Following its one-month 36 per cent decline from peak (20 February 2020) to its low (23 March 2020), the ASX200 has bounced 20 per cent. That’s a return most investors would be happy with over a year. The question is whether such optimism is warranted.

The bounce reflects the relatively simplistic and arguably misguided idea that peak virus infections and deaths will pass quickly and that central bank interventions in the bond market, which cheapen credit to businesses and households, and government stimulus such as wage subsidisation, will subsequently trigger a surging return to prosperity.

But it is important to note that, prior to the outbreak, economic growth was already faltering. Growth in China was slowing, a recession in Europe was widely predicted and US job availability, employment and wages were sliding.

When an economy is growing very slowly and asset prices are extremely stretched, not much is required to burst the bubble. COVID-19 represents a serious pin.

What we are now left with is a plethora of concurrent uncertainties.

First there’s the pandemic itself and getting on top of the virus is the first step. Herd immunity and or immunisation is the end goal. But today, lockdowns and curve-flattening are the tools to prevent outbreaks overwhelming medical systems. Amid 134,000 deaths globally, our best guess is that compliance with lockdowns might be in the region of 70-90 per cent. In Australia, for example, that means 2.5 to 7.5 million could still potentially spread the virus either because of dissension or they are essential workers.

The South Korean experience indicates that even with very effective draconian measures in place, the numbers decline much more slowly than they rise.

False dawns are likely. We may see countries relax the lockdowns before re-implementing them. As my colleague Tim Kelley noted, while improved testing, tracking and treating should see us move progressively closer to normality, even absent a vaccine, full normality could take quite a while. A return to normal too early risks a second outbreak and another lockdown as China’s Jia County has just discovered.

Meanwhile the speed with which the world has come to a crashing halt has seen the International Monetary Fund’s managing director, Kristalina Georgieva comment that the economic crisis is “like no other,” adding, “It is way worse than the global financial crisis.”

Restarting the economy will take time, if only because a population concerned about its health and safety is much more an anchor than one merely concerned about the economy. And as I have previously pointed out, we can’t truly return to normal until we have a vaccine.

Even if we get the virus under control, the optimism in the market may turn to dismay when investors appreciate the depth and reality of the resultant economic challenges. Workers unemployed for extended periods suffer from a reduction in the relevance of their skills, uncertainty surrounding employment and income prospects thwart spending, as does the plunge in savings, dependence on welfare rises and supply chains are damaged.

The US jobless queue is far above even the most pessimistic forecasts and unprecedented in history – while underscoring the damage already impacting the U.S. economy. And keep in mind these are numbers from a period before the worst of the crisis had impacted the US economy.

In that context it is easy to see why the trillions spent through fiscal support programs are just that, support programs. They aren’t stimulatory. Trillions in GDP are being lost every month. The positive economic impact of a few trillion in stimulus is debatable. The misplaced optimism in markets due to the stimulus, less so.

Elsewhere, with interest rates at virtually zero, many European governments are able to borrow as much as they want to navigate the crisis. But Italy’s 10-year bonds now trade at a yield of 150 basis points – 200 basis points higher than German Bunds. Consequently, geopolitical fissures are emerging in the European Union. In normal circumstances fears of a rupturing of the EU would put markets in a spin. But in the goulash of current circumstances, a collapse of the European Union is just another ingredient the market has no capacity to taste or appreciate.

Back in the US, many are quickly realising how dependent the nation is on China. When the majority of inputs for everything from antibiotics to electronics come from China – a country now considered notorious for obfuscation, IP theft and revisionism – a rethink of the very globalisation that made China is likely.

Here at home, economists are expecting a neat 3.5-4 per cent economic contraction. Perhaps they haven’t chatted to the Minerals Council of Australia, which warned miners might cut production by half or cease operations altogether if state borders remain closed, blocking labour from travelling.

Meanwhile, expect a conga line of equity-destroying capital raisings and cost cutting. Flight Centre raising $700 million and jettisoning 50 per cent of its 1600 stores, and Auckland Airports raising $1.2 billion, is just the tip of the iceberg.

In fact, for as long as fund managers continue to fund these capital raisings there is probably still too much optimism for the market to bottom.

Jonathan Rochford

Nice summary Roger, Italy's spreads could go a lot higher if investors start to believe that Germany's appetite for Greek and Italian bonds has a limit, like they have often stated

Wayne Terry

Well put. I think many investors are basing their views on the fact the markets are forward looking indicators, so everything must be priced in, right? You've pointed out a few things that may not be. I also wonder how markets react to a potential start/stop reopening of economies because that'll be pretty unpredictable in terms of timing. Ultimately, I don't think markets would like that kind of uncertainty. I'd be interested in your views about the 'lower for longer' argument which has been so popular in the last couple of years. Do you think this changed given all the fiscal and monetary stimulus we are seeing? What does this do to risk premiums?

Roger Montgomery

Thanks Jonathan. Hi Wayne, I think the discussion about lower interest rates must contemplate an ‘end game’. Do we see governments unable to fund debt, so forced to print $$$, debase currencies, inflate their way out resulting in a massive resetting of interest rates/required returns? Of course inflation doesn’t occur while we can import deflation through cheaper labour but with spare productive capacity locked down, printing dollars may be very inflationary, with implications for the cost of capital.

Christian Toime

Many virologists that a vaccine is not possible. What then ?

