Something happened on the weekend that made me think about what is happening in share markets.
On Saturday I went for a long walk, which took me to a national park with a pond in the middle. As I approached the water, stopped and looked around to soak up the beautiful environment, I was spotted by a small flock of geese on the opposite side.
Almost by reflex, a few started swimming towards me, gliding over the water, determined to overcome the distance. Instantly, their move was being noticed by others, who soon joined in.
As I stood there with the pond in front of me, I realised quite the spectacle was taking place on the water, with more geese, some ducks, and other birds all joining in to what by now had become quite a noticeable migration of birds swimming from one end of the pond to the other.
As I stood there, observing, I could just imagine the conversations taking place between birds.
Where are we going?
Over there, to that gentleman.
Is he going to feed us?
Why else is he standing there?
I thought if these birds are anything like humans, they'll soon start relishing in anticipation.
I hope he has some of that yummy stuff with him.
Ahhh yes, the really yummy yumm yums!
I swear, as I was observing a few dozens of swimming birds approaching I could see several happy faces with big smiles in the crowd. Anticipation was clearly building!
But I had nothing to share. As I continued my walk, I looked over my shoulder and noticed how most birds were making the best out of the situation, rummaging through the greenery with their beaks or trying to spot another potential benefactor on the horizon. As if the communal spirit was saying: you win some, you lose some. That's just life on the pond.
Sometimes, in the share market, similar processes can be observed. In particular because life out there, in the real world, tends to move at a gradual pace while decisions need to be made every single day in financial markets.
Are we buying? Selling? Or sitting tight?
Meanwhile, the first few of the flock have started to cross to the other side and the more join in, the stronger becomes the temptation to expect there are yummy yumm yums awaiting all who make the journey.
In the share market, sometimes investors are really good in anticipating events well before they happen; other times they simply want to see the evidence. Which is why all talk about the worst economic downturn since at least one hundred years ago did not stop markets from putting in a big rally over the past five weeks.
Facilitating this rally were two narratives. One is a potential treatment or vaccine for covid-19 could be close. The second narrative is the worst economic slump ever might prove a short disaster only, with a sharp V-shaped recovery to follow.
Both narratives remain valid, of course, but they will increasingly be put to test, and under the microscope as the true magnitude of the damage done to the world economy is starting to be reflected in economic data and corporate announcements and events.
Bear market sentiment is extremely sensitive to news flow, which makes any turn in the first narrative both unpredictable and potentially game-changing at any moment (in either direction).
The second narrative appears to have a lot of credence, but my analyses from the past two weeks have already debunked this incorrect impression. Share markets are not at all pricing in the potential of a swift V-shaped recovery; quite the contrary instead.
We can all speculate as much as we like, but, ultimately, the duration and eventual outcome of this year's Bear Market for equities will most likely be decided by corporate earnings and investor confidence in what earnings will look like beyond the short term. Here, I believe, the current quarterly corporate results season in the US is quite telling.
At face value, the Q2 update on corporate profits appears en route to challenge the -15.7% recorded during Q3 2009. According to Factset, bottom up median earnings per share is currently down by -28% for Q2 which would be a lot worse than any quarter during the GFC (with -20.6% in Q1 2009 the worst on record).
Best performing sectors are healthcare and consumer staples, while those suffering most include consumer discretionary, financials, industrials, materials and energy. Herein lays the key message about what is happening in share markets throughout these turbulent times, including in Australia. It easily explains why the Nasdaq in the US has managed to quickly recover more than 70% of the damage suffered by March 23rd.
To put any of this down to investors' over-exuberance or excess liquidity provided by central banks is simply wrong. As the narrative goes, pandemics change the world in that they accelerate the adoption of new technologies and this time around what is attracting a lot more traction are 2020's powerful tech trends including online services, the cloud, the Internet of Things (IoT) and artificial intelligence (AI).
It is no coincidence this year's best performing stocks in Australia include data centre operator NextDC ((NXT)) and artificial intelligence and voice translation enabler Appen ((APX)). Their robust outlook is being confirmed by peer results in the US on top of positive news flow domestically.
Elsewhere, Afterpay ((APT)) is making a mockery out of investors sitting on short positions and/or selling the shares down to below $10 only a few weeks ago.
