Coronavirus: We may be entering a 'decade long economic slump'

Friday, 24 April 2020

OPINION: Given a choice between altering my belief system and ignoring facts; I usually prefer to ignore facts. I've spent decades investing in the things I believe in and the cost of discarding these ideas is too painful compared to the simplicity of ignoring evidence.

Helpfully I do not have many beliefs. I alternate between stoicism and nihilism and have never really committed to either. Catholicism was discarded in my teenage years and my adherence to libertarianism is philosophical not empirical.

Which brings me to Air New Zealand.

Let me elaborate. The Efficient Market Hypothesis, which I stubbornly remained attached to decades after I knew it was bunkum, is the idea that the price of an asset is a function of all of the available information. This assumes rational investors and some liquidity in the market.

* Coronavirus: The serious threat the pandemic poses to our economy

* Do you feel lucky, Adrian? Why a coronavirus rate cut might do more harm than good

The empty terminal and Air NZ planes parked on tarmac at the Christchurch International Airport during the level 4 Covid pandemic

* NZX slides after coronavirus fears hammer Wall Street and world markets**

Behavioural Economics is a relatively recent idea that, if I may condense an entire school of economic thought to a pithy retort; assumes people are emotionally driven, intellectually lazy and irrational when it comes to investing.

If behavioural economists are correct there can be a sustained divergence between what an asset is worth and what it sells for. The Efficient Market quants reject this, pointing out that a very small number of informed investors will arbitrage away any mispricing.

Now. Let's come back to Air New Zealand.

In late February the company announced a slight drop in its half-year profit, to $198 million. Its share price on the date of the announcement was $2.37, down from a January peak of $3.00 before Covid-19 was on the horizon.

At three dollars a share Air New Zealand is worth about $3.4 billion, which for a business making $400m before tax seems about right.

Since then its revenue has fallen 98 per cent. The state has had to lend it 900m and has the option to turn that into equity.

Most of her planes are parked up. International travel has ended and it could be a year before there's any significant revenue from overseas customers.

The airline's major assets, aircrafts, are going to be hard to sell in the current market. It owes lenders 2.3 billion, not including the 900 million mentioned above.

NZ may be facing economic collapse post coronavirus pandemic.

Yet at the time of writing the share price was $1.36 and at that level the market capital is $1.5 billion.

It is difficult to see any justification for this valuation. Air New Zealand isn't going anywhere, financially or literally. Whatever value that can be salvaged from its domestic operation will go to repaying its lenders.There won't be any dividend between now and the next Beatles reunion tour.

Its share price should be two small rocks and a piece of string.

You can do the same analysis for most of the major firms on any bourse in the OECD; I picked Air New Zealand only for most readers' familiarity with it.

Equities have been holding up remarkably well; given the fact that we are on the precipice of an economic collapse greater than anything since the reformation.

WHAT IS GOING ON?

If the Efficient Market crowd is correct people like me who believe that we are entering what could be a decade long economic slump have read the tea-leaves incorrectly.

Everything was fine before the bat-flu took hold and we are headed for a strong economic resurgence, maybe on the back of a vaccine, better testing or a general tolerance for the risks of dealing with this virus.

Behavioural economists would point to a range of possible explanations, the one that appeals to me is loss aversion. Current equity holders are unwilling to abandon their positions.

In this scenario the prices will only slowly decline as existing shareholders would prefer to retain worthless shares than crystallise their losses.

An alternative explanation is that most of us have not accepted that the economic world we left on the 25th of March has ended. Being locked in our houses living off printed government money has created an illusion of security.

Many believe that an economy that was closed can simply be opened and the massive bubble created by a decade of cheap credit will be re-inflated as easily as Adrian Orr prints electronic money.

We are in for a shock. Once we are released from home detention we shall find a desolate landscape of mass unemployment, closed shops and a collapsing housing market.

Investors are stuck in a mental mindscape of a world they know and a belief in the power of governments and central banks to stimulate away any economic crisis.

The reality of the road that lies ahead is too painful to accept. It is easier to ignore the facts than face reality.

Some perspective. At the start of the last depression in late 1929 the Dow Jones was over 370. By the time the market hit rock bottom in mid-1932 it had fallen to just 41.

A fall of ninety per cent, and most of that fall occurred in a steady, slow, painful descent with many false dawns on the way down.