UE-EN Institutional

The stock market and the economy: Two different animals

The world economy will drag its feet in efforts to get back to where it started earlier this year. It has been floating on a sea of government largesse that will gradually be withdrawn.
October 2020

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COVID-19 has cut a swathe through the world economy thanks to government mandated lock-downs and restrictions. No business closes its doors voluntarily and no individuals enjoy confinement to “barracks” for months on end. It is therefore essential that there is an appropriate reckoning when the pandemic passes. It is clear that mistakes have been made, often fed by extravagant mortality projections, a hyper-ventilating media and posturing politicians.

In our previous Pyrspectives we remarked on the mortality rate compared to the oft-quoted Spanish flu of a century ago. That pandemic killed around 50 million people or approximately 2.8% of the world population at the time. COVID-19 is an extremely mild bug in comparison. Highly contagious, certainly, but with a remarkably high recovery rate.

Of note is the fact that Europe and the Americas dominate the left-hand column whilst greater Asia and Africa dominate the right-hand column. Why? We will leave the “experts” to deliver that judgement.

The final statistics are obviously yet to be compiled but so-far the mortality rate relative to the global population appears to be around 0.01%. The country with the highest number of deaths per million is Peru. Its death rate relative to its total population is 0.1%.

Current “active” cases in the world amount to around 7.7 million and 99% are deemed “mild”. As there are doubtless many cases that have not been detected it is likely that the “mild” percentage is in fact higher.

Your correspondent has been sitting out the pandemic in Australia which is one of the least impacted countries. The international border has been shut since March and many of the State borders as well. It has resulted in an ugly form of parochialism (not unique to Australia). The State of Victoria, which shockingly bungled hotel quarantining, is regarded as a particular pariah. It even introduced an overnight curfew (not seen in wartime) and home confinement extending to 22 hours each day. The curfew applied in Melbourne until a few days ago. A 5km travel limit still applies and residents are not permitted to visit each other’s homes. Retail remains closed. The restrictions are possibly the most severe in the world. The Australia-wide death toll at the time of writing from cases attributed to COVID-19 is 888 or 0.003% of the total population. This is fewer deaths than from the flu in a typical season and lower than the country’s road toll in 2019.

If we examine the development of global cases (not deaths) it appears that the 7-day average of new cases has levelled out to around (or just under) 300,000 – for the statistically minded it is starting to resemble a classic gompertz curve. We hope, that, in time, the curve reverts to a bell shape.

The OECD has re-evaluated global growth prospects based upon the latest information and has reduced the 2020 negatives for several countries, but, in particular, the United States. In June it forecast a 2020 GDP decline of 7.3% for the US but has now trimmed the decline to “just” 3.8%. Good news. The eurozone has seen its GDP negative adjusted by 1.2% to “only” -7.9%; Canada from -8.0% to -5.8% and the UK from -11.5% to -10.1%. The World is now forecast to experience a real GDP decline of 4.5% in 2020 (previously – 6.0%). In 2021 the World is expected to bounce back with a GDP increase of 5.0% but this and other medium-term forecasts are obviously extremely rubbery. A return to pre-COVID world GDP will not occur until 2022 – or later.

If we focus on just some of the larger developed economies and measure real GDP growth from the start of the last global recession (2008) to the end of the June quarter this year the COVID pandemic has wiped out 12 years of growth from the eurozone, Japan and the UK and substantially reduced growth elsewhere. Australia tops the growth list but even there the annualised growth has dropped to 1.7% whilst the US is down to 0.8% and Canada 0.4%. Two of the most grievously wounded eurozone economies are Greece and Italy (not shown below), which have, respectively, lost 35% and 22% of aggregate GDP since 2008. These numbers are simply appalling and underline the magnitude of the recovery task that lies ahead.

The ongoing problem is that much of the economic “activity” of the last half year has been courtesy of extraordinary levels of ‘fantasy’ money provided by panicking governments – all of which will gradually come to a tapered end. The US presents an excellent example: the fiscal response involving support for households, businesses and the health system amounts to almost 15% of GDP. This has pushed the gross Federal debt from 108% of GDP in 2019 to an alarming 138% (projected as at the end of 2020). If unfunded pension liabilities are included the percentage increases to 164% (source: IMF). In other parts of the world many of the fiscal responses have been more extreme. In the eurozone, Germany and Italy, in particular, have provided quite extravagant levels of fiscal support. Thus, a temporary and expensive cushion has been pushed beneath the labouring world economy. The key word is temporary.

