When the economy is toast

Investors who keep a level head can benefit from market meltdowns like the “March madness”

- GREG HOFFMAN

“What’s going on with the sharemarket? The economy is toast and we have a 7% rise?!” That WhatsApp message came through to me in late March from a friend who’s no dummy. He’s had a successful career in finance and now runs a small business. Or, at least, he did until it was recently closed, a victim of the Covid-19 recession.

I use the term “recession” with confidence, despite the economic measures that will make it official not being available yet. Two consecutive quarters of economic shrinkage (the technical definition) seem all but impossible for Australia to avoid in the March and June quarters.

The national economy has been cratered by governments around the country. The forced closure of many venues, sporting event cancellations and an effective halt to travel are unprecedented. You surely know people whose jobs have been impacted – either by being stood down, having to take pay cuts or, like my friend, having their small business all but destroyed. It’s devastating.

No doubt you’ve also seen the falls in the sharemarket that began in February and picked up steam in March. The fact that we have short-term bad news is obvious. The economy is, as my friend said, “toast”. For now.

But the second part of his message, about how the sharemarket could rise in such circumstances, is a more intriguing issue.

DISCOUNTING MACHINE

Every serious investor I know agrees on what a company’s value should be. It’s the amount of cash it will deliver to its shareholders over its lifetime, adjusted back into today’s dollars. The theoretical calculations involve projecting the cash that will be paid out by a company in the future (usually through dividends) and then figuring out what those are worth in today’s dollars.