Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 362

The three main factors when the next storm hits

Markets such as the one we're experiencing now show that we can't be agnostic about what's happening in the wider world. So, when I think about macro conditions and where markets might go, I always use a really simple way to break it down into three factors:

1. Fundamentals

2. Valuations

3. Liquidity.

If we've got good earnings growth, reasonable valuations, and abundant liquidity, then markets are more likely to go up. And vice versa. So, let's break it down.

1. Fundamentals

As we all know, we're in the midst of a pandemic which is bringing economic conditions that we haven't seen for a hundred years. If we look at the US, Gross Domestic Product (GDP) is probably going to be down 35% quarter on quarter for the second quarter.

Take the example of the energy sector. It is facing a triple whammy of excess supply, absent demand, and no access to capital markets to cushion the blow.

So, what we saw in March and April was the first half of the storm, the human cost, but soon we’ll begin to see the economic toll. One of the research providers that we talk to uses an analogy of dynamite fishing - where you blow up some dynamite beneath the water and then the fish start to rise to the surface. The first ones to rise are the little ones and then over time the bigger and bigger ones begin to rise.

This is the kind of process that will happen now. It takes a while for companies to experience financial distress and then actually go through to insolvency or bankruptcy. There's a lot of companies doing it tough now and we'll only see the ultimate impact as time goes by. So, we know the news will get worse from here but we don't know how bad it will be relative to our expectations.

2. Valuations

Valuations are not cheap. When you have periods of big volatility, predicting what earnings will look like becomes challenging and particularly hard because more than half of the companies on the Australian stock market have withdrawn guidance. Any kind of interim earnings estimate is really just a guess. But if you make some kind of a guess and then look at the price, we're actually back up to mid-term highs on PEs, although more so in the US market than here.

Australia’s price to book value is a better measure because it's more stable, but still moving around because there will be some write downs that will have to come out of this.

What’s impacting valuations on the other side though, is that we moved from a lower-for-longer expectation for interest rates to a lower-for-forever or lower-for-the-vast-foreseeable-future. And that is also putting a floor under valuations.

I think Australia and the US will have different fundamental outcomes but I think our valuation parameters are likely to be set by what happens in the US market. Lower rates or high valuation metrics in the US will boost us. If the US has challenging outcomes and their valuation parameters go back down, that will likely drag us back down too.

So that leads us to a really interesting question. What timeframe is the market currently discounting? Because we know that for maybe the next six months at least, economic outcomes will be very negative. So, either markets are looking through that and discounting all the way out - saying, “Well, I know this is going to be bad, but there's also the stimulus. And so, okay, I'll look through that.” And that's why share prices have bounced back up. Or markets are just not discounting at all.

How would that be?

We know markets are supposed to be discounting machines. They're supposed to look ahead and price every factor in to the value of stocks. We've had an unprecedented shift towards algorithmic and quantitative trading. I’ve been talking about this for a while and the shift of market participants from those that are trying to arbitrage price to fair value versus those in their trading on other proxies of outperformance.

It's possible now that the marginal buyer of markets is a bot or an algorithm that doesn't actually hear rumours, only published data. That old function - "I'll buy the rumour and sell the fact" or vice versa is not actually working anymore. Markets are not discounting the negative picture of the next six months. So, they've either lost a lot of the discounting capability and are just looking at the benign conditions that are currently on paper, or markets are looking all the way through to the end of this, even though we really don't even know how far in the future that is.

3. Liquidity

In March, we had a massive dislocation with very leveraged players, highly exposed to equity markets. As they exited positions, it created an enormously painful and rapid downdraft in share prices.

We've had enormous multi-trillion dollar Fed flows to the rescue and that put a floor under the panic and closed a lot of the arbitrage gaps that had opened up. But positioning in equity markets is now more fearful rather than risk-taking, so there's more money on the sidelines.

On the Australian side of the equation, the really interesting part now is superannuation. Super is an enormously-wonderful factor in the Australian economy, but right now we're asking a lot of it. We're asking for super to be the corporate re-capper. We've had a tonne of recapitalisations and they keep coming every single day. So we want superannuation money there to front up and buy these new issues.

And we now have a new role for super. We want it to be the household piggy bank. If a person has a cashflow problem now, they go to the ATO website and withdraw $10,000, and then again in July.

We now also want superannuation to abstain from dividends if companies cut or halve or restrict their dividends. And this is new for them because these superannuation funds have relied on very high dividend flows from their equity holdings. The Government is also asking super providers to step up and fund infrastructure and contribute to nation-building projects.

That’s all a big ask on superannuation and it's definitely a change from 2008 when super just stood there as a re-capping vehicle.

Putting it all together

So, what does that all mean? We know that the fundamentals will get worse from here, but there's excess liquidity and the lower-forever impact of interest rates is currently putting a floor under valuations. Over the next few months, as we move from the eye of the storm to the economically-devastating bit, we'll see if low rates and high liquidity are still enough to support markets.

We’ll find out if markets were looking way out ahead or actually not even as far as their noses.

 

Kate Howitt is a Portfolio Manager for the Fidelity Australian Opportunities Fund. Fidelity International is a sponsor of Firstlinks.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL 409340 (‘Fidelity Australia’), a member of the FIL Limited group of companies commonly known as Fidelity International. This document is intended as general information only. You should consider the relevant Product Disclosure Statement available on our website www.fidelity.com.au.

For more articles and papers from Fidelity, please click here.

© 2019 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity International and the Fidelity International logo and F symbol are trademarks of FIL Limited. FD18634.

 

RELATED ARTICLES

Beware of burning down the barn to bury the debt

Investors face their own Breaking Bad moment

The role of financial markets when earnings are falling

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

100 Aussies: seven charts on who earns, pays, and owns

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Latest Updates

Investment strategies

Finding income in an income-starved world

With term deposit rates falling, bonds holding up but with risks attached, and stocks yielding comparatively paltry sums, finding decent income is becoming harder. Here’s a guide to the best places to hunt for yield.

Economy

Fearful politicians put finances at risk

A tearful Treasury chief, a backbench rebellion, and crashing bonds. What just happened in the UK and why could Australia’s NDIS be headed for the same brutal fiscal reality?

Shares

Investing at market peaks: The surprising truth

Many investors are hesitant to buy into a market that feels like it’s already climbed too far, too fast. But what does nearly a century of market history suggest about investing at peaks?

Shares

Chinese steel - building a Sydney Harbour Bridge every 10 minutes

China's steel production, equivalent to building one Sydney Harbour Bridge every 10 minutes, has driven Australia's economic growth. With China's slowdown, what does this mean for Australia's economy and investments?

Investment strategies

Will stablecoins change the way we pay for things?

Stablecoins have been hyped as a gamechanger for the payments industry. But while they could find success in certain niches, a broader upheaval of Visa and Mastercard's payments dominance looks unlikely.

Infrastructure

An investing theme you can bet on for the next 30 years

Investors view infrastructure as a defensive asset class rather than one with compelling growth prospects. These five tailwinds for demand over the coming decades suggest that such a stance could be mistaken.

Investment strategies

A letter to my younger self: investing through today's chaos

We are trading through one of history's most confounding market environments. One day, financial headlines warn of doomsday scenarios. The next, they celebrate a new golden age. How can investors keep a clear head?

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.