Here’s the latest outlook for Australian equities from Pendal’s head of equities Crispin Murray (pictured above). Reported by portfolio specialist Chris Adams.

STOCKMARKET sentiment has been buoyed by a roll-back of restrictions and anecdotal evidence that some parts of the economy are recovering faster than expected – possibly as the result of pent-up demand.

That helped the S&P/ASX 300 to a gain of +1.9% last week. A second wave of infections remains the key risk – however this is too early to call.

The Australian equity market has consolidated earlier gains from the low and has effectively traded sideways over the last 30 days – albeit with material volatility.

It has also seen significant rotation within the market – this is driving investment opportunities.

Economic re-start

The market is now in an optimistic mood around economic recovery as restrictions are rolled back.

There has been talk of V-shapes, U-shapes and L-shapes in terms of recovery. We see a strong possibility of a “reverse square root shape” – a sharp drop and then strong initial recovery, levelling off at a lower range than the initial point.

We are seeing demand recover faster than many expected in several sectors. But there’s a risk that after an initial surge it then falls short of expectations and we see a more protracted economic slowdown.

The key factor is that the recovery is not evenly spread. Sectors such as durable goods, autos, take-away restaurants and housing are proving more resilient here and in the US. Other areas such as tourism and entertainment are likely to face stiffer headwinds.

Some key observations on sectors:

•  Traffic data is very strong in the US as people avoid public transport. We are seeing this start to feed through to auto demand as ride-sharers now opt for their own vehicle. This may have implications for steel.

•  Homebuilding seems to have held up much better than people expected. In the US new orders are stepping up and prices remain resilient. It is important to remember both the US auto and housing sectors were coming off relatively subdued bases, which helps in the pace of recovery.

•  There are signs that retail is quickly bouncing back. Some 75% of Australian retailers have re-opened their doors and, anecdotally, are seeing decent sales. It will be important to see how much of this is an initial surge of pent-up demand.

All this has important implications for the portfolio.

If we return to 90-95% of the pre-COVID-19 economy, there will be some parts at 80% and some at 100% or even higher. It will be important to identify the outlook for each individual company or industry and position accordingly.

We also need to remain mindful that, despite current optimism, the economic data will be awful. The hit to Global GDP, ex-China, in 2Q 2020 could be somewhere in the vicinity of 40% – even with the current bounce.

While the market seems well-supported at the moment, there are medium-term risks.

Longer term we remain mindful of the consequences of current policies and the potential for deflation.

Health outlook

It is too early to draw conclusions about the risk of a second wave of infections. In coming weeks we need to remain focused on case loads as countries open up.

High levels of testing and awareness of social distancing may help alleviate some risk. Warmer weather in the northern hemisphere may also help.

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VIDEO: Crispin Murray explains the current market environment

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A surge in optimism over the Moderna vaccine trial may have been premature, but expert opinion seems positive about discovering a vaccine.

A coronavirus vaccine for humans has not previously been found, however focused efforts and widespread use of modern technology platforms are encouraging.

More trial results are expected in June.

Policy

China’s leadership avoided the traditional GDP target at the annual National People’s Congress last week.

Some took this as a bearish signal, on the view that authorities will not feel compelled to stimulate to hit a target. However it also probably has a lot to do with the degree of uncertainty around global demand for Chinese exports.

There is also some disappointment at the scale of bond issuance to fund growth projects – also seen as suggesting less stimulus. We believe Chinese authorities remain focused on job creation and social stability.

The Chinese economy has seen a decent recovery. The smaller scale of stimulus perhaps reflects a desire to pause until some evidence of the effect of global demand comes through before enacting new measures.

Some of the initial US fiscal program are nearing expiry. However there is scope for extension of the Paycheck Protection Program – one of the more important packages – which is critical for small businesses.

Politicians continue to wrangle over the form of the next US fiscal package. The market expects up to a further $US1 trillion in spending – though this may not be until late June.

A key debate here and in the US is how to incentivise workers who may feel better off on government support. This may result in changes to the structure of government programs. 

Markets

Looking at some of the key indicators we flagged last week, gold and the USD were largely unchanged last week, while US 2-year yields rose a little.

The latter remains an important indicator of the market’s expectation of negative rates.

The Australian equity market has been effectively trading sideways since April 13.

This is constructive in the sense that it has held onto gains from the March 20 low and has managed to consolidate. However there has been a material rotation within the market.

Over this period small caps (+13%), resources (+11%) and discretionary (+8%) have all outperformed, reflecting an improvement in sentiment.

Defensive names that did well in the early phases of the crisis – such as health care (-6%) and staples (-3%) – have underperformed.

Financials have underperformed right through the crisis. We have been broadly underweight and have benefited from this.

However we are mindful of the degree to which they have lagged. We remain cautious on the banks, but insurers are starting to look interesting as we think the market is over-discounting the risk of pandemic-linked claims.

REITs (+4.4%), Resources (+6.4%) and Small Caps (+4.4%) all outperformed last week as sentiment remained positive. The banks (-1.3%) dragged.

Crispin Murray is Pendal’s Head of Equities. Crispin has more than 27 years of industry experience in equities and a strong track record leading Australian and European equities funds.

He is responsible for managing a number of our flagship funds and leads one of the largest equities teams in Australia. 

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