The economy is facing its worst crisis in almost a century, with the prospect of hundreds of thousands of people imminently losing their jobs. So why is the sharemarket chugging away at its own recovery? Alex Braae speaks to some experts to get an explanation.
How’s the economy doing? In normal times, the most regularly reported indicator to answer this question would be to look at the sharemarket. It’s on the news every night, with a big number for the overall market, and a few key stocks picked out. In the popular understanding, the NZX going up (or the Dow, or the Nasdaq if you live in the US) is a good thing – a higher number means the economy is going better.
Years of steadily escalating gains were brought to a screeching halt near the end of February, with an alarming plunge brought about by the realisation that Covid-19 was going to cause a serious hit to every economy in the world. The single-line graphs that track each individual stock exchange looked like they had been smashed with a hammer. And sticking with that popular understanding, that made sense – people were about to lose their jobs or businesses, so the economy would suffer.
Since that crash, we’ve seen a steady stream of increasingly dire economic updates. In New Zealand, over April alone, another 10,000 people have taken up the jobseeker benefit. A huge number of businesses have effectively had no income for a month, and some will never reopen. Tourism, which a year ago accounted for the largest single share of New Zealand’s export income, has basically ceased to exist as an industry for the foreseeable future. In the US, more than 20 million people have joined the ranks of the unemployed in the weeks since the middle of March. Food bank use has exploded in both countries. Regardless of any government stimulus, the picture for the real economy has got much worse, week after week.
And what happened to stock markets in that time? In New Zealand, the NZX50 index has gone up pretty much every day since the nadir on March 23. The Nasdaq index and Dow Jones industrial average have done basically the same thing since the same date. In fact for the NZX – which spent all of last year cracking new record highs – the top-line number is back to where it was in about September last year.
So what gives? Are the people playing the markets entirely untethered from reality? The answer is both yes, and no.
To start with, different stock exchanges have different characteristics, says Chris Lee, the managing director of brokering firm Chris Lee and Partners. “To connect the performance of the index with the real economy is slightly spurious, and never more so than in America, where the index completely ignores the real economy, and is really reacting to the flood of money, rather than the flood of sentiment.” In the US, the rise back up started after a massive injection of government stimulus money, worth an eye-watering $US1.8 trillion.
Lee notes that the reviving trend of the NZX50 index is much more driven by the real economy – but there are crucial complexities within that. In terms of definitions, the index is the combined market capitalisation of all companies listed on the exchange – all of the shares in the company, multiplied by the share price. The NZX50 Index itself is the top 50 companies on the NZX, out of a total of more than 150 companies listed overall.
“What’s made New Zealand’s index so distorted, and so irrelevant, really, has been the complete dominance – particularly in the last month – of two stocks,” says Lee. Those two particular stocks are for companies with direct, real-world relevance to the Covid-19 crisis: Fisher & Paykel Healthcare, which among other things makes hospital ventilator equipment, and A2 Milk, which exports huge quantities of white gold overseas under health-focused branding. Between the two of them, their market capitalisations make up about 20% of the entire NZX – not just the NZX50. He also lumps telco Spark in with the other two as a heavily distorting stock.
“If the rest of the market all falls, then the market could still have an ‘up’ day. The television would report that the market is up 1% or whatever, but it doesn’t tell you that three stocks were up 5%, and every other stock fell. So there’s the potential for distortion in our index being grossly overweighted by Fisher & Paykel, A2 Milk and Spark.”
It goes even further than that, says Simon O’Grady, chief investment officer at Kiwi Wealth. “I’d take it away from just individual stocks – 60% of the NZX is made up of health, utility and consumer staple businesses.” Utilities like power companies have low volatility and strong cashflow, says O’Grady, while the consumer staple businesses have had little trouble selling their products, and the value of healthcare businesses right now is obvious. “Well over half of the NZX is businesses that are strong through all cycles, and actually benefit when interest rates fall,” he adds, pointing to the recent decision by the Reserve Bank to slash the official cash rate.
