock markets in evaluating information about future events, particularly with regards to corporate earnings, Bank Islam chief economist Mohd Afzanizam Abdul Rashid says most awful economic news have been largely priced in since mid-March.

“While the data looks really grim, the equity markets have already priced in much of the negative news when it tanked in mid-March, ” Afzanizam tells StarBizWeek.

His argument for the case of higher equity prices now does hold water, as investors are looking ahead, willing to buy on early signs of improvement.

“For Malaysia, we have managed to flatten the Covid-19 curve, and we are now gradually restarting our economy after weeks of being under the movement control order (MCO).

“Globally, talks of reopening the economy have also gained traction, as lockdowns ease and governments across the globe, alongside their central banks, being proactive in prescribing stimulus measures to support the economy, ” he explains.

However, Afzanizam notes that intermittent corrections in the stock markets remain inevitable in the coming days, as economic data releases are expected to show a lot of weakness between April and June, and traders will be tempted to pocket whatever gains they may have made along the way.

On the sustainability of the current uptrend in stocks markets, Afzanizam reckons it will depend on whether there will be an uncontrolled resurgence in Covid-19 transmissions.

“If that happens, the markets could potentially revert back to square one or even worse, ” he says.

But as things stand, Afzanizam remains quite sanguine on equities.

A contrarian, his house is looking at a range of 1,450 to 1,500 points by end-2020 as its base case for the FBM KLCI.

One fund manager notes that while the current environment presents the most dangerous of times for equity investors, it has also offered the best of investment opportunities at attractive prices following the steep market declines less than two months ago.

“The fear of missing out on an eventual recovery has drawn investors into the market to pick up heavily-beaten stocks, ” he says.

“Many are looking beyond 2020, which they already know is going to be a bad year they are, instead, buying into 2021, ” explains the fund manager, who requested to remain anonymous.

Shape of recovery

Last month, the International Monetary Fund (IMF) predicted the “Great Lockdown” recession in 2020 would be the steepest in almost a century. The fund also warned the world economy’s contraction and recovery could be worse than anticipated if Covid-19 lingered or returned.

In its first World Economic Outlook report since the spread of the virus, the IMF estimated that global gross domestic product (GDP) would shrink 3% this year.

That’s a downgrade from its January projection of a 3.3% expansion, and would likely mark the deepest dive since the Great Depression that started in 1929 and lasted until the late 1930s.

The new GDP estimate also dwarfed the 0.1% contraction of 2009 amid the Global Financial Crisis.

However, 2021 looks like the year of a huge bounce back for the global economy, with the IMF projecting a 5.8% growth.

For Malaysia, in particular, the IMF is looking at a whopping 9% GDP growth in 2021, which is a sharp reversal from its estimated 1.7% contraction for the country’s economy in 2020.

Afzanizam says a V-shaped recovery for Malaysia’s economy is possible.

He expects the country’s GDP to be in the red in the first six months of 2020, and even into the third quarter, before rebounding in the final quarter of the year.

He notes Bank Islam’s base-case GDP forecast is a 1.5% decline for 2020 and a 3.5% growth for 2021.

Striking a more cautious tone, however, is Institute for Democracy and Economic Affairs research manager Lau Zheng Zhou, who sees a U-shaped recovery, that is a slow and gradual rebound, as a more likely case for Malaysia’s economy.

“I think the stimulus packages have played an important role in stabilising the economy. The gradual return to normalcy for some businesses will also provide hope and a sense of policy direction for other businesses as they adapt and respond to a new market environment, ” Lau says.

“However, much of the country’s growth will also depend on the global demand, and it is likely that our recovery phase will be prolonged. During the Asian Financial Crisis, our economy depended on, among others, export as a way to rebound quickly, but this might not happen this time around, ” he explains.

Meanwhile, most countries have already started seeing GDP contraction in the first quarter.

Bank Negara had previously warned that Malaysia would start seeing the economic impact of the Covid-19 pandemic in the first quarter.

The central bank is scheduled to unveil the first-quarter GDP numbers on May 13.

Overall, it expects Malaysia’s GDP to shrink, at worst, by as much as 2%, or, at best, grow at a mere 0.5%, this year.

Painful times

Malaysia is currently in its fourth phase of the MCO, which is expected to end on May 12.

