Equities outlook: debate shifts to re-opening the economy

Pendal's Head of Equities, Crispin Murray

 

Global improvement in health data has prompted a shift in the COVID-19 debate to how quickly economies can begin to re-open. 

Here’s the latest Aussie equities outlook from Pendal’s head of equities Crispin Murray (pictured above), reported by portfolio specialist Chris Adams.

 

GLOBAL improvement in the health situation underpinned a 1.9 per cent gain for the S&P/ASX 300 last week.

This has prompted a shift in the COVID-19 debate to how quickly economies can begin to re-open.

The divergence in health outcomes here versus Europe and the US is becoming increasingly important. It gives Australia the option of an “elimination/suppression” strategy rather than herd immunity approach. This means a more expansive initial re-opening of the economy is possible.

This has important implications for the outlook at companies and for portfolio construction.

Health update

Global new daily cases have stabilised and the rate of hospitalisations in the US has continued to fall this month.

This is important because it opens discussion on how economies ramp up again.

However, it must be borne in mind that in some countries such as Spain, the rate of reduction in new cases is far slower than the original rise. In other words, the rise and fall has not been symmetric.

That means total cases must still be managed carefully against health care system capacity.

We also continue to monitor place such as Japan to help understand the risk of a second wave of infections as economies open up.

There was some excitement last week around antibody tests and medical trials – notably for Remdesivir. Nothing conclusive could be drawn. Samples sizes were too small or control samples not robust enough for policy makers to change tack in response.

But the market’s optimistic reaction was instructive and demonstrates how much liquidity there is sloshing about, looking for any excuse to find a home.

Bookmark Pendal's News Centre for the latest COVID-19 market insights from some of Australia's top fund managers. 

That said, it’s becoming evident from intensive care units in New York, that throwing everything at a patient in terms of potential treatments is having success in saving lives – even if the reasons why are not clearly understood. This is important because it provides some help in managing the mortality rate.

For countries such as US and Europe there is no option but to adopt a herd immunity strategy. The balance here is how much of the economy can be opened up while keeping the case load manageable. Anything that helps dampen the case load and its severity means fewer economic restrictions need to remain in place.

The rate of daily new cases in Australia does look somewhat more symmetrical — and has fallen sharply. If the virus can be effectively supressed, this allows the option of locking down borders but opening up the domestic economy more than would be the case in a country pursuing herd immunity.

Policy and economy

There was little news-flow on the policy front last week, however economic data is starting to filter through.

Business confidence indicators have fallen twice as far as during the GFC – although we are likely to see a snap-back in response to falling infection rates. Nevertheless it is becoming apparent from talking to companies that we are unlikely to see a rapid return to business-as-usual in terms of structure.

A degree of shell shock may prompt a more cautious approach for a period. This could feed through to investment, capital structures and business models.

Many companies are unlikely to reinstate their furloughed workforces in full. This is important to keep in mind when we think about the trajectory at which the economy will recover from its current position.

Markets

The US market has surged in recent weeks and recaptured almost 60% of its fall. It has returned to the levels of mid last year. Some are asking if this is credible given the economy may contract 10% or more this year.

A large proportion of the recovery is also concentrated in a relatively small number of growth tech stocks.

We remain relatively cautious in the near term given uncertainty around earnings and the potential sticker shock.

But we are also mindful of the tide of liquidity looking for home. This has helped propel the growth stocks – given a lot of money has been chasing stocks with the greatest earnings certainty.

We are seeing large divergences in relative valuations and a lot of mis-pricing. It is a good environment for active managers.

Australia’s market has not rebounded at the same rate as the US. We are back to the point of the late-2018 low.

This is partly because we don’t have the big growth stocks to dominate performance. However we still think the Australian market is well positioned versus other overseas markets given the potential differences in the path of economic normalisation.

COVID-19 scenario analysis framework

Pendal’s Australian equities team is continuously monitoring and updating its COVID-19 scenario framework.

The team continues to meet companies to understand first-hand what they face and how they are reacting. This included more than 200 company meetings in March.

We have been using a framework of potential scenarios to position the portfolios during recent events. 

Our current view on the four key inputs into our scenario analysis are: 

Case load and severity: Australian case numbers, growth rate and severity are well within the capacity of the health system. Better outcome relative to some other parts of the world, though case number growth is slowing in most major economies.

Depth and duration of economic hit: Still highly uncertain, but fiscal response and avoidance (so far) of level 4 restrictions critical in containing economic damage.

Nature of economic re-start: Still unknown. Debate is whether government pursues “elimination/suppression” or “mitigation” strategy. Australia has the option of the former, due to geography, political structure and current control over virus spread. This is not the case in the US or Europe.

Timing of medical breakthrough: Anti-viral studies still inconclusive. Optimism around vaccines is high, but length of time until widely available remains an issue.

Here is a downloadable PDF covering the full COVID-19 scenario analysis from Pendal’s equities team

 

 

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