So what is the stock market telling us about the real economy right now? For one thing, almost everything with any connection to tourism and retail is down. The borders are closed, and there’d be nowhere for visitors to shop anyway. But in Lee’s view, the market still hasn’t priced in a basic truth about the medium-term future of New Zealand’s economy – there are simply going to be fewer people here than before.
“The biggest problem we’ve got in New Zealand can be summed up in having to downsize from a potential market of four million tourists and five million residents, to a new market with no tourists. Our shops, rental cars, hotels, motels, airlines and whatever else. It probably equates to something like 100,000 extra people in New Zealand on every day of the year. We have to pare down from the number of feet going into shops and bars, because before this, we had scaled our economy up to a population which now isn’t sustainable.”
The effects of that will be extremely wide-ranging for publicly listed companies, particularly when combined with the potential for less domestic employment due to widespread unemployment. Z Energy will sell less petrol. Tourism Holdings Limited will hire out far fewer cars. Companies relating to property, including those in the retirement home industry, will see their value fall. And this has largely all been reflected in the share price movement of these individual stocks.
However, within the wider trends, the prices are still bouncing around in a way that little reflects the real economy. Lee looks at the Auckland Airport share price as an example, as a business that won’t only not see many flights for the foreseeable future, but will also suffer through the loss of car-parking and retail income. Its share price crashed from just under $8 in March to a low of $4.59, but since then has had some days of big gains to now be at around $6. That’s with no certainty whatsoever about if or when international travel will return, and Lee says those currently paying $6 a share on the promise of future earnings are being “unbelievably brave”.
“As I look at it, Auckland Airport’s spread in income is going to be savaged by the international changes. But then domestically, there’s a threat that we’re entering into an era of ‘less is best’ – less business travel, less personal travel. And if that happens, the domestic side of their business won’t grow. When we do come out of out of this, I’ll bet you a bloody good meal that air travel patterns in two years won’t be anything like what they were three months ago.”
There’s also some oddities in the market caused by automated trading platforms and day traders trying to cash in on volatility. Lee cites the example of what happened to Air New Zealand’s share price last Friday. It went from $1.17 at opening, up to $1.60 during the day, before falling back again. “You couldn’t tell me that anyone actually sat down and said, ‘hey, Air New Zealand’s fortunes last Friday went up 40% during the day’. It’s complete bullshit, and it’s completely irrelevant to the real economy. But it happened, and I’d imagine some bugger bought them at $1.17 and sold them at $1.59 and had a good day.”
Lee also points to the heavy use of index funds on the NZX as having a distorting effect. These are basically investment vehicles that spread money across a group of shares, so that an individual share dropping might be offset by others rising. And there’s always plenty of new money coming into index funds, in part because they’re a popular vehicle for Kiwisaver providers. But they’re also an easily gamed device, says Lee, because most index funds have rules about how much each individual stock can constitute the total fund – often 5%. So it means that if a big share like Fisher & Paykel goes up, then most index funds have to then sell them off. “There are all sorts of distortions from the sort of robotic process of almost self-fulfilling movements in share prices. And while that’s happening, you’ve got the active fund managers gaming the index funds, because the index fund rules are spelled out and visible to everyone. So everyone can see what they’re going to do tomorrow, and the next day.”
For Simon O’Grady, the biggest point of disconnect between the sharemarket and the real economy in New Zealand is the fact that the companies being hit hardest right now are SMEs – small- to medium-sized enterprises. “The backbone of our economy is the small to medium sector. And, you know, accommodation, hospitality, tourism, these sectors are dominated by small businesses. So we’re not really seeing that come through to the indices.”
So what happens on the stock market has some limited usefulness in showing economic trends, and which sectors expect earnings to increase in the future. But for the average person wanting to understand how the real economy is doing, it’s nothing but one rapidly changing number among many.
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