A crisis of demand - not supply - has dented hopes of a swift recovery

Virus cells and graph lines going up and down (illustration)
Of the three concurrent crises afflicting markets today, it is not the medical or financial but the economic one that investors have underestimated

My previous assumption of 'reopen and they will come' may have been premised on an out-of-date view of human behaviour

I expect the seasonal stock market adage about selling in May and going away will get a good airing this year.

After a spectacular recovery in share prices in April, the disconnect between stock market valuations and persistently gloomy economic and corporate news is striking. Investors are generally rewarded for looking through near-term challenges to the sunlit uplands beyond, but their exuberance last month was starting to look, to coin a phrase, irrational.

Six weeks ago, the pendulum appeared to have swung too far the other way. My view then was that the coronavirus pandemic would provide a temporary, if spectacular, hit to the global economy, followed by a rapid rebound. Demand would quickly revive once lockdowns were lifted and we got back to work.

This V-shaped economic trajectory argued for a commensurately quick market recovery. The retrieval of around half the losses endured between February and March suggests I wasn’t the only person to take that view. It all looks a bit more nuanced now as it becomes clear that the end of lockdown will not be a light-switch moment. It is now obvious that we are not going to return to the old ways any time soon. 

The principal reason for my more pessimistic view of the economic outlook is the nagging doubt that this is a crisis of demand, not supply. 

Initial fears that lockdowns would be impossible to police proved unfounded, because many people have been more than happy to distance themselves. There has been no need, in the main, to enforce isolation because we are choosing it.

A recent trading update from clothes retailer Next showed its dramatic drop-off in sales pre-dated the stay-home edict. This is bad news for the economy as a whole because even those of us who are fortunate enough to be able to work from home conduct most of our economic lives in environments that depend on the possibility of physical proximity.

We shop, play sport, eat out, go to the dentist, travel, stay in hotels – or we did. My previous assumption of “reopen and they will come” may have been premised on an out-of-date view of human behaviour.

The real concern for many of the businesses meeting these basic needs is that their models were marginal in the old world of near-capacity utilisation. In the new world, they are unsustainable. A restaurant operating under social distancing rules is not viable for so many reasons. 

Half as many tables means sharply lower turnover will not cover fixed costs – and that’s before you’ve worked out how to run a kitchen with two metres between your staff. This means the crisis is about solvency, not liquidity. The prompt, massive and unprecedented Government and central bank support packages that gave investors hope in April may be fighting the wrong battle. 

Providing a low-cost loan or paying staff costs in the short term is a sticking-plaster solution for a company whose customers have disappeared. Of the three concurrent crises afflicting markets today, it is not the medical or financial but the economic one that investors have underestimated.

The bond market gets this. Equities, as is their wont, have been slower to catch on. Superimpose a chart of the S&P 500 over the yield on the US treasury bond since last summer and there is a strong correlation up until a month ago.

Then the two lines diverge, with bond yields remaining on the floor, where they signal pessimism about the outlook, while share prices have risen strongly. 

The next few weeks will test which set of investors is right because, on both sides of the Atlantic, a deluge of company results is starting to fill the gaps in our knowledge. The initial signals from last week’s results were not encouraging.

From an investment perspective, what is more interesting than what happens over the next year is what permanent social and economic changes the corona-crisis may trigger. 

If I were a real estate investor, I would be seriously questioning the future of my office and retail investments. Many of us feel more connected with our teams today than we did in the dispiriting environment of hot desks that the modern office has become. As for physical shopping, who won’t now view a trip to the shops as a relic from the offline past? 

Maybe this is all nonsense. Another possibility is that in 18 months’ time, when we’ve all been inoculated with the new wonder vaccine and are laughing at the memory of crossing the road to avoid our neighbour, we’ll be flying, working, shopping and drinking together as we always did. 

Extrapolating the recent past is a common investment mistake. 

And if you do sell in May, don’t be surprised if the market doesn’t wait until St Leger Day to price in that brighter future.

Tom Stevenson is an investment director at Fidelity International and the views are his own.

He tweets at @tomstevenson63