What a crazy month this has been. However, considering this is 2020, should we expect any less?
We’ve had one of, if not the biggest rallies ever on the ASX this month, with the market up over 13% and a week still left in the month.
Obviously, this is unprecedented. To put the rally into perspective, I decided to do some homework and run some numbers.
Using monthly data and going back to December 1992 (337 months in the sample), I found a couple of interesting data points:
– 1 sigma (68% of all occurrences) is between +4.25% and -3.00%
– 2 sigmas (95%) is between +7.75% and -6.50%
– The next biggest rally was 8.78% in April 2020. The next one after that was 8.18% in December 1993.
– We are currently beating the next biggest rally in almost 30 years by 4.34%!
This places the current rally in its own special category of a 3 sigma plus event, with a probability of less than 0.3%.
Why the market is exuberant
In my view, there are a couple of reasons for the market to be this exuberant.
1. The announcement of the vaccine
Without a doubt, some of the best news to come out of 2020. I assume that the government has vaccinations as a top priority.
If we are mostly immune to COVID-19, with an efficacy rate of 90%, we can get most of the economy back up and running again.
However, a very large part of our economy is exporting tourism and education – we need other countries to open up borders to us and start trading with us again.
This also means that we need quarantine protocols to be removed from both Australia and the country we are trading with.
Australia is also very zealous with protecting our borders – expect the government to only open up with no quarantine to the outside world once everyone is inoculated.
Additionally, since the efficacy is 90% and not 100%, there is still a health risk. I highly doubt the government will remove quarantine protocols again until COVID-19 is completely under control.
If we are fully vaccinated, the government would not want to see even one person die unnecessarily due to the opening of international borders with lax quarantine controls.
In my view, quarantine protocols are the main factor to watch and the main handbrake on our economy.
2. GDP is in hibernation, rather than destroyed
A lot of businesses right now are on government life support and/or in hibernation.
Tourism, education and industries that support it (basically everything, from small eateries to hotels to shopping centres) is still mostly here, waiting to get back to full capacity.
This means that in general, we should see a very strong pop in GDP once we open borders and remove quarantine protocols.
However, our GDP has been damaged significantly and will continue to deteriorate as this drags on.
This has been evident in the number of redundancies and collapses, especially around the tourism and education sectors.
Even though we now have a vaccine, producing and inoculating entire countries will take a lot of time.
Without the removal of quarantine protocols around the world, it is highly unlikely these industries which require discretionary travel will be able to be at full capacity.
The time it takes for the hibernating GDP to be at full capacity again could be significant.
These industries will continue to deteriorate as time goes on.
Why the market may be irrationally exuberant
In my view, the main linchpin of GDP recovery for our economy would be around the removal of quarantine protocols, not just for Australia, but for countries around the world.
Firstly, with the loss of jobs around the world, we can safely assume that discretionary spending would be severely dampened in the medium term.
Additionally, the fear of potentially getting sick or getting stuck in a sudden lockdown whilst overseas is also very real. It is a risk that not many will be willing to take.
The damage to tourism has already been done and would be a huge drag on the economy even with the vaccine.
Secondly, without the removal of quarantine around the world, it will be highly unlikely that significant travel will resume.
Being stuck in quarantine for two weeks is generally not a good start or end to a holiday.
To remove the quarantine protocol around the world, we will need to either eradicate or control COVID-19 around the world.
For this to happen, we would need to innoculate as many people in the world as possible so that the COVID-19 reproductive rate is below 1 and for the number of cases to become manageable.
This is an important factor – since this is a pandemic, a lot of less wealthy countries are also heavily affected.
Many of these countries don’t have the money or infrastructure to eradicate or control the virus in a reasonable amount of time, which would make removal of quarantine difficult unless visitors from those countries are barred.
Vaccine production will also take time and wealthy countries will get doses first, further exacerbating the problem for those further down the chain.
As an example, the SARS epidemic lasted from 2002 to 2004 where just 774 people died. Granted, they didn’t have a vaccine but the scale of the outbreak is nothing close to COVID.
Even then, it still took 2 years for the virus to be eliminated.
This means that even with a vaccine, it would seem to be highly optimistic that COVID-19 will be gone within a years time in all countries that we deal with significantly.
Additionally, we are now entering the end of the year which is the peak selling season for retailers and for travel as well.
With the pandemic still out of control around the world, sales from this period would be decimated for a lot of these businesses.
Optimism or pessimism?
I am a glass-half-full kind of guy. However, right now it looks like someone grabbed a pitcher and dumped it into a glass.
I am not a pessimist and in fact, I am very optimistic about the vaccine and for the world and economy to get going again.
I miss the days of travel and for things to be normal, as much as anybody else.
However, with the ASX200 now just 7% off its previous all-time high and a rally 50% stronger than any other in the past almost 30 years, I feel that greed is at all-time highs and is unjustified.
Markets are forward-looking and right now it is full of optimism, however, I feel this rally is looking a bit too far ahead.
With warning signals flashing everywhere, economies propped up by government stimulus and a world that is still very sick (60m active cases), the rally looks completely overdone and investors should definitely be more cautious.
Are you still looking for the best stocks to buy in 2021? We've put together a free report on 5 stocks that we think are the best buys on the ASX right now. Download it instantly here.
Want to join the discussion? Head over to our Facebook group and join 6,000+ other investors and traders discussing everything stocks and stock market related.
This is general advice only. MF & Co Asset Management has not considered your personal financial needs, objectives or current situation. This information is not an offer, solicitation, or a recommendation for any financial product unless expressly stated. You should seek professional investment advice before making any investment decision.