May 29, 2020 Guy Carson



A month ago, we asked “Are We through the Worst?“At the time we suggested that the economic fallout from COVID-19 had further to run. If one was to purely look at the share market a month later they would say we were wrong. The market has continued to rise and defy the expectations of most investors. Why has the market continued to rise?

There are two drivers of share prices, the future earnings of the company and discount rates. The rise in the market can clearly not be put down to earnings. From Fact Set we can see the impact of COVID-19 on the expectations of earnings per share this year:

  • 1st Quarter: -14.6%
  • 2nd Quarter: -42.9%
  • 3rd Quarter: -24.8%
  • 4th Quarter: -12.4%
  • Full year: -20.8%

That leaves discount rates and those have fallen considerably. The US 10 year yield is now sitting at 0.66% and indicates that markets expect another decade of Zero Interest Rate Policy (“ZIRP”). Lower discount rates means higher share valuations. The overall multiple of earnings that the market trades on therefore goes higher. The biggest beneficiaries of this are growth companies with “long duration”, i.e. those companies whose earnings are likely to rise in the future.

Given the earnings shock, it does also mean the market is becoming concentrated. In fact the concentration in the five largest companies is now the most pronounced in recent history.

This chart tells an interesting story. It is one covered in depth by Jonathan Tepper in his book “The Myth of Capitalism”. The lock down in recent months has continued a trend over recent years and even decades. That trend is that power is slowly becoming more concentrated in a smaller number of companies, most notably in the digital sector.

Facebook dominates social media, Google dominates search and together they can capture marketing spending. Amazon captures more and more of the digital shopping spend. These companies have benefitted from governments globally who are unsure how to regulate the digital world. They now are benefitting from people being forced to stay home.

On the other hand, the ones suffering through the lockdown have been small businesses. As a result the economic struggles are here to stay. According to the Small Business Administration, Small Business accounted for 47% of the jobs in the US prior to the lockdown. These are the companies that have been impacted and are letting employees go.

This economic impact shows up in the share prices of the cyclical sectors. The banking sector is still down 39% this year. Other companies such as Hertz have filed for bankruptcy. All is not well on Main Street.

Competition is a key component for a capitalist system. As the large technology companies grow it drags on economic growth and exacerbates wealth inequality. Despite the large amounts of government stimulus, it still remains an uncertain time for small businesses. As stimulus is rolled back and debt holidays are removed, a further litmus test of these businesses will come.

The result of this is that unemployment will most likely remain elevated for some time yet. The economy will likely recover slowly and the winners will be the large companies which continue to take a greater share of our wallets.

Small business owners and entrepreneurs should look at the economic picture and take steps to protect themselves. In a world where unemployment is elevated, risks are increased. Please reach out to Southpac if you wish to discuss your wealth planning and asset protection needs.

Guy Carson

Guy Carson is Southpac's Investment Specialist. Guy manages Southpac’s external relationships with investment advisors and banking specialists in client relevant jurisdictions around the world. In addition he works with clients to find the most appropriate solutions for their circumstances.
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