By David Prattent

What is real?

As Marketwatch gazed out over his garden, mentally listing the winter jobs, his thoughts turned to the state of the world.  We have talked before about the confusing environment which we are witnessing at the moment.  Trying to make sense of it is all but impossible.

But there is something we need to talk about, because it is important.  That “something” is the gap between what economic conditions look like and where investors are driving stock markets.

Let’s take a look first at stock markets.  The principal market is the New York Stock Exchange and this place possesses more stock indexes than Marketwatch has had red wine.  And that’s saying something.

The main index watched is not, interestingly, the one which is most frequently quoted.  All eyes are fixed on the Dow Jones Industrial Average index and the media hangs on its every movement.  It is an index made up of the trading of 30 major companies, like Apple, Microsoft and Boeing.  But it’s probably not the best indicator around although it has been there for ever and we have all got used to watching it.

A better representation is the S&P 500 index which, as the name implies, consists of 500 large corporations.  Along with the Russell 2000 index which measures 2,000 smaller companies, a better idea of what is happening in the investment world can be gained.

From the chart below, we can see that the S&P 500 has had a bumpy year but is actually higher than it was 12 months ago.  It took a beating for a short period around March when investors panicked over COVID-19 but has recovered admirably.

Pic Vba Marketwatch Image I Ab15 7 2020

The Russell 2000 shows a similar trend but, after its fall in March, is taking longer to recover and is down about 6% for the year.  It, too, is also trending upwards with a few wobbles along the way.

Pic Vba Marketwatch Image Ii Ab15 7 2020

 

The overall implication is that things are going well, and when they do investors jump on the bandwagon.

Hang on, I can hear you cry, this is a bit simplistic.  Yes, it is, because many factors make up a market.  But the fundamental truth remains; if investors think things are going well they will invest, and vice versa.

Sometimes investors get a bit punch drunk.  As an example of this recently, Hertz, the car hire company, filed for bankruptcy protection in the face of massive indebtedness and a fall off in business which started before the pandemic.  Its share price actually went up.  Now you and I would think that a company which is teetering on the verge of extinction might not be worth very much.  But investors think differently.  In fact, the company has just had a court’s permission to raise US$1 billion share capital.  Work that one out.

So let’s now look at the other world, the real economy.  Although you could write a book about it, this is a short article, not a PhD thesis, so we will look at a few examples.

In the US there are 20 million people unemployed.  States are re-opening their economies but we don’t yet know how that will develop.  The Federal Reserve has all but guaranteed that interest rates will remain at zero for the next two years, something you don’t do if you are confident about future growth prospects.  The UK is experiencing a massive economic contraction and the possibility of 4.5 million unemployed.  China looks like it will manage 2.5% growth compared to its usual 6%+.

Here in Australia, our tourism, hospitality and education sectors have been decimated.  Despite the continued success of the resources sector, it looks like we have a recession on our hands.  The talk is that the mining sector will rescue our economy.  That is irrelevant for the many businesses which will not survive and those who are unemployed.  Unless there is major policy change and reform all this will do is narrow our economy and make us more vulnerable to future shocks.

Worldwide, company reporting season is probably not going to look pretty and we have no idea when unemployment will get back to the low numbers we have seen previously.

The two worlds, that of the investor and the one we live in, the real economy, cannot exist in their current form for ever.  Current share market prices can only make sense if there is a quick, robust recovery which restores a trend of economic growth.  The converse to this is too horrible to contemplate.

MarketWatch is not a betting man, so he is not going to offer odds on how this will turn out.  But he is reminded of the comment made by the 19th century British Prime Minister, Benjamin Disraeli, “I am prepared for the worst, but hope for the best”.

I am sorry not to bring more cheer to your reading this month, but if you need to calm your troubled spirits, I recommend the Mountadam Cabernet Sauvignon.  This is from a family-owned company in the Eden Valley.  The 2015 is a gem. Enjoy.

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