September 07, 2020
Sam Green

Stock markets boom, while COVID-19 hurts the real economy

Everything this year is unprecedented, including the growth in the stock market

As the fallout from COVID-19 increases, stock markets have had their best six months ever. Why has this happened?

Major stock indices around the world are at all-time highs, with the NZX 50 just passing the March 2020 peak at the end of August. The stock markets are now disconnected from reality, with bad news prompting the value of stocks to rise. If bad news is good for stocks, and good news is bad for stocks, are we reaching a point where stocks can only go up?1

Need to store money somewhere

The response to COVID-19 certainly has contributed to the sentiment in the stock market. For large companies that dominate the large indices, there has been widespread government support, with access to very cheap debt, including for refinancing at a lower rate. The Reserve Bank is aware of this effect, and increasing the values of assets to stimulate spending is one of the intended outcomes of its monetary policy.

On the buyer end, investors have been turning to stocks and shares as the only way to store their wealth. Interest rates are now so low that it is below the target inflation rate of two percent, meaning every year saving in term deposits reduces your real wealth. This can be very problematic for retirees looking for a stable return from their nest egg, first home buyers saving for their deposit, or investors wanting some low-risk returns in their portfolio. For individuals investing through their KiwiSaver, the biggest moves have been towards lower risk investments, according to a Westpac survey.

Stock markets are more accessible than ever

Stocks are among the most accessible places to store money. Investing in individuals stocks or managed funds can now be done simplify through banks, your KiwiSaver provider, or on an app on your phone, through fractional investing platforms like Sharesies. For people looking for somewhere to put their money, particularly for a few years, there are two options, lose money in a term deposit, or risk your money buying other assets.

Additional risk taking supported by psychology

Daniel Kahneman and Amos Tversky’s prospect theory, which won them a Nobel Memorial Prize in Economics, is also applicable. This theory suggests that individuals are risk averse when making money (prefer guaranteed money than the chance to win much more) but are risk seeking in losses (prefer to risk losing a lot, to avoid a guarantee of losing something). One would expect in times like this people would look to hunker down to weather the storm. However, this period has seen unprecedented surges in the number of people joining the stock market, being facilitated by the recently developed accessibility.

There are two options, lose money in a term deposit, or risk your money buying other assets

Unusual investment behaviour is everywhere

With all the new investors in the stock markets some interesting and unusual things are occurring. Once a large international car rental company, Hertz has suffered from the rapid decline in tourism and travel, causing it to file for bankruptcy in May. Following this bankruptcy, the stock price surged, to well above the pre-bankruptcy levels, as shown below.

Tech Mania

The global tech giants that make up FAANG stocks (Facebook, Amazon, Apple, Netflix and Google (actually Alphabet)) have been enjoying an exceptionally good year. Amazon is leading the way, growing 79 percent, while Alphabet has fared the worst, with just 20 percent growth from 1 January 2020.

These companies have existed for years, the growth is not caused because they have been doing significantly better than previous years, but other sectors that are more directly affected are doing substantially worse. In storing money to avoid wealth-destroying savings rates, piling into tech stocks is an obvious solution.

The pinnacle of the tech boom in 2020 is undoubtedly Tesla. Following a five for one stock split, the value of one new Tesla share is greater than the pre-split shares at the start of 2020. At its current valuation, Tesla is by far the most valuable car manufacturer in the world, valued at more than $460 billion ($690 billion NZD). By comparison, Toyota is valued at just $330 billion ($490 billion NZD), while producing more than 36 times the number of vehicles in 2019

What about COVID-19?

With a stock market boom, it can be easy to ignore the elephant in the room. COVID-19 is very much an unsolved issue, and any number of future lockdowns will have lasting effects on the economy. COVID is a well-known risk facing the economy, and the stock markets, but there is little the unprecedented nature of 2020 certainly adds complexities in identifying whether the stock markets return to match the real economy. As interest rates fall to zero, and monetary stimulus increases, we may be seeing the end of the era of banks facilitating savings, with a growing role in facilitating savings in the form of asset and stock purchases.

1. I am not an authorised financial advisor, and this, nor any statement in this article, should be taken as financial advice.