Rod Oram: This way lies market madness
The global economy is tanking but stock markets keep rebounding. Rod Oram tries to explain the seemingly inexplicable.
We humans seem to have an infinite capacity for madness. Take, for example, Dave Portnoy, the self-styled “supreme” leader of US stock market punters. He picks three Scrabble tiles out of a little red bag, chooses the ticker symbol closest to them, and buys the shares, in this case in Raytheon, the US aerospace company.
He says it doesn’t matter what he picks. Shares only go up. And anyway, he says he’s “buried” Warren Buffett to claim the title of the undisputed greatest stock market investor ever. No matter the Raytheon shares have fallen since he bought them five days ago.
Portnoy’s complaint seems quite common, judging by the way stock markets around the world are performing.
The NASDAQ, which is heavily populated by tech stocks, has just set an all-time high, up 47 percent from its Covid-induced trough three months ago; the S&P 500 hit a record on February 14 but by March 23 had plunged 34 percent to its Covid-low before recovering two-thirds of its losses; and our NZX50 plunged 30 percent from its February 20 all-time high and has since recovered to a loss of only 8 percent.
Meanwhile out in the real global economy, Covid-19 cases are rising and economic activity is falling. The latest forecast from the IMF is a 4.9 percent drop in global GDP this year. It had forecast growth of 3.3 percent at the beginning of the year. NZ’s GDP is forecast to fall at least 6 percent this year, the steepest decline in decades.
“There is almost no correlation between stock returns and real GDP growth . . . In short, there is almost nothing of use to investors from poring over current macroeconomic data, which is one reason why markets have started ignoring them,” Aswath Damodaran, a finance professor at New York University, wrote recently in his blog Musing on Markets.
Yet, he still believes “there is always something that can be learned from market movements. Right now, it is true that markets are collectively more upbeat about the future than most economists/market experts, but given their relative track records over time, are you really more willing to trust the latter? I most certainly am not!”
Here are three of the biggest factors driving stock markets which he and some other analysts point to:
- Tsunami of funding: “Markets follow money,” says CrossBorder Capital in London. It calculates the total stock of financial assets in the world is currently worth US$231.7 trillion. But by year-end the global liquidity pool will rise to more than US$160 trillion, up some 25 percent during the year, thanks to central bank and government stimulus measures.
Back in 1980, the ratio of financial assets to liquidity was close to 1; it peaked at 2.3 in 1999; fell back to 1.5 during the Global Financial Crisis; and recovered to 1.8 pre-Covid. Currently, the ratio is 1.7 even with all the stimulus applied so far. But by year end it would fall to 1.45 if asset prices didn’t rise as liquidity increases. If they’re chasing the 1999 peak, markets have got a long way to go yet, which will only make them even more removed from the real economy.
While some of that stimulus money is supporting real economic activity, a large proportion of it is going into massive bond buying programmes by central banks in a frantic effort to keep credit flowing in the economy. But that drives down interest rates to minimal or even negative rates. Thus, some investors, desperate for any kind of return, are piling into stock markets.
Meanwhile, the stimulus money makes it easier for companies to refinance loans, borrow more or in other ways still attract investors to their equity. The most absurd example so far is Hertz, the US car rental company. It has filed for Chapter 11 bankruptcy proceedings, a move that almost always wipes out shareholders. The Securities and Exchange Commission warned that investing in such companies was “extremely risky” and warned doing so is “likely to lead to financial loss.” But the shares have kept rising.
Investors have become addicted to stimulus. And they are sure they will get it. “We really are going to use our tools to do what we need to do here,” Jerome Powell, chairman of the US Federal Reserve, told Congress in March.
The NZ stock market is exhibiting exactly the same behaviour. Shares in many companies have recovered far more strongly than their business outlook over the next few years could justify. Three examples are Auckland Airport, Air New Zealand and Tourism Holdings. And, likewise, investors have every confidence the Reserve Bank and the Government will keep copious stimulus flowing.
Sixteen stocks on the NZX full board have more than doubled in price in the three months since the market bottomed in late-March. The best performer, Marlin Global, “invests in quality, growing international companies and its portfolio typically holds between 25 and 35 stocks.” Its warrants are up 318 percent.
The top five, which are up more than 249 percent, include Tourism Holdings and Serko, two companies whose customers are mainly international travellers.
- Not all stocks are equal: Beneath the dramatic rise in stock markets are some crucial variations. US markets, which are heavier in tech stocks, are out-performing European ones which are heavier in cyclical industries. And within markets, tech, health and consumer staple companies are out-performing energy, airlines, consumer discretionary companies, aerospace and other manufacturing. This broadly reflects winners and losers in the Covid-economy.
In the S&P 500 for example, five stocks account for 20 percent of the index’s market capitalisation – with the other 495 accounting for the other 80 percent. The five – Amazon, Alphabet (parent company of Google), Apple, Facebook and Microsoft – have out-performed the market while helping to drive it up.
But four of those companies have surprisingly few employees. For example, Apple’s staff worldwide numbers only 137,000 and Microsoft’s 151,000. Yet, both have market capitalisations greater than US$1.5 tr. By comparison, back in the early 1960s when stock markets reflected the real economy, AT&T and General Motors employed nearly 1.2 million people combined.
We have a similar pattern here. Fisher & Paykel Healthcare and the a2 Milk Company have the third and fourth largest stock market capitalisations behind two of the Australian banks. Yes, they have good growth prospects but they are unrepresentative of the economy. F&P has 4,200 employees (mostly in New Zealand); a2Milk had 228 globally according to its 2019 annual report. The number here is likely less than 10, although, in addition, hundreds of farmers supply it with milk and the likes of Synlait Milk contract manufacture for it.
The NZX50 companies generated only 10 percent of GDP and 3 per cent of the government’s tax revenue, according to a 2018 report by NZIER on the NZ stock market’s contribution to the NZ economy. Of course there are listed companies which are sensitive to the behaviour of consumers and the economy but whatever signals they're sending are largely lost on investors.
- Retail traders pile in: The NZX’s trading volume was up 212 per cent in the year to May but the value of shares traded was up only 45 percent. That’s a sure sign of an influx of retail investors. Likewise, there is clear evidence that institutional shareholders have sold down heavily from Air NZ since February, for example, with retail investors taking their place.
Retail investors have a number of new online services to help them trade. But the first question they should ask themselves is whether the service is regulated or not. For example, Sharesies, which offers a limited range of shares, is. But Stake, an Australian app offering full access to US shares, is not. This excellent article by Tim Hunter in the National Business Review, explains how Stake works and why the Financial Markets Authority has decided not to regulate it.
In the past year, Sharesies’s share of retail trading transactions on the NZX has gone from zero to 27 percent, but its share of retail trading value has gone from zero to less than 3 percent, as the accompanying charts from the NZX show.
Meanwhile in the US, the retail stock trading frenzy is extreme, as Portnoy’s Scrabble picks show. A flood of new customers has enabled well-established apps such as Robinhood and a wave of imitators to force established brokerage houses to cut their online trading fees to zero.
One new source of customers is sports bettors who have turned to the stock market while professional sports are in abeyance. They are considered one reason for a surge in options trading because they like win/lose bets. The Chicago options market is signalling its most optimistic market outlook in 20 years.
While this flood of retail investors is insufficient to move the market on its own, it is very much the foam on the tide of money pouring into the markets.
Says Steve Sosnick, the chief investment strategist at Connecticut-based Interactive Brokers, an online trading platform: “You have heard of a flight to quality. How about a flight to crap? You’re seeing a speculative fervour.”
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