Hope trade fades

The sharp rebound from March lows is beginning to stall as record levels of uncertainty are juggled with extended valuations. With optimism priced and upside momentum fading, it appears trading on hope is being replaced with caution and a local top may in for equities. The disconnect between the real economy and equity markets has been surreal. For the S&P 500, P/E multiples derived via forward earnings estimates are at levels last seen in 2002, post the dotcom crash when the index was still ~30% from its eventual low. Although that period teaches, valuations can remain departed from reality for longer than is comfortable. Now heightened geopolitical tensions, mounting second wave risks and labour market destruction are eroding the expectation of an aggressive V shaped recovery that has been priced by investors. The market has been discounting a swift return-to-normality, but in reality, the post-pandemic outlook is likely not one of mean reversion on many fronts and that uncertainty is not reflected. If we are to live with rolling outbreaks until a vaccine is delivered, it is increasingly hard to justify current valuations. And as new infection waves materialise in China and South Korea, the “reopening reality” of prolonged distancing and a slow return to normal is being considered. It feels like the decisive moment for this bear market rally is approaching.

A raft of billionaire investors have also publicly denoted stretched valuations, a dire economic outlook and a 1999 style speculative fever, will the explosion in retail account openings and Robinhood traders piling into the stock market heed the warning?

Overnight, Chairman Powell also joined the cautious chorus that has seen sentiment dampened in recent days, again reminding investors not to confuse liquidity with solvency. ‘But the recovery may take some time to gather momentum, and the passage of time can turn liquidity problems into solvency problems’. Whilst the worst of the health crisis may be behind us, the economic crisis remains. Powell also pushed back on the notion of negative interest rates and called for ongoing fiscal support for the US economy. This is in line with our view that stimulus packages to date represent a bridge to the other side of the pandemic outbreak, but more will need to be done when it comes to rebuilding the economy. When it comes to NIRP, we see the Fed experimenting with yield curve control to anchor long-term rates, prior to NIRP.

Australia Jobs Report

The much-anticipated April jobs report delivered a surprise beat on the headline unemployment rate, which came in at 6.2% vs. 8.2% expected, despite a record fall in employment as almost 600K jobs were shed in April. However, do not let this beat on the headline fool you, below the bonnet the report was every bit as dire as expected and Australia has by no means dodged a bullet.

The participation rate, which refers to the size of the workforce as percentage of the working-age population, fell to levels last seen in 2004, thus masking the true hit to the labour market as those individuals dropped out of the labour force all together. If the size of the workforce had not diminished by almost half a million people, the unemployment rate would have surged to 9.6% in April, representing around 1.3mn unemployed.

As we have previously noted, the JobKeeper subsidy is also artificially supressing the headline unemployment rate. The ABS has said “people who are paid through the JobKeeper scheme will be classified as employed, regardless of the hours they work (e.g. even if they are stood down).” Prior to COVID-19 a member of the workforce had to work at least one hour to be considered employed. That is why we look to hours worked and underemployment in order to gauge the real impact of COVID-19 on the Australian labour market.

Hours worked plunged by 9.2% in April. The underemployment rate (which refers the number of people who are employed but who want to work more hours) rose to 13.7% and hours worked dived 9.2%. Underutilisation, another measure of labour market slack, (which refers to people who are either unemployed or looking for more hours of work) rose to 19.9%. The above illustrating that the impact of COVID-19 on the Australian labour force has been substantial, with the most significant pain being felt via reduced hours.

According to the ABS, 2.7 million people were affected by either job loss or reduced hours between March and April. Out of that 2.7 million, 1.8 million people worked fewer than their usual hours, or no hours at all, for ‘economic reasons’:

• And over 750,000 did not work at all; and
• over 1 million did some work, but worked fewer hours than usual.

Including those workers who would have been considered unemployed prior to the ABS classification change AND those who left the labour force all together would see the headline unemployment rate well above 10%.