The markets must be crazy – understanding the pandemic boom

Pandemic boom Aussie companies dollars cash iron ore banking lockdowns borders 2021
Many Australian ASX listed companies are flush with cash despite the pandemic.

Visiting the pub in between lockdowns has become a dangerous game for me, with some fairly unusual greetings from mates.

“Hey Bevo, you’re meant to know something about the share market, why is everybody going crazy and keeping the market rising when any idiot can see that COVID is pushing us into another recession?’’

It is a hard question to answer quickly, but in order to show that markets are still behaving quite rationally – despite the seeming insanity of continual rises in the face of a damaging pandemic – here are a few pointers as to why markets seem to be defying gravity and why there may still be a lot more to come.

Aussie companies are handing out billions of dollars

The first thing to point out is that many Australian listed companies are absolutely awash with cash which they are beginning to shower on their shareholders in the form of dividends and share buybacks.

Just looking at two sectors for a start, banks are set to deliver around $30 billion to their shareholders in dividends and buybacks and the big miners are set to pay truly enormous dividends.

Miner Rio Tinto (ASX: RIO) alone is delivering $12.2 billion for a half year dividend – the equivalent of handing out an entire top 50 company twice a year if it can be maintained!

In some ways both the banks and the miners are achieving exceptional results as a direct result of the pandemic.

After being the initial epicentre of the pandemic in Wuhan, China has worked hard to both contain the effects of the virus and also to stimulate its own economy to avoid any unnecessary damage.

Iron ore and banking booming

That has delivered a once in a lifetime boom for the big Australian iron ore miners, who have been shipping massive quantities of the steel ingredient to China with massive profit margins, courtesy of unprecedented prices as high as US$220 a tonne.

Similarly, the big banks were very constrained last year due to the pandemic – officially barred from paying out too much in dividends so that they could remain stuffed with capital in case the recession and lockdowns resulted in a rash of bad loans and forced property sales.

As it turned out, with ultra-low interest rates reducing repayments, property values flying and Job-keeper supporting incomes, the banks had a much better than expected year, with frozen home loans thawing out nicely and profits back on the rise.

Now the banks are ready to effectively distribute their excess capital and profits with shareholders set to scoop up billions of dollars.

Looking past the pandemic

A second and very important thing that is propelling the Australian share market is the fact that investors are looking through this pandemic to what will happen on the other side.

While on the ground it seems like we are in a dreadful place with a faltering vaccine rollout and millions of people stuck in lockdowns, markets are now able to see what is happening in other countries that are further down the track and opening up with a large proportion of the population vaccinated.

After a couple of years of restrictions, the usual reaction is to progressively spend a lot of money on travel and other things that have been restricted – in other words, something of an economic boom that will benefit a host of different industries.

Lockdowns are not all bad

Thirdly, and perhaps perversely, it is becoming apparent that lockdowns are not the economic disaster that many have thought they might be.

While the initial effect is strongly negative – in the broadest sense as businesses are closed down and people lose income – there are other things going on as well.

AMP Capital chief economist Shane Oliver has estimated the total direct cost of the restrictions in NSW and other states since the end of May is nearing about $14 billion.

At the same time government spending has been strongly boosted, effectively making up for much of the lost ground on the income side even if there will be a massive debt hangover on the other side.

That stimulus money is highly supportive of economic activity – either straight away or later on – so it is good news for forward looking investors.

Lockdowns also have the effect of keeping interest rates lower for longer as central bankers keep their monetary stimulus taps running harder than they would have otherwise.

Closed borders mean billions are stashed

Finally, the Australian borders have effectively closed during the pandemic, with offshore travel out of the question for most.

Australians spend a lot more travelling overseas than overseas travellers spend here – around $38 billion a year – so we are a net tourism exporter.

So, in some ways the longer the international travel ban stays, the more tourism dollars that will be either spent within Australia or saved and spent on future holidays.

Some of these dollars might also find their ways into the booming share and property markets as well.

In short, while it is tempting to think that there is a logical disconnect between booming share markets and a bruising and damaging pandemic, there are some real reasons behind what might seem to be a case of stupid over-enthusiasm,

Markets are prone to overdoing things but, in this case, they may have more logic and cash driving them than usual.

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