Steven Goakes

Thanks Roger, I agree with your insights. Of the economic forecasts I have read so far, all appear to be based on some form of status quo-based underlying assumption set which doesn't happily accord with what we are seeing 'on the street'. I fear that Winston may have been correct here to: "Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning."

john bassett

A very well written article Roger. Thank you. The problem is that everyone still has a bull market mentality, hence the strength of the recent US stock market rally. Today oil futures crashed. If that isn't the canary in the coal mine I don't know what is. Unfortunately, I don't think this virus and the consequent fall out are going to be shrugged off easily. It may be some time before the development of a vaccine and things get back to some kind of normal.

Roger Montgomery

Hi Christian, a return to volatility and a reset of earnings expectations perhaps?

Roger Montgomery

Thanks Steven, yes indeed. And Churchill will always be a great source of inspiration..and quotes.

Roger Montgomery

Thanks John. Delivery logistics and storage mechanics have had a lot to do with the expiry of the May futures contract. The steepness of the contango curve however will hurt a lot of oil traders and investors. SO perhaps not the canary in the coal mine as much as a reflection of already-known collapse in demand. Agree the market might have been too optimistic too soon. Markets tend not to be very patient and so a return to weakness seems entirely plausible.

Philip Somers

Enjoy reading your views Roger. What is backing all the money printing around the world? Is it debt? If so how can it possibly be repaid?

Billy Weston

You have a penchant for drama Roger. I well remember your assertion that China was littered with empty apartments that would never fill some years ago, while predicting an explosive collapse in property prices. There were, you said, similarly large proportions of empty apartments in Sydney - collapse imminent. I did OK in the Montgomery Fund for a number of years - I guess we both did. Thanks for that, but I have learned that you are by nature a pessimist. Of course, this temperament is ideally suited to a significant proportion of investors.

Carl Maissan

Love the Churchill quote "...perhaps the end of the beginning"! Very apt I think. To me it's a a no-brainer that most equities are still far too exxy relative to economic reality & outlook for next 12 months. The real question l have is whether this will trigger unwinding the "bubble of everything" in asset prices beyond equities (real estate, art, bonds, etc)? On one hand, with stimulus & QE there will be even more capital looking for a home, which could help prop prices. On other hand, will also be a sig downward impact on demand & earning capacities at an individual person & company level, plus reductions in global trade & huge public debt. Thoughts?

David Heath

Thanks Roger. Here are a few more optimistic comments. (1) It seems to me that there was more uncertainty say 1-2 months back because we did not know then that lockdowns could significantly reduce spread of the virus and avert a complete collapse of health systems. (2) You could argue that the disconnect between the markets and the economy stated with the GFC and we have survived more or less for the last 12 or so years. (3) With the GFC it was unclear for many years if we were out of the crisis and what was the role of QE in protecting markets and the economy. Surely with this virus the worst will definitely be over in say 6-12 months. On the other hand unlimited stimulus surely has some type of upper bound. For example if globally we introduced say USD 740 trillion of stimulus we could then give every human USD 100,000 as a "support" payment.

Roger Montgomery

Thanks Philip. The reputations of governments and in the case of the US, no alternative to its status as the reserve currency.

Roger Montgomery

Hi Billy, Property prices fell as expected up until the federal election when I wrote we’d seen the low - and I upgraded the house. I’ll be “fearful when others are greedy and greedy when others are fearful”. As stated good buying opportunities are when there’s 1)max panic, 2) capitulation, and 3) a wave of deeply discounted capital raisings. That’s when broad value will be available. At other times opportunities will be stock specific. Please read our blog where we discuss the fact COVID-19 will inevitably end, we will move on and you want to be invested before a vaccine is announced which could be sooner than current predictions. That said, thanks for your thoughts.

Roger Montgomery

Hi Carl, I am wondering whether the high levels of debt can only be paid with significantly more money printing, ultimately impacting the cost of capital.

Roger Montgomery

Good thoughts David.

Brett Davies

Spot on Roger. And particularly well articulated. I have been bamboozled by the optimism in the market. It seems that there is a plethora of positive discussion, which in turn becomes a distraction and diversion. I have a picture of unsuspecting investors happily fossicking for little mushrooms which the investment market deems "opportunities" - on the railway tracks. My economic reasoning is that even beyond the massive loss of jobs there will be an absolute collapse of consumer and business spending short term and long term due to changes in thinking and positioning. How can there not? That will absolutely choke business and economies and the flow on effect will fundamentally impact every company. Medical solutions of course will be fantastic but, they will take time to roll out to 7.6 billion people and won't change much of what is already underway. I don't believe it is 'doomsday' but I do believe the market is substantially underestimating the impact on our world.

Roger Montgomery

I hear you Brett and while I currently agree with that line of thinking I have to remain open to being wrong and therefore must hear the counter arguments. One fund manager recently noted the following positives, for example; 1. Intrinsic value is the present value of future cash flows but during uncertainty price discounts are exaggerated. Those discounts will erode in six months when we are sufficiently progressed through this health crisis and more normal sets of company earnings forecasts will dominate. 2. The time to buy is not when the crisis is resolved but when the worst is behind us. 3. After only about a month of lockdowns, countries are already planning a staged unwinding of restrictions. 4. A drug will be found. 5. Low interest rates will continue now more than ever.