Crispin Murray: Covid, bonds and this week’s ASX outlook
Here’s what’s driving Australian equities this week according to Pendal’s head of equities Crispin Murray (pictured above). Reported by portfolio specialist Chris Adams.
- Crispin Murray names the big policy shifts driving equities
- Find out about Pendal’s Focus Australian Share Fund here
THE COUNTERTREND bond rally continued last week, pushing down yields and supporting a continued recovery in growth and defensive stocks.
It is worth noting the market overall has risen in both environments. The ASX 300 was up 4.2% in Q1 when yields were rising and it is up another 4.2% quarter-to-date with yields falling.
This highlights the market’s breadth. The laggard sectors have held up reasonably well in both the value and growth-dominant legs, allowing the overall market to rise. This reflects high levels of underlying liquidity and the continued chase for returns.
The S&P/ASX 300 gained 1% for the week and the S&P 500 was up 1.4%.
The question now is how long the bond rally phase can continue. More on that below, but at a high level we believe the move lower in yields will be limited and bond yields are likely to return to their higher levels within three months.
The bond market rally
There have been five key drivers of the recent rally in bonds, in our view:
- Positioning: There was a strong consensus position and very crowded trade long recovery and re-opening plays and short defensive assets like bonds in Q1.
- Yield differential: The yield pick-up for European and Japanese investors buying US treasuries hedged back to domestic currency was at its highest levels for five years.
- Peak growth approaching: In terms of the second derivative – the rate of growth — this peaks in April and early May and slows thereafter.
- Covid spike: Cases are picking up in US and big emerging markets such as Brazil, India and Chile. There are also renewed fears about Covid variants.
- Vaccine safety concerns: The Johnson & Johnson vaccine has now also been linked to blood clots, leading to a temporary suspension in the US.
Covid and vaccine issues
Looking at points four and five above, we believe there are some material medium-term risks for the management of Covid and full global re-opening. But the near-term trends are supportive enough to avoid any breaking down of the current re-opening economic recovery.
In the EU new daily cases remain elevated. The seven-day average is more than 300 people per million compared to fewer than 200 in the US and about 100 in the UK. There are signs this number is stabilising in the EU.
Brazil is surging and is now running just ahead of the EU. Given low rates of testing there, the real number is probably 50% more.
There is some focus on Manaus where some 70% of the population already had Covid — but people are being re-infected with the Brazilian strain (P1). This highlights concerns with the duration of immunity.
Adding to the confusion a new double mutant strain has been reported in India. So far no one knows if it is more resistant to vaccines.
Regarding the surge in Covid cases, the key point is we will achieve herd immunity later than many expected. The outlook for emerging markets in particular has declined. This means a more subdued medium-term global re-opening recovery, which means monetary policy remains looser for longer.
The debate over how long vaccines remain protective is important in this context.
Pfizer released data indicating the average effectiveness of its vaccine was 91% over six months. While ostensibly a good number, given it starts at 95% this implies effectiveness is falling into the 80s by the end of the period.
This is backed up by studies showing the presence of relevant antibodies has fallen by two-thirds (for people in the 18-55 year cohort) over that period. For people in the older age cohorts, the degree of antibody decrease is greater still.
This still leaves enough antibodies for the vaccine to be considered effective against the original strain after six months, although for people above 70 years old it is getting closer to the cut-off mark.
However it’s believed the degree of relevant antibodies is deflated by a material factor in the case of the South African and Brazilian variants. It’s unclear if older populations would still be immune after six months.
There is a degree of complexity in measuring the presence of antibodies and rates of decline, particularly among different types of vaccines.
There can be no conclusion on the Covid outlook at this point, but we can make some inferences:
- Covid is likely to remain an endemic disease like the flu. It will remain prevalent and disease management will be an important focus.
- Re-opening international borders is likely to be more complicated than expected. New variants are one issue. So is the fact that we will have people with different vaccines received at different times. There is no homogenous standard to assess people’s risk of getting the disease.
- The need for booster shots will continue for some time. Hence Pfizer’s comments regarding the need for a third shot.
