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Home > The Great Disconnect
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The Great Disconnect
20 Jul 2020
In the last decades, global equity investors have gone through several financial crises. From the dotcom bubble burst early in the new millennium, straight through the great financial crises that almost brought about the downfall of the financial system itself, many investors thought they would never again experience that sort of fluctuations.

The COVID-19 pandemic showed us, if any proof was indeed required, that no crisis is identical to the one before it. Given the systematic and global nature of a pandemic, equity markets across the globe experienced some huge drops. Not the largest in history but definitely amongst the fastest on record. The level of volatility and price fluctuation experienced during March 2020 was 20% higher than that experienced in the 2008 financial crises itself.

Depressing as it may seem, this rapidity was a reflection of the velocity by which the pandemic spread across countries and the immediate and abrupt impact this was having on all global economies. Whilst in a recessionary environment, different sectors experience a slowdown in activity over some months, the pandemic literally shut down entire industries on a global scale.

What is also evidently different from previous market crashes, however, is the magnitude and rapidity of the market recovery itself. Whilst equities usually take years to recover the losses following such a seismic economic shock, this time round, in less than three months global equities have almost regained all the territory lost during the height of the pandemic.

This quick V-shaped recovery has taken many by surprise, particularly as the global economy is facing an extreme recessionary environment. In a recent update to its global outlook, the International Monetary Fund (IMF) is projecting a global economic shrinkage of 4.9% by the end of the year. These predictions have been revised downwards by almost 2% in less than two months as the real impact of the pandemic on economies is starting to become more visible. On top of that IMF forecasts seem to point towards a slower recovery next year than what originally hoped for.

Nevertheless, financial markets, particularly global equities seem very disconnected from this bleak economic outlook. Fuelled by an unprecedented economic risk, government and central banks worldwide have reacted swiftly through aggressive monetary and fiscal support. As central banks maintained their ‘easy money’ policies, governments globally are injecting nothing short of $8 trillion through government guarantees, direct spending, tax reductions, deferrals and job protection measures.

Despite this massive economic support, profitability forecasts are however dismal. Many companies are retreating previously provided profit forecasts and many are refraining from providing any forward-looking guidance at all. In this context, it is impressive to see that all major economic sectors in Europe and the US are expected to register a decline in profits and earnings in the next twelve months. 

More worrying is the magnitude of these earning drops. Almost all sectors are expected to register a double-digit profit reduction over the figures anticipated before the pandemic hit the globe. 

The pre-COVID aggregate earnings per share on the largest 500 companies listed in the US was $174. It is now estimated that the average profits for these companies in the next 12 months will be closer to $125. A drop of almost 30%. The situation in Europe is even worse as the largest 600 listed companies in our region are expected to generate a profit for every share of €17 over the next year. This is a far cry from the €28 expected to be generated before the pandemic.

This has led to a situation in which equity valuations are today way more expensive compared to pre-COVID months. Indeed investors are today ready to pay almost $22 for every expected dollar of profits in the US. Ironically, equity investors are today willing to pay much more for a riskier chance of weaker profit.

Equity investors are essentially investing money today in the hope that companies return a profit in the future which is in turn paid back to the shareholders through dividends and capital appreciation. Whilst share ownership is a long-term business, one needs to be sensitive to such evident disconnection between market sentiment and economic fundamentals.
 
This article was published on the Sunday Times of Malta on 19 July 2020. It was written by Steve Ellul, Head of Asset Management at BOV Asset Management Limited (“the Company”).  

The writer and the Company have obtained the information contained in this document from sources they believe to be reliable but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed. The writer and the Company make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in this document. They have no obligation to update, modify or amend this article or to otherwise notify a reader thereof in the event that any matter stated therein, or any opinion, projection, forecast or estimate set for the herein changes or subsequently becomes inaccurate. BOV Asset Management Limited is licensed to conduct investment services in Malta by the Malta Financial Services Authority.  Issued by BOV Asset Management Limited, registered address 58, Triq San Zakkarija, Il-Belt Valletta, VLT 1130, Malta. Tel: 2122 7311, Fax: 2275 5661, E-mail: [email protected], Website: www.bovassetmanagement.com. Source: BOV Asset Management Limited.
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