Tuesday, Oct 29, was the day of the Great Crash of 1929, which sparked off a decade-long global depression. I still vividly recall the Monday, Oct 17, 1987 crash, when the Dow dropped 23% — rescued only when the Fed Reserve cut interest rates. That year, the KL Composite Index declined by 53% between August and December. Every October, I reread John Kenneth Galbraith’s The Great Crash of 1929 (1954) and Charles P Kindleberger’s Manias, Panics and Crashes (1976) just to remind myself of stock market booms and busts.

This October, we have a most unusual situation. Why are global stock markets doing so well amid the worst pandemic and economic recession imaginable? As at Oct 21, the Nasdaq Composite was up 28%, although the S&P500 was up only 6.3% on Dec 31, 2019. Similarly, the Shanghai Composite Index has risen 9% for the year, but Shenzhen is up 30.8%. On the other hand, other global markets are still suffering compared with last year, although turnover in the US and Asia is up. The Nikkei has been flat, Euro STOXX50 is down 15.1%, Hang Seng Index dropped 12.2%, Bursa Malaysia by 6.1% and Singapore by 21.6%.

In contrast, the world economy is on life support because of the Covid-19 pandemic. The IMF October 2020 World Economic Outlook estimated that world GDP growth would decline this year by 4.4%. Roughly US$12 trillion or 13% of world GDP has been spent to deal with the pandemic and revive the economy — about three times that spent for the 2008 financial crisis, and 90 million people will fall into poverty. Unemployment levels are rising.

The US administration has all but admitted that it has lost control of the coronavirus, as second waves hit the US and Europe at the onset of winter. The latest Institute of Health Metrics and Evaluation (IHME) model projected that there will be an estimated 1.9 million deaths worldwide by year-end, with 319,000 in the US alone. The epicentres now are the US, India, Brazil, Russia, Spain, Argentina, France and Colombia, with over a million infections each.

As long as the pandemic cannot be controlled, periodic lockdowns can only delay recovery. Since most of the bad loan deferments, unemployment benefits and medical bills will surface next year, the most infected economies will need further life support.

The World Federation of Exchanges (WFE) has noted that in markets where turnover has increased markedly, the average value of trades has gone down, indicating that retail investors have piled into the stock market. World stock market capitalisation reached US$96.8 trillion or 110% of world GDP, with the US market cap at 181% of GDP — a historic high. By comparison, the Chinese A-share market cap was only 67% of GDP, but, for the first time, exceeded US$10 trillion in value. Adding Hong Kong’s market cap and Chinese ADRs (shares) in the US, the Chinese stock market cap would be 115% of GDP.

The Ant Group dual-listing IPO in both Shanghai and Hong Kong is set to raise US$35 billion, surpassing the Saudi Aramco IPO of US$29 billion, and will give the group a higher market cap than JPMorgan, the largest US listed bank. Companies are raising funds through IPOs to help their deleveraging and investing in new technology.

Given higher market turnover and volatility, the WFE is warning exchanges, investors and regulators to be vigilant about risks and the need for fair and transparent trading, as well as resilient stock trading and clearing systems. The Tokyo Stock Exchange drew market criticism for its hardware shutdown for one day on Oct 1.

An obvious reason why the markets are high is because reserve currency central banks have been pumping them with liquidity through quantitative easing of monetary policy. The S&P500 index tracks very closely the growth in size of the balance sheets of the Fed, European Central Bank and Bank of Japan, which have grown by US$7 trillion since the beginning of the year. Furthermore, since retail investors have been getting near zero interest rates on their bank deposits, they may be trading in the stock market to earn some extra income, especially during the lockdown.

On the other hand, McKinsey thinks that the US stock market resilience is due to three factors: market valuations of expected profits, changing composition of listed companies, and investors’ expectations. The first involves shifting of profits from offline traditional industries to online businesses, especially the tech platforms. Taking a longer point of view, even though short-term profits may be down 50%, the pandemic will only damage long-term overall profits by about 10% since online tech business revenue and profits are up.

Secondly, tech platforms now account for a higher share of profits, as industries concentrate. The top 1,000 companies account for 35% of market cap compared with only 14% in 1995, and the top five technology companies (Amazon, Apple, Facebook, Alphabet and Microsoft) account for 21% of market cap compared with only 2% in 1995. Thirdly, the winning stock market companies do not account for significant GDP or employment contribution. The technology, media and healthcare sectors account for about 17% of GDP, but 46% of market cap.

In short, as long as investors think that the technology, healthcare and media sectors are winners, there is a disconnect between stock market performance and the overall state of the economy.

But no stock can defy gravity. Galbraith thought that 10 good years of the 1920s had to be paid for by 10 bad years of the 1930s. He attributed the causes of the Great Crash and Great Depression to five factors that still resonate today: bad distribution of income, bad corporate structure, bad banking structure, dubious state of foreign balance and the poor state of economic intelligence.

Kindleberger, on the other hand, used financial economist Hyman Minsky’s reminder that markets go through the basic pattern of displacement, overtrading, monetary expansion, revulsion and distress. The displacement has already happened with the rise of China, new technology and, now, the pandemic. The monetary expansion has already occurred with quantitative easing. Over-trading has occurred with high debt and low interest rates. So, sometime or other, the market must turn, but no one knows the trigger nor the timing.

What we do know is that we do not know how to value the future with interest rates near zero. The discounted cash flow valuation model no longer works when the discount rate is zero or negative. Without good professional valuation methods, investors are willing to bet on tech companies with very high price-earnings ratios and to discount the valuation of traditional companies, such as banks. Your guess as to the right price is as good as any expert’s.

The big lesson for retail investors is not to bet their pensions on one basket, and especially not to buy on margin, which would amplify both profits and losses. For those who enjoy the thrill of speculation, enjoy it while it lasts, but beware of the consequences.

Tan Sri Andrew Sheng writes on global issues from an Asian perspective

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