COVID-19 Roadmap: Reality bites
About the author:
- Author name:
- By Andrew Tang
- Job title:
- Analyst - Equity Strategy
- Date posted:
- 15 June 2020, 7:40 PM
- Sectors Covered:
- Equity Strategy and Quant
The reality for the equity market is that even with strong fiscal and monetary policy support it will be around two years before business conditions get back to the levels needed to support pre-COVID-19 share prices.
Even then, the world may not be as it was. As the Reserve Bank put it: ‘It is quite plausible that the current economic disruption will have some long-lasting effects, not only because it will take some time to restore work forces and re-establish businesses but also because it could also affect mindsets and the behaviours of consumers and businesses’.
The US Federal Reserve also reminded investors yesterday of the very long road ahead as economies attempt to rebuild themselves from the historic plunge in growth and employment.
- On the plus side, with supportive economic policies and preventative measures such as lockdowns and social distancing, it is plausible that we are at or near the low point of the global economic cycle.
- On the downside, there is no certainty in what happens next, and even countries like Australia, which has been effective in controlling COVID-19, remain hostage to a haphazard pace of recovery.
Meanwhile the ASX 200 Index rallied over 30% from the 23 March low leaving ‘normalised’ PE valuations (FY22 Market PE 16.9x) near the pre-COVID-19 highs. As we’ve pointed out over the past few weeks, we think the equity market is pricing in very little downside given the risks.
These include: weaker-than-expected company updates (analysts earnings forecasts continue to fall), a global resurgence of COVID-19 cases (13 US states have seen a significant rise in cases), rising corporate defaults (high-yield credit spreads have widened again), and growing geopolitical tensions (US/Australia/China relations).
Low interest rates and fiscal support can help minimise downside to the economy and support equity prices for a time, but ultimately the extent of the hit to corporate earnings will be determined by how quickly economic activity recovers.
And with both consumer and business confidence still very subdued, we doubt the turnaround in demand is likely to be swift.
In summary, we think the equity market may need a breather since valuations have ‘stretched’ to historically elevated levels that didn’t include a total economic shutdown.
The next 10% rally will likely be more challenging than the last, and while we remain confident equities will trend higher over the next 12-24 months, they are primed to face volatility in the interim.
See our recent Sells, Trims and Non-preferred stocks for trim ideas.
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