The investment consequences of this are complex. One outcome is a dispersion in performance within cyclicals in the US. Domestic cyclicals are outperforming global cyclicals given the issues in both the EU and emerging markets.
Positive near-term news on Covid
These are all medium-term issues. In the near term, developments have been positive on balance, despite the issue with the Johnson & Johnson vaccine.
In Europe, vaccination rates are now dialling up and supply issues are being resolved. The EU is about two to three months behind the US in terms of the vaccine roll-out.
At this point the increase in US Covid cases remains relatively muted, despite a sharp spike in Michigan. The vaccination rate remains at record levels and more than 80% of over-65s have had at least one shot.
The manufacturing capacity of the Moderna vaccine looks set to meet demand requirements. This helps alleviate concerns with other vaccines, though it has run into some supply issue outside the US. At this point we expect concerns over vaccines — which have helped drive bond yields down — should not persist.
Economics and policy outlook
Returning to drivers of the recent bond rally, we believe the strength of the economy will prove more durable than the market expects.
Therefore the peak growth argument for buying bonds will not be sustained.
Data suggests the US economy is booming and this is flowing through into the rest of the world. Consumer spending is at record levels, supported by a surge in consumer net worth and the economic re-opening. The question is how sustainable this is, in the context of an expected peak in the next month.
Our first observation is that the increase in net worth extends well beyond the top decile by wealth. The top 10% of the US by wealth has seen a total 30% increase in net worth, but the next 40% have seen a 33% increase. This is important because it includes income groups that are more likely to spend than save.
This is flowing through into spending plans. Recent survey data asking about expected spending one year out has surged, indicating that consumer spending could extend for longer than expected.
Another reason is that we are seeing household net worth rise at the same time that household debt has fallen materially — from about 105% of GDP to about 75%. The starting point for the savings rate is also very high.
This is fundamentally different to the post-GFC era. Then households had run down savings rates and built up debt, so consumption faced a double headwind as savings rates rose to repay debt. The opposite could happen this cycle.
Meanwhile we are in an environment where households are still covering their spending with wages, ie they are still not eating into the estimated US$3 trillion of excess saving.
In addition, companies are reporting record low levels of inventory as they struggle to meet demand. This suggests they will need to re-build inventories in future quarters. Some of this is being constrained by supply bottlenecks (eg in auto), so this also helps extend the cycle.
Housing also continues to boom. Low rates are a cyclical tailwind, but structural factors are just as important. Housing formation declined materially post-GFC. We are now seeing a supply response to address the current underbuild, which is also supported by aging Millennials and the work-from-home trend. This provides a more sustainable platform for on-going economic strength.
The point here is that the expectation of a peak in growth, as a driver of recent bond strength, is more about sentiment. We expect continued economic strength, evidence of supply chain bottlenecks and some emerging inflation pressures in the next here months.
In this environment it is hard to see real rates staying at -1% and anchoring bond yields at current levels.
There are a few broad observations on equities at this point.
- The correlation between the yield curve and performance of defensives versus cyclicals and growth versus value has been very clear in recent weeks. If we get a reversal in recent bond rally we should see the value and cyclical trade resume.
- Equity market volatility continues to be supressed. This is worrying some people who believe it’s being held down artificially by central banks. If it continues this should help bolster confidence in equities. It also potentially encourages more equity positioning in risk parity strategies.
- There is not yet any negative signal from credit spread, which have hit post-GFC lows. We see this as correlated with equity valuations.
Last week we got the trifecta of bonds, commodities and equities rallying together. The US dollar also began to roll over, which supports commodities.
Australia, like the rest of the world, last week saw growth stocks lead in what was otherwise a broad rally. Names like Xero (XRO, +5.9%), CarSales.com (CAR, +5.1%), Afterpay (APT, +4.9%), NextDC (NXT, +4.5%) and Wisetech (WTC, +3.8%) were among the best performers in the ASX 100.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia.
Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions , as this graph shows:
Source: Pendal. Performance is after fees and before taxes. *From 01 Apr 05; **as at 28 Feb 21. Past performance is not a reliable indicator of future performance.
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