According to Prime Minister Tan Sri Muhyiddin Yassin, Malaysia has been losing around RM2.4bil a day since the MCO was first implemented on March 18 to contain the spread of Covid-19.

The country has to-date lost an estimated total of RM63bil due to the MCO, Muhyiddin said in a televised address to the nation yesterday.

He also announced that from May 4, almost all economic sectors would be allowed to operate, subject to stringent guidelines.

While the reopening of businesses is good news, some analysts reckon there is still a lot of uncertainty as to where the country’s economy may be heading.

“Disruption to certain industries and companies could be far more permanent than we think, and investors may not have all the information to price in this, ” Lau says.

“It will be interesting to see for how long can the divergence between the stock market and economy be sustained, ” he adds.

Meanwhile, the devastatingly low oil prices are another whammy for Malaysia.

It is estimated that every US$1 drop in the Brent crude oil price will cause the net oil and gas exporting nation to lose RM300mil in oil-related tax revenue.

According to the US Energy Information Administration, per-barrel Brent crude oil is expected to average at US$33.04 in 2020, down from US$64.37 in 2019, before climbing to US$45.62 in 2021.

All these indicate that there are plenty of lingering risks to the country’s economy and stock market.

Government support

At this point, it seems investors are confident that the governments will do what it takes to stabilise their economies to ensure that they emerge from the Covid-19 crisis in a reasonable shape, StashAway Malaysia Sdn Bhd country manager Wong Wai Ken says.

“The market has rebounded on the collective news that policymakers have introduced stimulus packages to replace the economic output during this period of lockdown, ” the former investment banker points out.

“Globally, governments have collectively announced US$18 trillion worth of stimulus packages; these initiatives have effectively calmed the markets, ” he notes.

Wong reckons how fast economies can bounce back from the Covid-19 fallout will depend on how effectively the governments can implement their stimulus policies.

For the short term, he expects the stock markets to remain volatile, potentially reacting negatively to signs of worsening health.

Similarly, JF Apex Securities head of research Lee Chung Cheng says stock markets have in general responded positively and quickly to policy actions by governments to support the economy.

“However, investors may be too optimistic and fail to assess the aftermath of the pandemic, as there will be an economic paradigm shift, ” Lee says.

He points out that some businesses might be gone permanently, or change their business models post-pandemic misery. In addition, there will be the unintended negative effects of massive quantitative easing (QE) over the medium to long term.

Maintaining a cautious stance, Lee says he doesn’t think productivity and economy can fully recover within the next six months upon the reopening of the country and the world’s economies.

“The risk-reward of buying now is unfavourable as compared to a month ago. Hence, investors are advised to adopt a cautious stance and only go for short-term trading, ” Lee explains.

“We expect market correction to happen in the second or third quarter, ” he adds.

A dead-cat bounce?

Hong Leong Investment Bank (HLIB) Research, for one, calls the recent uptrend of the market as merely a “dead-cat bounce”.

Envisaging a W-shaped trajectory for the market, the brokerage expects the FBM KLCI to fall again to a bottom of around 1,029 to 1,236 points in the coming months before hitting 1,350 by the end of the year.

Its year-end target values the market at 14.6 times the estimated mid-2021 earnings.

“With this ‘Covid-19 recession’ likely to be worse than the 2008/09 Global Financial Crisis and almost as bad as the 1997/98 Asian Financial Crisis, we reckon that the recent reprieve will be short-lived; past bear markets have all seen a ‘dead cat bounce’ ranging from 10%-13%, ” HLIB explains in its recent report.

It expects Malaysia’s GDP to contract 6% this year.

Similarly, Affin Hwang Capital Research believes the worst is not yet over for the local equity market despite the recent strong rebound, according to its report dated March 31.

The brokerage says: “We believe the market is downplaying the large economic impact of the Covid-19 virus and overestimating a revival of the economy once activity resumes.”

It expects the FBM KLCI to bottom at 1,008, based on a price-to-book ratio of one.

Before the market collapsed in mid-March, investors had been paying around 19 times forward earnings for stocks on Bursa Malaysia.

The FBM KLCI is currently valued at 15.7 times forward earnings, or 1.4 times price-to-book ratio.

Eventually, investors will begin to re-evaluate how much they are willing to pay for stocks, given the lingering economic risks.

That’s when the resilience of the market will likely be tested again.

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