For much of the last 18 months the equity markets have defied the pandemic to reach new all time highs, but is the run coming to an end?

Major equity indices, including the ASX and the Dow Jones, are still above where they were pre-pandemic.

The ASX 200 in the last 2 years

But the ASX has retreated nearly 5% since mid-August (as has the Dow Jones).

The ASX 200 in the past 30 trading days

The Fed stimulus has been one the key ingredients to the market defying the pandemic.

In the last 18 months there has been the occasional few days of negative returns on the market indices – some triggered by the prospect of the unwinding of stimulus from the Federal Reserve.

When COVID-19 first broke out, central banks and governments rapidly rolled out stimulus packages, such as bond buying and wage subsidies, intended to mitigate the damage in the economy and rapidly cut interest rates.

The US alone has spent US$5 trillion in the past year and a half.

The results for global markets and (most) commodity prices since late March 2020 speak for themselves.

But this week the Federal Reserve is meeting again and this time the threat is arguably the greatest in 18 months.

While the Fed is not expected to halt its stimulus measures immediately it is expected to announce it will begin to taper its bond buying program, starting later in the year.

Our own RBA has begun tapering its program from levels seen last year but has locked in current levels until at least February next year.


How central bank stimulus provoked the current bull market

Bond buying was not the only component of global stimulus packages. Another measure was interest rates being cut to record lows, leaving disincentive to do anything with cash but hoard it.

And COVID-19 resulted in many new investors entering the market for the first time as well as existing institutional investors to hedge their bets further.

Adding sugar to the current bull market were companies, both listed and unlisted, raising capital. A grand total of $51.7 billion was raised by ASX companies in 2020.

At the start of the pandemic many firms faced significant uncertainty and raised capital to guarantee survival.

But while some have struggled all pandemic long (such as a travel stocks), others haven’t fared as bad as expected and in raising capital were given additional flexibility to acquire other businesses.

Nearly US$3 trillion in M&A deals have been completed worldwide in the first six months of the year.

In the past few weeks alone several ASX large caps have advanced M&A deals including Sydney Airport (ASX:SYD), AusNet (ASX:AST), ALE Property Group (ASX:LEP), Spark (ASX:SKI) and Afterpay (ASX:APT).

And several other ASX small caps have faced potential suitors as well.


It’s under threat

The withdrawing of stimulus will probably not have a direct impact on many of these companies and their operations.

But it will un-mask the fact that while the global pandemic has been raging for 18 months now, some parts of the economy are roaring, others are not.

While earlier in the year investors were hopeful the pandemic could be contained by vaccination alone, the Delta variant has turned that on its head.

Many developed economies have grown since COVID-19 first hit, many are below pre-COVID highs or just above them.

Despite Australian GDP recording booming growth every quarter since the June quarter of 2020, Australia’s economy is only 1.6% higher ($8 billion) more than in December 2019.

And even though the economy grew 0.7% in the June 2021 quarter, growth was slowing even with minimal COVID-19 restrictions.

Graph: Australian Bureau of Statistics

Of course, when figures the September quarter are released in early December, growth will turn negative thanks to Delta and restrictions governments have been forced to implement as a consequence.

While other global economies not turning to lockdowns may grow, they too will likely slow.

Taking America for example. A Reuters survey of economists tips growth of just 4.4% in the September quarter which is down from the 6.6% growth recorded in the preceding quarter.

To make a long story short, it seems – as Van Eck’s Arian Neiron said last week – the recovery will not be as easy as investors thought it would be. And with stimulus being withdrawn there’s little else left to hide the economic reality.

“The surging Delta variant is playing on investor confidence and we expect to see more of a grind in the months ahead,” he said.

“We expect the recovery will not be short and sharp.”


What can investors do?

Neiron says it could be the time for investors to position their portfolios more defensively and look towards “quality investing”.

“Targeting companies with durable business models and sustainable competitive advantages offers investors protection against downturns and any Delta-variant induced share market weakness,” he said.

“Quality investing is achieved by targeting companies that tend to have high ROE, stable earnings, and strong balance sheets with low financial leverage – all powerful protective factors against economic recession and market drawdowns.”

Also commenting was deVere CEO Nigel Green, who says investors should expect volatility for the rest of 2021.

“Investors should buckle up, remain invested and seek out the inevitable opportunities,” he said.

“Yes, the Fed’s hints on tapering are critical, but investors shouldn’t take their eyes off potentially more explosive issues that could impact markets and their returns.”