Treasurer Josh Frydenberg admitted the inevitable, on Wednesday.
Australia is in a recession.
Under the accepted definition of a 'technical recession', Australia would need two quarters of GDP contraction in a row.
(Don't get me started on arbitrary labels. That's a rant for another day.)
And Wednesday's GDP numbers for January to March showed a decline of 0.3%.
In ordinary times, that's the first shoe to drop, and we'd all wait to see what the April – June quarter brings, hoping madly to avoid having to use 'the R word'.
But these aren't ordinary times.
Everyone accepts that coronavirus restrictions will bite — hard — making the current quarter an absolute lock for economic contraction.
So sure are we all that even the most optimistic, clinging-to-the-faintest-hope politician needs to admit that we're in recession.
It's a foregone conclusion.
So the market crashed on the news, right?
Not so fast, Olly.
The ASX 200 was up 1.8% on Wednesday, the very day the news was announced.
Huh?
Not only that, but we've gained around 20% since the mid-March lows.
The economic news keeps getting worse. The ASX keeps getting better.
So much for the doom-and-gloomers, thus far at least.
Buy why? How?
Before we get to that, Flight Centre Travel Group Ltd (ASX: FLT) and Corporate Travel Management Ltd (ASX: CTD) (I own shares in the latter) were up 8% yesterday on nothing more than an announcement that Qantas was tripling its number of daily flights: from 'bugger all' to 'not quite bugger all'.
No actual extra flights, yet. No extra bookings, yet. Just an announcement, of an intention, by one airline, while the other domestic airline remains mired in administration.
Huh?
Has the market lost its marbles, or is there some sanity prevailing here?
I think it's the former. Here's why:
I want to present you with a simplified version of the sort of algebra that wonky analysts do to value companies.
In the full, complicated (but really useful) version, they forecast growth, and allow for an expected return. They also recognise that if $1 in 5 years time is worth less than $1 today (because, why wait for the same return if you don't have to?). That's the 'time value of money'.
So the summary below is woefully simplified for the purpose of valuing a company, but is useful to illustrate a point.
Let's say you have $100, and I offer you 10% a year for 5 years.
Assuming I'm as good as my word, in 2025 you'll have $150 (your $100 back, plus $10 per year).
Now, let's say I came to you and said 'Look, there's this coronavirus thing. I can't pay you this year. But it'll be over soon enough. I'm pretty sure I can pay you next year, and we're both convinced I'll definitely be able to pay you in 2022'.
Your investment won't deliver $150 any more.
The $10 payment in 2020 is gone. And 2021 is uncertain. Maybe a 50% chance.
Your $150 is reduced by $10 for 2020, and we'll lop $5 off our expected 2021 payment.
Instead of getting $150, you reckon $135 is more likely.
Your money is now worth 10% less than it otherwise would have been worth ($135 divided by $150).
Apply that to the sharemarket (with the caveats I outlined above), and shares should fall by 10%. And maybe 15% once you factor in all of that 'time value of money' stuff.
So how much did the market fall between mid-February and mid-March? About 38%, give or take.
Seems kinda overdone in hindsight, doesn't it?
And, given that, the rally over the past 6 – 8 weeks seems rather logical, rather than blind optimism.
And even more so, given the regular stimulus announcements made during that time, adding more cushioning for a struggling economy.
The 'don't panic' message is one I've tried to hammer home in this space ever since the beginning of the pandemic. So far, it's been the right approach.
I'm not a 'victory lap' kinda guy. And even if I was, it's patently obvious the race isn't over.
There are a multitude of things that could go wrong, for the economy and for markets, over the coming months. Frankly, the most likely cause of a market fall is probably investor sentiment, I reckon. Investors and traders run in packs.
Right now, they're all believing in each others' confidence. If that starts to wane, the pack can reverse course quickly. That's how we ended up with the stock market's pandemic overreaction (not to the health crisis, but to the economic impacts) in the first place!
About now, you might be thinking "Yeah, but the economy!"
It's true, the economy is suffering right now. But 'the economy' isn't really a thing, other than a conglomeration of the people that make up business owners, employees, parents, kids, retirees and everyone else.
So it's important to remember that it's not the economy that suffers, but people.
And, as WSJ columnist Jason Zweig tweeted yesterday:
"It is deeply uncomfortable to watch Wall Street party while Main Street emerges from lockdown into tear gas, but the market isn't taking a moral position."
It is uncomfortable.
But don't let that blind you, as an investor, to the way you need to think about markets.
Share prices are, at their core, 'the sum total of all future cash flows, discounted for the 'time value' of when that cash is received'.
And, as with my super-simplified example above, even a dead stop in profits for one year doesn't impact the underlying value of a company as much as you might think (or as much as the market assumed, in March).
Remember, too, that while shares are up 20% over a couple of months, they're still around 17% down from the late February high point.
Context is a funny thing. "How on earth are shares up 20%?" and "Shares are down almost 20%" are both correct — but the starting points (and dates) are different.
I understand the feeling of not wanting to invest until 'the coast is clear'.
But it's important to remember that by that time, prices will likely be much higher.
The stock market is absolutely connected to the economy, but the timeframes are hugely different.
Wednesday's GDP was a snapshot of a recent — yet past — three month period.
Share prices are an estimate of all — future — cashflows, from here to eternity.
It requires a very particular effort to partition those things, and treat them separately.
Many can't. That'll probably cost them a fortune.
We confuse those two things at our peril.
And I think you and I should keep investing, with our eyes not on yesterday or today, but on the long-term horizon.
Fool on!
