Investment Insights -
Economy vs share market
One of the most common questions we are asked is does the rosy outlook and performance of share markets make us uneasy when it is contrast against the underlying economy? In this Investment Insight we answer why a share market recovery will differ from the wider economic recovery.
Share markets in the United States and New Zealand have followed a dramatic V-shaped recovery. As we wrote in 01 May 2020 | Market Update 9, a V-shaped recovery represents the most bullish outlook and would consist of a rapid return to the same level of output once social distancing restrictions are removed.
While the brutal sell-off has now given way to a lively recovery in the share market, a V-shaped path for the economy—a brief recession, followed by a swift recovery—seems unlikely. The scale of job losses in New Zealand and globally suggests the economy is in a hole too deep to climb out of quickly.
So why has the stock market rallied so hard?
Share markets tend to be forward-looking. Investors have already accounted for what’s expected to be a cataclysmic drop in economic activity and are forecasting a relatively rapid economic recovery afterward.
Being positive and forward-looking in part reflects the ‘bazooka’ efforts by governments to backstop the economy. In our 27 March 2020 | Market Update 4, we summarised the New Zealand Government’s response in announcing the largest stimulus package in the country’s history. In the United States, the Senate approved the largest economic stimulus package in modern history. At the same time interest rates have hit the floor and are unlikely to increase any time soon, further bolstering company earnings and making share market returns much more attractive than holding cash.
Tellingly, though, the recent rise in share prices has been uneven. As highlighted by The Economist last month, share markets in Europe are full of troubled industries like automobile manufacturing, banking and energy, which have all lagged. This compares to the United States which has put faith in a group of tech darlings—Alphabet, Amazon, Apple, Facebook and Microsoft. This small group now makes up a fifth of the S&P 500 index. Healthcare shares and consumer staples have also proved resilient.
This means that, although the market has risen sharply, share markets are not looking much beyond shares judged to be recession-proof. The market’s V-shaped recovery is selective, rather than an indication of a broad-based recovery. Being an active manager allows us to select the companies, industries and geographies which we think will perform well in this uncertain environment. A good example is clients’ overweight to technology, growth and quality shares.
Where to from here?
As more countries ease lockdown orders, citizens are starting to eat out, book flights and buy houses again. The return of these activities is stoking optimism. But the mood of share markets can shift suddenly, as an extraordinary couple of months has proved.
While the journey will likely remain volatile, the median recovery period following a share market fall of 20% or more is only 211 trading days. NZ Funds’ view that share markets grow in value over time means that the opportunity is right to re-engage with the market for the long term.
Share markets in the United States and New Zealand have followed a dramatic V-shaped recovery. As we wrote in 01 May 2020 | Market Update 9, a V-shaped recovery represents the most bullish outlook and would consist of a rapid return to the same level of output once social distancing restrictions are removed.
While the brutal sell-off has now given way to a lively recovery in the share market, a V-shaped path for the economy—a brief recession, followed by a swift recovery—seems unlikely. The scale of job losses in New Zealand and globally suggests the economy is in a hole too deep to climb out of quickly.
So why has the stock market rallied so hard?
Share markets tend to be forward-looking. Investors have already accounted for what’s expected to be a cataclysmic drop in economic activity and are forecasting a relatively rapid economic recovery afterward.
Being positive and forward-looking in part reflects the ‘bazooka’ efforts by governments to backstop the economy. In our 27 March 2020 | Market Update 4, we summarised the New Zealand Government’s response in announcing the largest stimulus package in the country’s history. In the United States, the Senate approved the largest economic stimulus package in modern history. At the same time interest rates have hit the floor and are unlikely to increase any time soon, further bolstering company earnings and making share market returns much more attractive than holding cash.
Tellingly, though, the recent rise in share prices has been uneven. As highlighted by The Economist last month, share markets in Europe are full of troubled industries like automobile manufacturing, banking and energy, which have all lagged. This compares to the United States which has put faith in a group of tech darlings—Alphabet, Amazon, Apple, Facebook and Microsoft. This small group now makes up a fifth of the S&P 500 index. Healthcare shares and consumer staples have also proved resilient.
This means that, although the market has risen sharply, share markets are not looking much beyond shares judged to be recession-proof. The market’s V-shaped recovery is selective, rather than an indication of a broad-based recovery. Being an active manager allows us to select the companies, industries and geographies which we think will perform well in this uncertain environment. A good example is clients’ overweight to technology, growth and quality shares.
Where to from here?
As more countries ease lockdown orders, citizens are starting to eat out, book flights and buy houses again. The return of these activities is stoking optimism. But the mood of share markets can shift suddenly, as an extraordinary couple of months has proved.
While the journey will likely remain volatile, the median recovery period following a share market fall of 20% or more is only 211 trading days. NZ Funds’ view that share markets grow in value over time means that the opportunity is right to re-engage with the market for the long term.
Source: Bloomberg, Stats NZ, NZ Treasury forecasts (in red), New Zealand share market index is S&P NZX 50 Portfolio Gross Index.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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James Grigor is Chief Investment Officer for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. James' comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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