Kosdaq to Be Affected by Lifting of Short-selling Ban
The authors are strategists of NH Investment & Securities. They can be reached at tedoh@nhqv.com and julie.cho@nhqv.com, respectively. -- Ed.
US real economy looks to have hit bottom, but full-fledged recovery yet to materialize
The New York Fed’s Weekly Economic Index (WEI) arrived at -11.5% at end-April. Of note, as the WEI is scaled to four-quarter GDP growth, if the aforementioned figure had persisted for the entire quarter, one would expect 2Q20 GDP to fall 11.8% y-y.
While the index has not shown a notable decline since end-April, neither has it seen a meaningful recovery. Against this backdrop, it appears that while the US real economy likely touched bottom over end-April~early-May, a full-fledged recovery has yet to materialize. All in all, while it looks like the US economy has begun to rebound ahead of the market’s expectation (3Q20), the pace of recovery appears to remain slow.
Recent economic indicators have beaten market expectations
Weighed upon by the Covid-19 crisis, economic indicators for major DMs (including the US) remained extremely sluggish over March~April. But, indicators released from May onwards have beaten market predictions—a phenomenon that we attribute to an earlier-than-expected rebound in economic conditions, mainly helped by swift policy measures.
US’s policy response to Covid-19 has proved swift vs that for past crises
To weather impacts from the 2008 global financial crisis, the Obama administration implemented the US$862bn American Recovery and Reinvestment Act of 2009 (ARRA). About 43.1% of the ARRA budget was executed within a year of its enactment.
Meanwhile, signed into law on Mar 27, the CARES Act is a US$2.2tn stimulus package. We note that around 55.6% of the total budget was spent within three months of the package’s execution. In addition, the Fed’s asset purchasing (including TBs and mortgage-backed securities) has been undertaken at a swift pace versus that seen during the 2008 financial crisis. We believe that the US government was able to roll out relief measures more quickly this time, in part because it was unnecessary to identify a party responsible for the crisis.
S&P 500 valuation multiple surges on policy measures
The S&P 500 index’s 12-month forward P/E averaged 18.7x over January~February of this year, prior to the spread of Covid-19. The figure then fell to the 14x-level in March before rebounding to around 23x.
With the Fed adjusting the pace of its asset purchasing for fear of a possible overheating in asset markets, stock market valuations should hinge more upon the introduction of additional fiscal measures, rather than monetary policies.
Policy variable 1: Effects from Covid-19 relief measures to fade after July
A number of emergency measures put in place under the CARES Act will soon expire or be used up. We note that: 1) the budget allocated for the paycheck protection program (PPP) is expected to be exhausted over end-June~early-July; 2) the due date for 2019 federal income tax payment (extended from Apr 15 to Jul 15) is to arrive soon; and 3) the additional US$600 a week in federal unemployment benefits is set to end on Jul 31.
With the US Congress not in session between Aug 10~Sep 7, any additional policy measure bills will likely need to be passed before Aug 10. We believe that employment indicators for June (slated for release on Jul 2) will likely determine the scope and pace of any additional relief measures.
Additional relief measures required
While a fourth coronavirus package is being discussed, Democrats and Republicans are at sharp odds over key directions of the new package. Democrats are focused more on expanding welfare benefits, whereas Republicans are calling for more tax cuts. Of note, President Trump has recently presented a US$1tn-worth infrastructure investment plan, which has yet to obtain Congressional approval.
Possible effects from additional relief measures
In January (prior to the Covid-19 crisis), the Congressional Budget Office (CBO) sized 2020 GDP at US$22.1tn. In June, taking into account both Covid-19’s impacts on the economy and effects from the CARES Act, the agency adjusted down its 2020 GDP forecast by US$1.7tn (-7.7%) to US$20.4tn. Excluding effects from the CARES Act, Covid-19 would slash 2020 GDP by US$2.5tn (-11.4%). Given such, the CARES Act will likely push up US GDP by US$0.8tn (+3.7%).
In considering how much a fourth relief package would contribute to GDP, we take into account the budget plans presented by Democrats, Republicans, and the White House, as well as forecasts made by Goldman Sachs. In our estimation, the Democrats’ and Republicans’ schemes could offset a respective 82% and 47% of Covid-19-related damage.
What would Senate Republicans choose?
