I think the ASX share market seems to be at a crossroad right now. Should investors be bulls or bears in this environment?
There are arguments for both sides. The S&P/ASX 200 Index (ASX: XJO) is struggling to stay above the 6,000 point level – which is a symbolic market measure. The ASX 200 spent most of the 2010s below 6,000.
Here are my thoughts about the bull and bear case for the ASX share market:
Bull case
I was surprised at how strongly the ASX share market recovered after the initial COVID-19 selloff.
Since 23 March 2020 the ASX 200 has gone up more than 31%. The share prices of the big four ASX banks of Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ) are still down materially from their pre-coronavirus prices. If you exclude the banks then the ASX share market recovery looks even stronger.
I think the lower interest rates do go some way to justify the higher prices. All assets are meant to be valued compared to the 'risk free rate of return', namely government bonds. With the RBA interest rate now down to just 0.25%, I think it's clear that share prices would rise in reaction to that.
Obviously another key factor for share prices is the earnings and expectations of future earnings.
Listed businesses are bigger and more resilient
You'd expect the ASX share market to fall during a recession. The share market did fall and it's still down. But remember that the ASX share market isn't just a collection of random businesses in the economy. ASX shares tend to be among the biggest and best in their respective industries.
ASX shares generally have better balance sheets than smaller unlisted businesses. Listed businesses can get access to capital a lot easier as well.
I think what's been most interesting during this period is that many ASX shares have actually reported an increase in revenue during the last couple of months because of all of the stimulus provided to the economy. We've seen a lot of spending in certain categories like groceries, DIY home projects and home office products.
Some of the shares that have reported strong revenue growth include: Wesfarmers Ltd (ASX: WES), Woolworths Group Ltd (ASX: WOW), JB Hi-Fi Limited (ASX: JBH), Harvey Norman Holdings Limited (ASX: HVN), Adairs Ltd (ASX: ADH), Nick Scali Limited (ASX: NCK) and Accent Group Ltd (ASX: AX1).
If we accept that earnings ultimately decide share price movements, then I think it's fair to say the ASX share market has behaved quite rationally with the shares that have seen stable or even growing revenue.
Bear case
But arguably this surge of retail spending is going to be short lived. Jobkeeper, jobseeker and the coronavirus supplement have supported households during this difficult period. But the broad government support is scheduled to come to an end in September. What happens after that?
Has most of the country recovered enough for the economy to go back to normal? I'm not sure it has yet, particularly for Melbourne which has gone back into a lockdown.
The OECD warned that if there is a return to lockdowns in Australia then GDP could fall by 6.3% in 2020. Thankfully it's not the entire country that's facing a lockdown. But Melbourne is important as it's Australia's second biggest city. Hopefully COVID-19 hasn't escaped from Victoria into another state during the last couple of weeks – that would be bad news for the ASX share market.
US issues
What particularly concerns me at the moment is the prospect of a large second wave in the US – there are now 3 million confirmed cases. Some economically important US states like Texas are now slowing and reversing the lifting of restrictions. More restrictions means less economic activity. Obviously officials must make the right decisions to protect lives, but it does mean earnings hits for people and businesses. The ASX generally follows the US share market in the short-term.
The key for stopping a COVID-19-caused share market fall is some sort of healthcare breakthrough in my opinion. Without a healthcare solution it will mean either extended restrictions or increased infections (and deaths), neither of which is good for the economy or share market.
I'm also cautious for the global share market with the upcoming US election later this year. I think it could cause a lot of uncertainty over the next six to nine months depending on who wins and what actions they take. Biden may choose to reverse the tax cuts given to US businesses and President Trump is very unpredictable.
Foolish takeaway
I'm bullish about the long-term future of the ASX share market. However, I feel cautious about what may happen over the rest of 2020. I think the recent bull run has mostly been justified because many companies have delivered strong updates and the economy hasn't been hit as hard as expected. But the last three months of 2020 could cause a lot of share market volatility both in Australia and internationally.
