Why hasn’t the stock market collapsed, yet?
“The four most dangerous words in investing are: “This time it’s different”.”
Despite the global pandemic and the preventive lockdown measures, the performance of the stock market hasn’t really reflected the situation on ground. Yes,there were downturns in March 2020 (9th and 16th of March) as countries closed borders and shut down businesses in response to the corona virus pandemic. Stocks tumbled erasing up to 30% in value of security indexes. The UN estimated that around 305 million jobs could be lost in the 2nd quarter alone and also the certainty that we are entering into a global recession. The IMF’s Chief Economist Gita Gopinath called this resulting recession ‘the worst since the Great Depression’, estimating that it could cost the globe around $9 trillion in lost revenue. But despite it all, the market quickly rebounded so much so that, April 2020 was recorded as the best month for Wall Street since 1987. The question has been asked time and time again: what’s going on in the stock market? Has the worst happened?
To take a view of what is going on, I will quote Warren Buffet when he stated that winners in the security markets are the “players who focus on the playing field — not by those whose eyes are glued to the scoreboard”. Let’s step back and take a good look at how the market works. To start with, the stock market isn’t the economy. At its best, the market can be a reflection of the economy, especially when investors worldview align with its current reality. On a micro-level, it reflects the society when investors see opportunities in the market and act based on this knowledge. If the investor’s knowledge is fact and interpretation accurate, where (s)he invests should be in an area of growing concern. This growing concern should yield a plethora of benefits to the society…ranging from job, earnings, foreign exchange to even intangibles such as a sense of pride. So when we see a disconnect from the market similar to the current market rallying, we should consider the market attributes: the decision framework of the investor, the ambiguity of information, and the nature of the stock market.
Let’s start with the investor. For the sake of this article, I will categorize investors into personal and professional investors with the main distinction being who owns stake in said investment. Personal investors are individuals with a direct stake in most of the funds being invested into risky assets. Professional investors rather are employees, whose investment portfolio comprise mostly of other people’s money. The are armed with experience, market knowledge, information privileges and ability to decipher from these signals on the best course of action.
It should be noted that about 40% of the stock market valuation comprises of investments owned by personal investors. Most aren’t able to carefully analyse the fundamentals of their financial instrument they have or use the information provided to predict the market’s move. So a bulk of their investment decisions stems from emotional stimuli and gut feeling. A buzzword in the investment circle encourages people to buy when the stock values are low or hold on to investment portfolio when there is a drop in its value as recovery might be rapid. The problem is, this advice might not hold true in all circumstances and investors in this category aren’t equipped enough to know when. Some might assume that the drop on the 16th of March was the market has bottoming out and thus, invest with that understanding. There are others who would see this trend and with the fear of missing out, commence investing or increase investment.
Why the personal investor is limited in his/her capabilities to make a robust analysis of the fundamentals of their personal financial assets, the professional investor’s limitation might have more to do with the processing of too much information. More information isn’t without its setback, so goes the phrase “analysis paralysis”. Information overload gives room for complexities and ambiguity. With:
- Global relief package of around $5 trillion,
- breakthroughs in science like Gilead Sciences Inc’s experimental antiviral drug remdesivir,
- lenders willing to consider moratorium clause to outstanding liabilities,
and an openness to make negotiation around force majeure clauses on contracts, it can be logical to be optimistic about the very near future. It might be logical to expect a return to normalcy before the end of this year. Translating events this way could make experts conclude on a v shaped recovery. Betting on a V shape would only means one thing… ‘buy more stock!!’
There are fundamental flaws in the stock market that can confuse any investor not taking the big picture into account. Take quarterly reports that would have been released early April 2020. It would report January to March 2020 (most countries implemented lockdown measures in the middle of March 2020). The effect of the lockdown measures might not have been fully realized then, dampening the impact of the pandemic on global activities. There is also the structure of indexes. Market stock indexes are useful tools to hedge risk but can be skewed reporters of the market’s performance. The S&P 500 depends heavily on the valuation of stay at home stocks for its high performance. This index comprises of all the hugely successful FAANG stocks along with poorly performing stocks like Marathon Oil (heavily hit by the Saudi Arabia/Russia Oil Trade war) and Royal Caribbean Cruise Ltd, both losing an average of about 75% of their valuation as a result of the lockdown measures.
Making a fair assessment of the stock market requires stringing together activities from the wider economy into a model of how the stock market works. The global economy has about 3.5 billion people in its workforce. Consider these.
- If almost 10% of the global workforce (referring to the 305 million projected unemployment quoted earlier) become unemployed, their reason to retain their sizeable investment portfolio would be examined in the face of pressing needs and compel many to cash out early.
- CNBC did short documentaries exploring the impact of the lockdown measures on restaurants, airbnb, events, and the airline Industry. The documentaries painted a gloomy picture of the survival of many companies that might not be apparent. But as Warren Buffett states ‘only when the tide goes out do you discover who’s been swimming naked’. It is when the impact of this prolong slowdown in economic activities starts biting, when companies begin to fall short in their obligation, when bankruptcy filings increase, that is when the real scramble for safety would begin…and the market will truly bottom out.
So is there going to be a market crash? I would say, yes and hope to be wrong. A lot argue that the crash of the 16th of March was the market bottoming out. It should be noted though that this hasn’t been the first time a lag in bottoming out took place. For the financial crash of 2007,the market bottomed out in 517 days. It took longer in the crash of 2002 ; it took 929 days!! One shouldn’t take solace in relief packages being doled out by governments all over the world. As much as they limit the potential impact of the lockdown measures on the economy, there is still so much uncertainties that would be hard to unravel at this time. Jerome Powell warning of prolong recession following the pandemic sent stock prices tumbling suggesting an absence of fundamentals in the recent rallies.
I believe we have a long road ahead and are only beginning to witness the impact of a global pandemic in unraveling our lives and how we chose to live it. Investors would need to go back to the drawing board to revise their strategy on equities to invest in and how to approach the market.As we enter uncharted territories, the era of the docile investor is over…only the flexible,the gritty and the financially liquid will survive!