Many jobs will not return and many businesses have been permanently wiped out. In particular, enterprises with high levels of fixed costs (airlines, restaurants, hotels and the like) have been smashed.

Will there be a vaccine, and, if so, how soon? We have never been in the rabidly optimistic camp on this question. The world has always suffered from coronaviruses and there has never been a successful vaccine. The common cold and SARS are, after all, examples of coronaviruses.

Short of a vaccine the world will have to learn to live with the virus. In time, these things do seem to pass. We will elect to wear that optimistic hat.

Equity Valuations

The long-term return from a stock market is its dividend yield plus its growth in dividends. Not a particularly difficult equation but of course the world of finance does its best to make it all sound far more complicated. If you can crank a high (and sustainably high) dividend yield into a portfolio you don’t need to be so optimistic about growth, and vice versa.

Right now, the world is incredibly optimistic about growth judging by the extremely low dividend yields on offer and the remarkable recovery in markets since the March nadir. Pandemic – what pandemic?

In the US, the S&P 500 index has shrugged off COVID-19 and is bouncing close to its all-time high. This index accounts for about 80% of total listed-company market cap in the US.

The performance of the S&P500 is obviously impressive but it is important to scratch below the surface. If we do we find that Facebook, Alphabet (Google), Amazon, Apple and Microsoft account for around one-quarter of the total S&P500 market cap and are responsible for the bulk of the gain in the index since the beginning of the year. So, five companies have done very well and 495 not so well.

The skew in stock representation in other broad market indices around the world is not quite so pronounced but all have, nevertheless, picked up markedly since the March lows. So what dividend yield is being baked into future returns?

The S&P currently has a dividend yield of around 1.7%. The ‘world’ average dividend yield is around 2.1%.

Caution needs to be exercised in taking the current dividend yield as a ‘given’. Once government fiscal support tapers and a degree of normality returns many dividends will be cut or eliminated.

The Bank for International Settlements estimates that in the lead-up to COVID-19 approximately 15% of firms in selected rich countries could officially be classified as “zombies” – companies whose operating profits are lower than the interest payments on their debt. They are kept on life-support by compliant banks and creditors – afraid of the consequences if the firm goes under. COVID-19 and government largesse will increase the zombie numbers. Continuing to pump capital into such enterprises is a costly diversion of scarce resources and disruptive to healthy companies.

We would therefore view the current “quoted” dividend yields as the absolute best that can be locked-in when constructing a share portfolio. In other words, if you can get 2% you are doing well. Now many will regard this as excellent since bond yields reside on the floor and bank interest is worse than derisory. But that would be to make the mistake of buying one asset class simply because the other offers no value. Occasionally in markets none offer value.


The US Federal Reserve has given up on inflation targeting. You might remember that it has been attempting to get inflation to 2% (why 2%? – that’s a good question) but has consistently failed to achieve that rate or come close to accurately forecasting where it might be headed. Should inflation rise above 2% in the future the Fed will no longer be obliged to automatically raise lending rates to help club it into submission. In other words, extended periods of below 2% inflation could be followed by extended periods above 2%. Needless to say, the stock market liked this new policy.

Our view is that it is very brave of central banks to believe they can manipulate the rate of inflation. Inflation dances to so many different jigs in an increasingly interconnected world that it would probably be a more productive use of time for central bankers to go out and bash a golf ball about. President Trump often seems to employ that option.

In the UK we have the benefit of some extremely long-term inflation data thanks to Oxford and Cambridge Universities (both founded over 800 years ago). In the “old days” inflation used to bounce up and down with the seasons as the economy of the UK (and others) was almost entirely based on the land. Deflation was as common as inflation. With industrial and economic advances the amplitude of the swings lessened as the country moved through the 1800s until the second half of the 20th century when the swing was in only one direction – up. The 1970s were characterised by extremely high inflation and interest rates. In those days easy monetary policy and big deficits (and the oil crisis) spurred inflation but since then inflation has been far more modest with only a very brief glimpse of deflation in many countries during the Global Financial Crisis.

So what next? It is clear that unlike the 1970s big budget deficits and easy money policies have not propelled retail price inflation. Rather, they have propelled asset prices. But other factors are now in the mix. The vast debt loads in the household sector in much of the world have disinflationary consequences. Endeavouring to reduce a debt load is anti-inflationary. It reduces the velocity of money – something that inflation needs in order to thrive.

