Spring 2020

The global financial crisis (GFC) was a failure of the financial system. This is different.

In 2007, the world’s money systems – banks, insurance companies, and stock exchanges – came under huge financial stress, leading to a severe credit crunch and high household debt.

But the Covid-19 recession is more like both a natural disaster and a market disruptor.

It has shocked financial markets, like a natural disaster would, but that impact will be temporary.

We’re seeing the correct response – central banks are cutting rates and governments are helping households and businesses to rebuild.

But it has also been a massive market and political disruptor. There’s been an acceleration of online and digital business, which has come from people being forced to, and then preferring to, work from home.

This is an ongoing market disruption with massive, ongoing, permanent effects.

It’s similar for governments, because global lockdowns are creating the need to offer financial help and reassurance to entire populations.

Policy response, both fiscal (spending) and monetary (what central banks do) has been never been seen on this scale. It is meaningful, and lasting.

The share market is not the economy

Are you wondering why the share market went up when the economy isn’t performing well?

That’s because markets are always forward-looking. So, what you see in front of you today is not what the market is looking at.

Typically, the market looks anywhere between six and 12 months ahead.

For example, the market was rallying in May, when people were losing their jobs. That was because the market was not looking at the May economic situation.

It was looking ahead, trying to make an assessment, and saying, ‘What will the economy look like in May 2021?’. The market tries to anticipate what the future is going to be.

Likewise, when it’s going down, the market is trying to anticipate things getting worse.

Central banks’ cash injection

The second reason why the share market is not the economy is that, since 2008, we’ve seen extraordinary monetary policy intervention from central banks.

That started with quantitative easing, which effectively is central banks printing money to buy bonds.

Money-printing has now extended for over a decade, since 2008, to the point where Japanese central banks are even buying shares.

In the Covid-19 crisis, central banks have stepped up their existing money-printing programmes, big-time.

Asset prices fell heavily at first, but this intervention inflated them back to where they are now.

This prevented a financial crisis, which was the main purpose of providing so much liquidity and confidence to the market.

Central banks have achieved their goal. Money has flooded into the system and, of course, it has found its way into shares.

Term deposits drop

The bad news of all this additional stimulus is that investors’ return on cash is approaching zero, where it has been in Europe for the last decade.

Banks are now flush with cash (which is good news, by the way). That means they no longer need to offer attractive rates on term deposits.

Ten years ago, term deposits could earn you 8 per cent. Now that’s down to 1.5 per cent – probably not enough income to live off if you’re retired.

This means Kiwis who have relied on term deposits for income may start looking elsewhere, perhaps towards riskier assets.

We’ve seen evidence of this, as low-cost investor share platforms are experiencing growth in new clients.

Conservative managed funds may also be of interest to investors because, while they can still dip, they are lower-risk and should give better returns over the long term than term deposits.

Stimulus and second-wave fears

Now we now must think about investing in a landscape where stimulus is driving asset prices. The result is a renewed focus on growth assets.

So, what about fears of a second wave of the virus? Share investors are experiencing vertigo with the highs they’re seeing. What will happen?

Governments have committed to the current course of stimulus and more is likely to be announced globally in the coming months.

I predict wage-support schemes worldwide will be extended further. With elections looming, it would be political suicide to cut people off at this juncture.

If you’re expecting shares to fall back to March’s lows later this year, I’d say the chances of this happening are reducing.

We’ll either steadily recover out of Covid-19 and the situation will keep improving (like a rebuild after a natural disaster), or things will get worse (more aftershocks) and more stimulus is applied until we eventually do recover.

Mike Taylor is the founder and chief executive of Pie Funds. This article is general in nature only and has not taken into account any particular person’s objectives or circumstances. Before relying on it, we recommend you speak with a financial adviser. Information correct as of 16 July 2020.

Definitions:

Quantitative easing: QE is a monetary policy used by central banks and governments to stimulate their economy, often by buying government bonds and increasing the supply of money.

Stimulus: Economic stimulus is steps by governments or central banks to kickstart growth during tough times.

Liquidity: Liquidity means how quickly you can get your hands on your cash or convert an asset to cash.

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