Beware the rally as more bad news to come

Investors are being urged to resist the lure of the rally in global markets as coronavirus fears ease because economic data is painting a much darker picture of things to come.

Morningstar senior equity analyst Brian Han says the global stock market rally, which saw the ASX 200 storm back 21 per cent by mid-April after the March crash, suggests investors are blind to the dire jobless numbers that loom large.

"The rally over the three weeks until 17 April was too fast and too furious, even for us," Han says in his latest column, noting the Morningstar house view that a strong economic recovery is likely from the beginning of calendar 2021.

"Fear of Missing Out, or FOMO, appeared to be staging a comeback.

"This at a time when a large chunk of the economy is still in lockdown, restrictive social-distancing measures remain in force and the outlook for unemployment (and under-employment) is dire even with the government's stimulus measures."

New figures from the Australian Bureau of Statistics, based on ATO payroll data, reveal the devastating impact of the pandemic on employment. Numbers suggest 780,000 jobs were lost as a result of the COVID-19 restrictions. Total wages are also down 6.7 per cent.

Analysis from the Grattan Institute estimates up to 3.4 million Australians could soon be out of work, even with the government's JobKeeper wage subsidy, warning that the unemployment rate will hit between 10 and 15 per cent in the coming months.

"It's clear that the initial hit to employment is as large, if not larger, than any recorded in Australia’s history, including during the Great Depression," the report said.

Too fast, too furious

From the 23 March low point to 17 April, the ASX 200 staged a strong recovery, bouncing 21 per cent. Even the moat-rated but "bombed-out" stocks Morningstar analysts recommended last month, including SkyCity Entertainment (ASX: SKC) and Vocus (ASX: VOC), surged 37 per cent on average.

Investment growth | ASX 200

Time period: 01.01.2020 to 29.04.2020

Define drawdown as decline by 10 per cent or more

Source: Morningstar Direct

Han attributes the recovery to massive government stimulus, kickstarted with the $17.6 billion parcel for small business and aged care. But he says this has become before we get a first real look at the COVID-19 damage on company earnings.

"The unprecedented nature of this crisis is not just confined to the health scare and the uncertain duration of the current lockdown," he says.

"It extends to how long the economy will take to reboot after the lockdown is lifted, and what the recovery trajectory will look like thereafter.

"When the reporting season comes around in August, don’t be surprised if we see management wheel out another definition of profit to add to the plethora of creative ones already in place.

"Anything to dress up what is likely to be a sobering parade of ugly profit and cash flow numbers, due to the debilitating impact of the pandemic."

The ASX's rally mirrors similar activity global markets. The S&P 500 is up 28 per cent over the same period, the FTSE 100 up 16 per cent and the Hang Seng up 12 per cent.

Han says global markets need a reality check as companies prepare for an extended journey in uncharted waters, and urges investors to incorporate a margin of safety into their investment decisions. Investors should focus on balance sheet strength, competitive advantage and valuation. Defensive names should also be top of mind as investors put their money to work.

"It is critical investors keep an eye on the erratic mood of Mr Market, and make sure they don't get caught in any FOMO-redux on the way up, especially when the immediate outlook is so uncertain."

 Read Brian Han's column in full: Beware of covert rally ahead of COVID worry