While the GOP is cautious towards additional stimulus measures due to concerns over excessive fiscal deficit expansion, it is likely to feel growing pressure for additional stimulus measures in the run-up to the November presidential election.
It remains uncertain if the GOP will win a majority of Senate seats in November. Out of 55 Republican seats and 45 Democratic seats, 33 seats (21 Republican seats and 12 Democratic seats) are to be replaced. With Republicans and Democrats already holding 32 and 33 seats, respectively, if Democrats continue to hold their 12 seats and snatch 5 Republican seats, the party would become the majority.
We expect additional stimulus measures to focus on policies that require immediate attention, including an extension of unemployment benefits, SME support, and state government support, rather than infrastructure investment policies.
If Democratic Party’s US$3.4tn stimulus package is implemented…
As of Jun 23, the US stock market cap-to-nominal GDP ratio stood at a historical high of 163%. If the Democratic Party’s stimulus package (worth US$3.4tn) is passed and the US nominal GDP increases by US$1.26tn, the ratio would come to 154%. Even considering the Democratic Party’s sizable stimulus package, the US market cap appears high when considering the size of the economy.
Covid-19 cases resume increase in the US
With economic activity resuming in New York, California, etc, the US’s daily new coronavirus cases have surpassed the 20,000 mark for 11 days in a row, confirming that Covid-19 is on the rise once again.
According to a Cambridge research team in the UK, the coronavirus has mutated from Type A to Types B and C, with mutations helping the virus to infect more human cells. In Singapore, where a second wave of Covid-19 has erupted, Type C has appeared, and in India, even a Type D has been identified. Los Alamos National Laboratory has announced research results showing that while most cases in the US are Type A, a mutation that is 10x more infectious has also been found.
Covid-19 scenarios presented by US medical experts
The Center for Infectious Disease Research and Policy and the American Medical Association have released a report on how the Covid-19 pandemic is likely to play out.
In Scenario 1, the current wave of Covid-19 cases is followed by a series of smaller waves, or ‘peaks and valleys’, that occur over a one- to two-year period, but gradually diminish sometime in 2021. Under Scenario 2, the current wave is followed later this year by a new wave twice as fierce and even longer-lasting. In Scenario 3 (best-case scenario), the initial spring wave of Covid-19 is followed by a ‘slow burn’of Covid-19 transmission.
What all three scenarios agree on is that Covid-19 is not going away any time soon. Most experts predict that Covid-19 will last through 2022, as the virus has been mutating over time and becoming more infectious.
Policy variable 2: Kosdaq to be affected by lifting of short-selling ban
On average, the Kosdaq has tended to retreat over July~September after rallying from the beginning of a year through May~June. Recently, the Kosdaq has rallied on ample pent-up investment capital (customer deposits of W47tn), rallies of US growth stocks, and expectations for the Korea New Deal. But, with valuations for the index rising, the Kosdaq is likely to peak out from 3Q20, rather than rally throughout the year. With the current short-selling ban likely to be lifted on Sep 16, the Kosdaq could begin to reflect anticipated effects of the removal from July~August.
Short-selling ban removals tend to favor large caps
During the global financial crisis, short-selling was banned over Oct 1, 2008~May 29, 2009, and during the US’s sovereign rating downgrade, the same action was taken over Aug 10~Nov 9, 2011. After the bans were removed, net foreign capital flowed into large caps.
In contrast, during the two previous cases, short-selling ban removals led to foreign net-selling of Kosdaq stocks. Considering the past patterns, the upcoming removal of the short-selling ban is likely to put small/mid-cap stocks in a disadvantageous position vs their large counterparts in terms of foreign capital flows.
That said, as foreign capital flows are also affected by economic conditions, passive fund supply-demand circumstances, and forex rates, as well as short-selling bans, we advise keeping an eye on macro-economic variables.
In wait of additional US fiscal policy...
We attribute the current share-price rallies and high valuations to US government policies. Unless additional policies prove as strong as the previous ones, the stock market will likely disappoint. In July, the stock market is likely to adopt a wait-and-see attitude in advance of confirmation regarding the magnitude of additional US fiscal policies. Given that inflationary pressure remains weak, interest rates are low, and the effects of surprisingly robust economic indicators (seen in May and June) are unlikely to last, we advise focusing on large growth stocks.