Completely confused?

Published on: 10 December 2020

'Nature is completely confused!' Years ago, Van Kooten and De Bie, a Dutch comedy duo, were concerned about the timing of nature. Blooming carnations on the beach in December - things like that. Even now, people are amazed at seasons that are out of phase. It's the middle of winter in the economy: entire sectors are frozen. At the same time, the wonderful spring feeling of growth and prosperity has prevailed on the stock markets for some time now. Now, who's mad?


There are several explanations for the gap between the stock market and the economy. First of all, most of the economy is unlisted. We will not see the inactive hospitality and events industry and Dutch Railways, which runs at half speed, at the trade fair. Many companies that benefit from corona, including technology companies, often do have a listing, also in the Netherlands.


In addition, investors are not so concerned with the now. That doesn't sound very mindful, but the expected cash flows in the future do determine the value of a company. In financial markets, it is therefore mainly about tomorrow and the day after tomorrow. And sooner or later, the coronavirus will have been subdued, or at least its ability to cause serious economic damage. And if we return to old trends, wouldn't it also include comparable stock prices?


Still, that's not the end of it - apart from the fact that after corona, there will be winners and losers. The broad MSCI World index is up 10% since January. Based on IMF figures, we estimate that economic activity in the next ten years will be 3.5% lower than expected. Because profits are a residual item, they are more volatile than the economy itself. On that basis, profits would turn out 6 to 11% lower. This macroeconomic estimate is in line with adjustments in the consensus among stock analysts who monitor companies. But one way or the other, it remains a contrast to the rising prices.


The fact that more is paid for less profit has everything to do with the low interest rate. Profit in the (distant) future is therefore worth more. In addition, investors are demanding less high-risk premiums, aided by the strong government interventions that are keeping a financial crisis at bay for the time being.


As such, the high stock valuations are logical.

I don't know whether that is completely reassuring. Profits can be disappointing if deferred bankruptcies still get through. Without wanting to come across as an extremely fearful person - another character of Van Kooten and De Bie - positive economic news can also hit the market. An overly vigorous economic recovery, while justifying earnings expectations, could also herald the end of the corona support and push up interest rates. Who knows, maybe next year, we might be surprised about the markets doing so badly, while the economy is performing at its peak. Nature…




Charles Kalshoven is a senior strategist at APG