Incidentally, I don't think the ASX is doing investors a favour by colouring all these companies with the same "technology" brush. NextDC is infrastructure and a time will come, when this business is much more mature, that the market will recognise this and treat the stock accordingly.
Afterpay is simply an alternative credit provider. A lot of technology today facilitates the use of credit, but we don't call Visa, Mastercard or American Express "technology" companies. Either way, Tencent becoming a substantial shareholder is a massive endorsement for the local payments disruptor that was only founded in 2014.
For investors, the trick is to not fall into the trap of these generalised sector groupings and distinguish between which company's outlook is much more tied-in with the state and direction of economies. Such companies, irrespective of their labeling, are currently being treated as "too much risk" by investors who dare not price in a recovery in earnings next year and beyond.
The day shall come that investors will sell and ignore all of today's winners and instead turn to those shares considered "value" and "cheap". The switch will be violent and rapid, and it can only take place once a lot more clarity has become apparent about the timing and potential shape of the post-pandemic recovery.
The switch will be violent because money will always flow where the highest rewards are waiting, even if that opportunity is only temporary in nature. Stocks that go down by -40%, -50%, -60%, and more, offer a lot more upside potential when the time arrives to get set for economic recovery.
It goes without saying, most companies that were already struggling prior to February won't have acquired super-power abilities during this year's lockdowns and economic recession, so they'll find themselves back in struggle street once the recovery turns into fact.
Investors need to make a clear distinction between the variation in scenarios that lay ahead, and decide what their strategy is. The market does not necessarily facilitate a smooth switch between, say, CSL ((CSL)), TechnologyOne ((TNE)) and a2 Milk ((A2M)) and National Australia Bank ((NAB)), Whitehaven Coal ((WHC)) and Worley ((WOR)) at the other end.
As has become increasingly obvious outside of periods of forced and generalised selling, investors have no bones about selling shares in banks, energy producers and small cap cyclicals, but they rather hold on to shares in Coles ((COL)), Woolworths ((WOW)), ResMed ((RMD)), Xero ((XRO)) and the aforementioned outperformers.
This, in my view, is the true dynamic that is playing out during this year's Bear Market. It'll largely determine whether predictions by technical chartists that share market indices must retest their March low in the weeks/months ahead will prove accurate. Imagine, if shares like CSL, Woolworths and NextDC refuse to go back to where they were in the eye of the maelstrom in March, what this translates to for the banks and the cyclicals?
Once again, the obvious question for investors to ask is what is the real bargain opportunity here? Is it the Ferrari 488 Spider that can temporarily be purchased at a -$5,000 discount? Or is it the crappy looking second hand car for which the desperate dealer has reduced the price by -50%?
The beauty of running a portfolio means a strategy can be devised in order to benefit from opportunities on both sides of today's share market. Still, the question needs to be asked, and investors should be well aware of the different "value" opportunities, as repeatedly witnessed over the past seven years.
One simply cannot change human nature and the natural instinct remains that we assume that what comes down the hardest must go up by a lot once better times arrive. It's why every time a company goes bust -like Virgin Australia- there are always investors on the register who lose the lot.
But companies don't necessarily have to pull the plug to prove that instinct wrong. 2020 is rapidly transforming itself as the busiest year for capital raisings on the ASX since 2008/2009. For many a share market laggard a successful raising means "saved from the abyss", but equally "low valuation chiseled in stone".
As per always, there are two sides to the story. Take Flight Centre ((FLT)) for example. The consensus for price targets by stockbroking analysts has settled around $13.50, which implies significant upside from a share price that has sunk below $10. But anyone speculating this share price can return to levels last seen last year of around $45, or even anything remotely nearby, will surely be disappointed.
In fact, it is not inconceivable Flight Centre shares might never return to such level ever again, or at least not in a very, very long time.
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Afterpay's share performance has been amazing and more so because of the disconnect from its performance. UBS has a $13 target. I'm not shorting (yet) but I wouldn't buy it ... ditto EML, FXL, ZIP, and the plethora of other companies in the "give away money" sector. The banks' bad debt provisions should have rang the bell on this sector.