Perhaps of greater importance is the quite extraordinary increase in world trade over the last 50 years. In 1970 trade amounted to 27% of world GDP. In 2019 the percentage was 60%.

It is tough for inflation to raise itself to a gallop when any spike in the price of domestically produced goods can be met with a rush of imports of similar goods produced more cheaply abroad. The spread of the internet has made price comparisons extremely easy – internationally – and a savvy consumer rarely pays any more than necessary.

The component of inflation that is relatively sticky is services inflation – and it now forms a decent chunk of the GDP of advanced economies – but durables and non-durables inflation are not remotely sticky and they have played the major role in keeping inflation low in the last few decades.

The massive COVID-induced drop in global capacity utilisation will make deflation more likely than inflation in the short to medium term. It may take years to close the capacity gap.

We have often publicly fretted about the possibility of significant inflation because of the extraordinary increase in global money supply that has been unrelated to economic activity – or anything else. But we fret no longer. The world has changed (always a dangerous statement). We see little prospect of significant inflation for some years. Will it ever come again? Of course it will, but in our prognostications relating to our 5-year investment horizon we do not embrace the possibility.

The Final Word

The pandemic will undoubtedly change some aspects of everyday life permanently. Working from home is now seen as increasingly viable for many occupations and will continue to be utilised – although not to the extent employed in the depths of COVID-19. Social interaction and face-to-face contact are very important so a new balance will need to be established. The trend to move out of the major cities is likely to continue. Inner-city apartments may start to languish on the vine. Business travel is unlikely to gain its former vigour – at least for some years. Airlines will bounce back but it may be a small bounce. Retail has been transformed by the internet over many years but COVID-19 injected rocket-fuel. In the UK we’ve run some statistics indicating that internet sales as a percentage of all retail sales jumped from 20% in February to over 33% just 3 months later. By August the percentage had fallen back to 28% following a phased retail opening but it is still a massive increase in a very short time. It has been a boon for delivery drivers.

The world economy will drag its feet in efforts to get back to where it started earlier this year. It has been floating on a sea of government largesse that will gradually be withdrawn.

And the stock market? If you had suffered amnesia for the last 8 or so months and simply looked at index levels you could be excused for thinking that everything in the world was hunky-dory. Some stocks have doubled, tripled, quadrupled whilst others have suffered severe falls. But that is not so unusual. On the other hand, if you looked at global GDP and unemployment levels after 8 months of amnesia you would have assumed some tragic statistical error had occurred.

So the great disconnect continues. The stock market and the economy. Two different animals. We could, however, show you a chart demonstrating that from 1960 and until the end of 2019 (in the US) whole-economy corporate profits and GDP rose at exactly the same rate over the six decades. That should not come as a surprise as profits cannot be taking a permanently expanding or shrinking share of GDP. The relationship is steady over long periods. And yet here we are naively believing that corporate profits have something to do with the stock market. We may be able to suspend belief for a short while – but it won’t last.

So there you have it. We have managed to get through a Pyrspectives without making any mention of the US Presidential election, the latest Brexit brouhaha or even Elon Musk. We may not get away with it next time.


Pyrford International Ltd is authorised and regulated by the Financial Conduct Authority, entered on the Financial Services Register under number 122137. In the USA Pyrford is registered as an investment adviser with the Securities and Exchange Commission. In Australia Pyrford is exempt from the requirement to hold a financial services license under the Corporations Act in respect of financial services it provides to wholesale investors in Australia. In Canada Pyrford is registered as a Portfolio Manager in Alberta, British Columbia, Manitoba, Ontario and Quebec. Pyrford is a wholly-owned subsidiary of BMO Financial Group, a company listed on the Toronto Stock Exchange (ticker BMO).

This is a marketing publication and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. This publication is prepared for general information only. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. The value of investments can fall as well as rise and an investor may receive less than the amount invested. The investments and strategies discussed here may not be suitable for all investors; if you have any doubts you should consult your investment adviser. Performance data shown in the document may not be in the base currency of the country where an investor is based. Actual returns may increase or decrease as a result of currency fluctuations. Although the information contained herein is believed to be reliable, Pyrford does not warrant its completeness or accuracy. All information provided in this document is for information purposes only and should not be deemed as a guide to investing. Pyrford does not guarantee that the views expressed will be valid beyond the date of the document. Past performance is not a guarantee of future results. Investments cannot be made in an index. Gold is subject to special risks associated with investing in precious metals, including prices being subject to wide fluctuations; a limited and unregulated market; and sources being concentrated in countries that have the potential for instability.

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