Markets will learn to live in the truth

A good friend of mine preaches the mantra of living in the truth. I can think of no better description for what we are about to see in the stock market during the remainder of 2020.
Eric Burns is Chief Analyst for the CFP SDL UK Buffettology and Free Spirit fundsEric Burns is Chief Analyst for the CFP SDL UK Buffettology and Free Spirit funds
Eric Burns is Chief Analyst for the CFP SDL UK Buffettology and Free Spirit funds

Much has been written on the strength of the recovery in global markets since March at a time when the pandemic continues to run riot. Indeed it was the subject of this very column back in May.

Ultra low (and in some cases negative) interest rates, unprecedented central bank action to pump liquidity and a natural bounce in the economy from an induced deep freeze are all plausible explanations.

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In our view, the second half of the year is going to be less about how markets as a whole behave and far more focused on the individual stocks that make up the indices.

Back in March, when the panic button was struck, companies took the swift and prudent actions of self-preservation. Almost all the companies we spoke to had either furloughed staff, drawn down existing debt facilities to the max, turned off the capex tap or axed the dividend payout. Some had done all four.

That was the easy bit. Company announcements of late have been less about the emergency actions of survival and more about how business is shaping up as we come out of lockdown. By and large trading statements issued during June and July have been upbeat. Next said only last week that its experience since reopening had been better than even its best case scenario.

One caveat. It is a natural consequence of having restricted large parts of the economy for three months that there will be a bounce as things open up. It would be very strange indeed if there were not. Pent up demand is visible in many corners of the economy be it an active housing market, traffic jams to the coast or long queues outside H&M. But whether that is sustainable beyond the short-term fillip from consumers’ rediscovered freedom remains to be seen.

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The uncomfortable truth is that the pandemic isn’t over. It’s merely under control for now and we seem to be a bit better at managing it.

This isn’t meant to be a pessimistic assessment of H2. Companies and economies have an age-old knack of adapting and even prospering during adversity and as a whole I see no reason why it will be different this time.

But from this point on, I expect markets to be driven far less by knee-jerk reactions to the actions of central banks and far more by the underlying fundamentals of companies themselves.

Valuations in many sectors are at arbitrary levels, not least because many companies have withdrawn profit guidance hence analyst forecasts are either a finger in the air job or non-existent.

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As we get towards September, with pent up demand having worked through the system and Government schemes being gradually wound down, the real impact of the new normal will start to become apparent. We will get a feel for the real level of revenues, profitability and cash generation of quoted companies.

It is not an exaggeration to say that for some their raison d’etre may no longer exist.

The second half of the year, therefore, will be less about the movement in markets as a whole and far more about the performance of individual companies. This should be a market for stock pickers, giving active fund managers a golden opportunity to prove their value over increasingly popular passive investments.

To paraphrase my friend, we are about to live in the truth.

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