It took a mere 22 days from February 19 for the S&P 500 to decline by 30%, the fastest correction in history. The second fastest was the 1934 and 1931 market corrections, which took 23 and 24 days respectively. On the upside, the S&P has recorded a return of 37.7% from the bottom over a 50-day period, marking it as the fastest rebound in history. Meanwhile, economic data is still expected to show an economy that is severely damaged by the Covid-19 pandemic. This affirms a widely recognised fact — the stock market is not the economy.
Some anecdotes to back up this assertion include that China is reported to be closing schools and suspending thousands of flights due to new cases of coronavirus. In the US, new infections have increased in California, Texas and Florida. Yet the stock market roared to pre-Covid levels last week. Nothing has fundamentally changed in the underlying economy — we are in the middle of the worst recession since the Great Depression, with company bankruptcies and increasing unemployment rates expected.
Yes, stock markets are forward-looking with expectations that are driven more by lower interest rates and earnings expectations. Interest rates are rock bottom globally, but earnings expectations have seen downward revisions. Even with the reopening of economies, a lack of confidence-induced-liquidity trap is likely to lead to bankruptcies.
That the stock market is not the economy should cause a mind shift in domestic investors, particularly those of long-term savings such as pension funds. This is supported by other factors besides the apparent dislocation we observe between the performance of the stock market and the underlying economy.
Let’s look at some of these factors, which must make every investor think, particularly those that proclaim to invest to boost economic growth and employment.
Relative to other emerging markets, SA is having a lower share of value-added in manufacturing, agriculture, energy and construction. The manufacturing sector, at 13.5% of GDP, is 7.5 percentage points lower than the emerging market average. Agriculture, at about 2.7%, is just over three percentage points underrepresented. At 2%, energy is one percentage point underrepresented. Construction accounts for 3.6% of GDP and is 3.7 percentage points underrepresented compared to an average of emerging markets.
Let’s take the JSE Shareholder Weighted (Swix) benchmark index to illustrate the point that benchmark-cognisant investment strategies, which are the lion’s share across many asset managers, underinvest in underrepresented sectors and overinvest in over-represented sectors.
The weight of the manufacturing sector in the Swix is about 7% while it is 13.5% in the GDP. In effect, those investors who don’t deviate significantly from this benchmark will always underinvest in the manufacturing sector, which is why it remains much lower compared to the emerging market average of 22% of GDP.
Let’s pick construction, with a weight of 2% in the Swix and 4% in GDP. The emerging market average is 7% of GDP. Once again, benchmark-cognisant investors will always underinvest, though there is room for growth if SA were to grow in line with other emerging markets.
Lastly, agriculture in SA’s GDP is 2.7% while its share in the Swix is 2%. Its average share in emerging markets’ GDP is 6%, which suggest there is room for more growth in this sector but there is underinvestment.
While there are differences in sectoral composition between countries, there are structural features that are common among those countries with better economic growth than SA. I believe if we increase the share of manufacturing, construction, agriculture and energy in GDP, by investing in these sectors, economic growth would rise and be in line with high-growth emerging markets.
Hence, these are some of the sectors that have been identified by the investment and infrastructure office in the presidency, and hold the future for economic growth, employment creation and transformation.