Why is the stock market doing fairly well, while we expect economy to go into recession

There is no doubt the economy globally is getting into a recession. Technically, recession is when an economy faces a decline in two consecutive quarters. Most economies are facing lockdowns situation between the end of first quarter and second quarter of 2020. That by itself would have caused a technical recession for the 2 quarters. For some economies that are dependent on foreign purchases of our services, goods (such as Malaysia, Singapore, Thailand), even if we do well for our local economy, lower demand from overseas would cause a recession nevertheless. What is in most economists and government would be not to allow prolonged recession which is what we termed as depression. In short today, the argument is to whether we are moving into a depression or not and how to prevent it.

This time around people have been shocked by the so-called disconnect between the general economy (which we called Main Street) and stock market. In US, while technical unemployment is registering close to 20%, its Wall Street (stock market) is actually registering record numbers (Nasday which is mainly for technology stocks). Many stock markets although have not been registering as good numbers as Wall Streets, it nevertheless has rebounded and seemed to be doing well. KLCI which is the main blue chips stocks in Malaysia, is not at 1,556 points after touching a low of 1,219 on 19 March 2020, days after the Movement Control was announced. Our peak was about 1,878 points, the period when oil price was still registering above USD100. Hence, I would call it that the market is now at midpoint. However, the economy is seemingly going to suffer beyond the mid-point level for the stock market as we suffered a what I would call a double whammy - COVID-19 pandemic and low oil price (our economy is dependent to a large extent on oil).

Now the question is why is the stock market holding up? Here are a few explanations.

Emergence of retail investors

I have been investing in the market for a while. The last time I have seen the huge participation from retail was 1997 - prior to the last major Asian financial crisis. During then, we were trading at what we called T+7, which was we only pay 7 days after we made our trade. Today it is T+2. Hence, during then a lot of people were playing contra - where we do not have to pay for the trade until many days later. Hence, during the trade, if the stock rises, we do not need to pay any money for the purchase. Since the crisis, with EPF (a very large fund) started to come into the stock market, retail players started to dwindle. The market has been largely determined by how EPF and several smaller others wanted the market to be (together with smallish foreign institutional funds).

The emergence of the retail investors seemingly is appearing from the lockdowns. I have started to hear doctors, lawyers, young professionals, executives started exploring the market. I call this healthy as it is obviously a financial lesson for many of them whether they made money or not. (I am not worried of rich doctors losing money in the market and started learning about fundamentals - they can learn fast)

One of the stockbroking license holder which focuses on retail (Rakuten) for the first time experience profits. Now, whether post COVID-19 these retail investors remain. I hope so, as the market is starved of new groups of investors. Imagine, how eager for us to hope for this group while these new investors whom have been looking at other asset classes such as bitcoins, forex are now putting some attentions on stocks. The focus now is for them to make money over the long term rather than losing and leave.

Stocks as alternatives for other investment assets

As mentioned above, while the younger generations have gone into other kinds of investments, this time around those alternatives are not doing well. Those includes commodities mainly and to a smaller extent bonds.

It helps when in US, the largest of the stocks such as Amazon, Microsoft, Netflix are expected to report record numbers. In Malaysia, those are the rubber gloves companies. It does help to spur the stock market economy as there are no substitutes for investing into rubber gloves companies if not investing into the stock market. Similarly, there is no other way to invest into Amazon.

Flush with liquidities

The Federal Reserve of US is throwing $4 trillion or more into the economy. We are far, but we will get some as well. In Malaysia, we are getting hundreds of billions of stimulus cash or other forms. Imagine if the banks tell us we do not have to pay our loans for 6 months, we suddenly have extra cash. That is probably where money will flow into the stock market. At the same time, when we cannot spend outside of our homes, we may buy some goods online, the remaining some would probably go into the stock market. Profits feed more liquidity into the market and this time around the liquidity is into the hands of the small guys rather than the institutionals - which is good.

In addition, when the system is flush with liquidity with the Feds printing money, it also means the cash we hold has come down in value. This encourages even with the complex investment thoughts not to hold cash in the long term as the money they hold would lose value.

I have been chasing where the money has flowed to - however I have missed out that it actually moved from the banks (system) to the hands of the consumers but some of it ended up in the market. I have originally thought that the institutional guys (such as funds) would be keeping funds to pick up the debt instruments. It has yet to really happen.

Market valuation is a not a fix situation

One of the reason I have never put a price onto a stock - although I generally think what a price would be for me to be interested. When interest rates go to zero in US and in Malaysia, dropped by more than 1%, that investments or savings would tend to move somewhere else. The opportunity investments from bonds or fixed deposits would be other asset classes. In finance, we call this risk free rates. So now risk free rates has dropped, so when we do a discounted cashflows, the other alternative asset would increase in price. Example for this, risk free rate drop to 2% - generally this means I am willing to take risk of a straight line PE (better still DY) of 50x (not encouraging the thinking that a 50x PE is a fair value but just as example). In the past, when risk free rate was 4%, that PE I was willing to tolerate was 25x. That is a 1 single X factor increase.

Will this trend last?

I hope it does last long enough. Nothing beats the need to rekindle or beefing up the Main Streets. However, the market itself can play a role as happy investors will translate into happy consumers. This is the way generally the poorer income group (here we call them B40) can get helped besides giving cash alone.

The financial economy (includes capital markets) is also a part of the economy, and we need to get this to be more active.