By Myooran Mahalingam, portfolio manager, global equities, MLC Investments
This content is produced by The Australian Financial Review in commercial partnership with MLC.
While equity markets have rebounded strongly from the initial shock of the world economy basically shutting down as a result of COVID-19, this burst of optimism needs to be tempered with a note of caution.
There are a couple of major reasons for this approach. Firstly, the range of possible outcomes is still very wide as economies emerge from pandemic-induced lockdowns. Therefore, markets will continue to be volatile where sudden dips followed by strong rises are quite possible.
Secondly, much of the rise in markets has been concentrated on those companies that are perceived to have been beneficiaries of the shutdown. Put bluntly, global equity markets, which have now bounced back to be close to flat for 2020 are being led by the winners in this new environment such as companies in the information technology sector and e-commerce.
Equity markets have become bifurcated as the tech stocks have carried the markets back to near all-time highs, yet more than 60 per cent of stocks are more than 20 per cent away from their pre-pandemic highs. So while companies such as Amazon, Netflix and Microsoft have thrived, many stocks have been left behind in the recent rally.
This bifurcation now sees the top five stocks (Facebook, Amazon, Apple, Alphabet and Microsoft) account for more than 20 per cent of the US market’s entire value – the most concentrated it has been in history.
Part of the reason these companies and others like them have thrived during the pandemic is global lockdowns have in many ways accelerated the rate of change in economies we knew was coming with increasing digitisation. We’ve begun to see how major structural shifts in a digitised society might play out. For example, the changing nature of work with more people working from home, as well as entertainment with consumers utilising streaming services and online shopping.
Moreover, the success of the tech companies has inflated other company values. It’s also important to note that markets and economies have a different view of the world – markets look forward but economic performance is generally measured on historical data like employment levels, manufacturing output and retail sales.
Share markets are already looking beyond the current quarter and factoring in a V-shaped recovery. There is some reason for this exuberance. Last month saw an unexpected recovery in US employment and the share market continues to rise, spurred by government stimulus and a sense that the economy is beginning to normalise – Siri requests for driving guidance in the US have returned to January levels, while foot traffic in European malls is back to 80 per cent of pre-crisis levels. But this may be simply pent up demand driving a short-term spike in consumer behaviour.
Then there’s the increasing confidence that a vaccine will be found sooner rather than later, although expert opinion suggests it will take a minimum of two years to develop. That’s before we factor in how affordable the vaccine will be and how it will be distributed globally.
There are also important macroeconomic questions that we can’t answer yet. For example, what sort of structural changes are we likely to see to global supply chains? Will just-in-time inventory become just-in-case?
Bearing all of this in mind, there are a number of key messages for investors. Firstly, they should take a long-term view and not be panicked by short-term volatility. Secondly, maintain adequate portfolio diversification given the broad range of possible outcomes. Finally, be prepared to be offensive when others are fearful and defensive when others are greedy.
There are still lots of important questions. Will there be a second wave of infections? How will emerging economies cope as the pandemic spreads in countries where health systems are not well-developed? How will geopolitical tensions play out, especially between the US and China?
The one thing we can be sure of is that the answers to these questions will have a profound impact on the future of the global economy.