Commentary

Making sense of a disconnect in the global economy

Stock prices are painting a different picture from the gloom of a downturn

If you are feeling a strong disconnect between stock prices and economic numbers, you are most likely not alone.

At a time increasingly dominated by harrowing headlines on riots, trade tensions, a pandemic, recession and sanctions, it feels like the world is headed for one of the toughest times in recent history.

Yet stock prices are certainly painting an entirely different picture. At times, it seems as if we are seeing the world through two separate, unrelated lenses.

Under normal conditions, a market correction is typically defined as a decline of 10 per cent or more. Based on the MSCI World Index, the decline this year has amounted to a mere 3 per cent, definitely not a reflection of the massive fiscal stimulus globally to get most economies out of recession and millions of job cuts.

It is starting to look like yet another typical trading year with its regular ups and downs. However, just three months ago, the same index had fallen 32 per cent.

What caused the remarkable sharp turnaround? Is it time to jump into the market or take profits and seek refuge in other assets?

Let's look back to see if we can get some semblance of a trend.

In the past four decades, the world has witnessed a handful of key crises with stock prices plunging more than 15 per cent - the decline hit 51 per cent during the global financial crisis.

During the past seven such events, global markets corrected an average of about 28 per cent over 15 months, and then posted an average gain of 70 per cent over 28 months.

This indicates that while declines are short and sharp, usually led by some unforeseen event, recovery is over a slightly longer period - but markets typically do recover most of the losses.

WHY THE DISCONNECT?

As the world gradually reopens, the market theme has shifted to companies that are likely to benefit from a turnaround in the economy. While recovery is expected to be choppy, there will be opportunities to take advantage of price weaknesses to rotat
As the world gradually reopens, the market theme has shifted to companies that are likely to benefit from a turnaround in the economy. While recovery is expected to be choppy, there will be opportunities to take advantage of price weaknesses to rotate into quality stocks.  ST PHOTO: KELVIN CHNG

After the low of March 23, equity markets have largely regained most of the losses, effectively dismissing the painful repercussions that the pandemic has exerted on economic activity and growth.

Massive central bank pledges, as well as expectations that key economies would continue to adopt policies to aid recovery and keep jobs, helped support equities. With each round of support, share prices moved up.

Every crisis is marked by several key words. In this pandemic, the buzzword in the financial sector is "unprecedented": From an unprecedented fiscal stimulus to an unprecedented slump in economic outlook and activity due to lockdown measures.

Most major economies have now committed almost 10 per cent to 40 per cent of their gross domestic product to unprecedented fiscal stimulus packages.

Singapore introduced four Budgets in four months (again, unprecedented) totalling about $100 billion to ride out the crisis.

However, the market has seemingly ignored the sizeable fallout from the coronavirus pandemic. First, the virus is still spreading; second, there is still no cure approved for mass use; and third, the dent in consumer sentiment together with an increase in job losses will impact most segments of the global economy.

While equity markets have continued their upward trajectory, fuelled by optimism over economies reopening and stimulus measures, the path ahead is likely to be choppy.

Costs for companies will rise as firms have to ensure that safe distancing measures are in place.

Online shopping, learning and entertainment will continue. Remote working seems to have gained a huge following and will likely be adopted in some form by many companies.

This crisis will also direct more companies to focus on building up resilience in their business models, strategies and balance sheets.

Companies are likely to leverage technology to enable employees to work remotely and conduct their businesses more effectively.

There is also a need to relook at supply chains to reduce dependency on a concentrated pool of suppliers. A key takeaway will be the need to strengthen balance sheets, ensure longer-term funding and reduce leverage.

There will be restructuring and consolidation in most sectors as weak or poorly capitalised firms exit, but the stronger players are likely to be well placed to capture market share.

There is also the new reality for investors - reduced dividend payouts. The pandemic has sparked a dire need for firms to conserve funds, and several have cut, withheld or deferred dividend payouts.

The crisis has severely impacted the cash flow of most companies and some have had to seek other forms of life support.

Shareholders need to understand that companies will need to be prudent and conserve funds whenever possible, so that they can ride out this massive down cycle, which could stretch beyond a year.

BUY OR SELL?

Earnings estimates have been adjusted down in recent months but earnings visibility remains low.

Based on the S&P 500, earnings will fall 22 per cent this year before staging a recovery of 26 per cent next year.

Asian markets have underperformed their developed market peers until recently.

Most Asian key equity indexes were trading at or below 10-year historical averages in terms of price-earnings ratios versus most developed market indexes, which were trading significantly higher than historical averages.

Last week, Asian equities finally caught up and closed the gap.

The Singapore market topped the region and outperformed strongly with a gain of 9.6 per cent for the first week of this month, while the rest of the region saw gains of between 3 per cent and 8 per cent.

In Singapore, real estate and banks led the market with weekly gains of 10.8 per cent and 9 per cent as investors rotated into stocks such as City Developments Limited (up 19.4 per cent), DBS Bank (up 15.1 per cent), United Overseas Bank (up 12.8 per cent) and OCBC Bank (up 10.4 per cent).

As the world gradually reopens, the market theme has shifted to companies that are likely to benefit from a turnaround in the economy.

Attention has also moved to oversold industries and stocks. In a typical scenario, the most beaten-down stocks in a crisis are also the companies that often register the strongest recovery.

Since recovering from the lows in March, equities are no longer as attractive. While recovery is expected to be choppy, there will be opportunities to take advantage of price weaknesses to rotate into quality stocks.

• The writer is the head of OCBC Investment Research.

A version of this article appeared in the print edition of The Straits Times on June 11, 2020, with the headline 'Making sense of a disconnect in the global economy'. Subscribe