Investment officeJuly 14 2020

Investment Team Update: What is the market discounting?

2 mins read

StJohn Gardner

Chief Investment Officer

With the MSCI index of companies globally having recovered to near levels seen at the beginning of the year, it would seem that investors have decided that the Coronavirus will have no lasting impact on future corporate growth and profitability. Indeed, some markets have reached new highs, with the S&P 500, which took just 22 days to fall 30% in March, having gained 38% in just 50 days subsequently. Of course, confidence has been bolstered by the huge additional stimulus, but the rally in markets is against a backdrop of one of the worst expected downturns since the Great Depression, according to the International Monetary Fund, which expect the global economy to contract 4.9% in 2020 before growing 5.4% in 2021.

The fast shrugging off of the immediate issues perhaps seems to relate to historical precedent of health issues, combined with the fast paced and substantial government stimulus efforts and perhaps plain ‘animal spirits’ in the face of adversity. Previous health crises have had a temporary effect on the economy so it stands to reason this time it could be the same and the medical industry will either defeat the virus or humankind will adapt our way of living and working to cope with it. Markets tend to look through current woes and focus on the expectations of earnings into the future, investing in those firms which the consensus believes has good prospects of recovery or with those where the investor feels the market’s expectations of future earnings is poorer than their own more bullish outlook. Shares can exist for a long time and potentially produce an endless stream of earnings. It is this long term belief that keeps those with wealth and assets, and with no immediate spending need but a desire to at least retain the purchasing power of their money, invested for the future. Short term dips in earnings will have minimal impact on the value of long term earnings steams; it takes a sustained hit to earnings and / or a loss of confidence to create a longer term bear market. Confidence is clearly in abundance which we can see through the price / earnings ratios which remain higher than their long term average but not massively so. Nevertheless, there are costs associated with even the basic hygiene methods being instilled upon people and businesses, not least the risk that lockdowns are re-imposed and then lifted and then re-imposed again in a perpetual cycle that prevents businesses, over an extended period, returning to the earnings streams they previously enjoyed.  

In conclusion, there remain significant risks to the level of ongoing corporate earnings and thus their stock market valuations and we should expect to continue to witness heightened volatility until a more defined trend emerges.