The euphoria of 2000 is back
Equity markets have been surprisingly resilient to the negative impact of the coronavirus.
And in some fast-growing segments, the hype is reminiscent of the exaggeration phase seen in 2000.
Last week, the American, European and Chinese stock markets all rose by around 1.5%, and the S&P500 and the Stoxx Europe 600 indices registered new highs. Bond prices too continued to rise, driving rates a little lower. Oil and commodity prices managed to recover somewhat from their huge correction in previous weeks. In the currency markets, the dollar and sterling strengthened against the euro.
The markets are upbeat despite lacklustre economic news
It is striking how complacent the markets are. Recent records contrast with mixed economic data and the messages from numerous companies warning of a negative impact from the coronavirus. Investors thought that the number of new contaminations was starting to fall. However, this perception was contradicted by a revision of the figures, which revealed an exponential increase. The number of recorded contaminations has exceeded 70,000 cases and the number of deaths stands at some 1,800, already far more than the 800 deaths due to SARS. The markets also found support on the news that many Chinese factories were trying to reopen after two weeks of closure. Not everything is going to plan, however, because workers have not all been able to return or due to supply problems. But the markets are looking to the future and assume that this hurdle will be overcome within a few weeks or months.
Meanwhile, the effects on the economy are beginning to be felt. In January, auto sales fell by 21% in China. This figure might be even worse in February. Oil consumption in China in recent weeks was also 20% lower than normal, leading the International Energy Agency to warn that global oil demand will contract in the first quarter, for the first time in a while. And many companies (including Apple) have warned that their production and deliveries are suffering from delays due to supply problems in China.
The general economic landscape is still not showing the expected recovery.
Economic growth in the eurozone stood at a paltry 0.1% in the fourth quarter, with a stagnation in Germany and even a slight decline in France and Italy. Despite a slight recovery in confidence indicators, real economic data in January have not yet shown any improvement: an ongoing fall in industrial production, auto sales: -8%.
In the United States too, industrial production fell in January (-0.3%), mainly due to the halt in production of the Boeing 737 Max, and consumption grew less than expected in December and January. In contrast, US consumer confidence for February rose slightly.
Is this the final melt-up?
Risk factors such as the trade war and Brexit fears in 2019 and, more recently, the military threat in Iran and the coronavirus pandemic are so easily overlooked or so quickly forgotten by the markets, showing extreme complacency. Some growth segments or hyped stocks are even soaring at a ridiculous (or exuberant) pace. Tesla's share price doubled in January on the news that the company had achieved positive cash flow for the first time. The market value of Tesla, which plans to sell 500,000 cars this year, is now higher than Volkswagen, which sells some 11 million cars every year and generates substantial cash flow. This valuation difference between the old economy and the new is often excessive. In some cases, investors no longer look at valuation or risks as long as the growth story is favourable. This is a strong reminder of the exaggeration phase in 2000. After 11 years of rising equity markets (the longest in history), have we reached the final ‘melt-up’, which usually heralds the end of a stock cycle?
Today, it is striking that, apart from oil and commodity prices, almost everything is rising (equities, bonds, real estate, gold). Even Greek bonds are highly coveted, as the 10-year rate has fallen below 1% (a stark contrast to the 17% reached 7 years ago). A flight to gold and bonds (resulting in falling rates) and low commodity prices usually indicate higher risks and a weakness in the economy. On the other hand, a rise in share prices usually reflects a strong economy. One of these two market perceptions must be wrong. But we know why everything is increasing. This naturally comes from the policy of low rates and massive liquidity injections by central banks. They are increasingly likely to be (unintentionally) building a bubble. The average valuation of equity markets is not yet at the extreme levels of 2000, especially in Europe. But the S&P500's price to earnings ratio has already soared to 20 and the Nasdaq’s to 26, on the back of the unstoppable rally of expensive internet and technology stocks. As there are no alternatives, we continue to participate in the overall wave of risk appetite. That said we will remain on our guard and keep an eye out for any exaggeration in particular segments or a general peak later on in the year.