Crispin Murray’s weekly Australian equities outlook
Here’s the latest outlook for Australian equities from Pendal’s head of equities Crispin Murray (pictured above). Reported by portfolio specialist Chris Adams.
THE COMBINATION of a short-term, over-bought market; an increase in virus case-loads in some parts of the US – and perhaps a case of “sell the fact” as the Fed confirmed its current monetary stance – prompted the biggest sell-off in Australian equities since March.
The S&P/ASX 300 fell -2.5% last week and the trend continued Monday.
US bond yields also fell last week. However key industrial commodities held onto most of the recent gains, as did the AUD, while credit only saw a small sell-off. This suggests underlying sentiment remained resilient, underpinned by the ongoing recovery in economic activity as restrictions are unwound.
Within the market, there was rotation away from cyclicals and value towards growth, defensives and gold. This was a reversal of the prevailing trend of the past few weeks.
Are we entering a new market phase?
Some are warning the market fall may signal a more prolonged downturn – focusing on the disconnection between a major hit to the economy and ebullience in markets.
As it stands, our view is this is not the case. Rather, we are entering a period of healthy consolidation in which the market should manage to hold on to most of the recent gains.
Clearly there is material risk to this view. But disconnection between markets and the economy is not unusual in economic turnarounds.
- In 1982 the S&P bottomed 4 months before payrolls
- In 1990 the S&P bottomed 7 months before payrolls
- In 2002 the S&P bottomed 10 months before payrolls
- In 2007 the S&P bottomed 11 months before payrolls
This time the bulk of job losses seem to have been concentrated in a very short space of time. However the market is likely to focus on the rate of change in job recovery.
In our view the real issue is the outlook for economic recovery on a medium-term basis.
In this context:
- The bull case is that COVID-19 is analogous to a natural catastrophe – a sharp, hard hit that can result in a swifter re-opening than first thought. Coupled with spare economic capacity and a vaccine sometime in 2021, this could see strong growth and zero rates for a couple of years, driving markets higher.
- The bear case is that a combination of excess corporate leverage and structural damage to significant parts of the economy will lead to a wave of bankruptcies, a permanent increase in unemployment and financial stress.
It is too early to call either way. These two scenarios represent the “book-ends” of possible scenarios. They underpin why we believe it is so important to ensure portfolios have a mix of stocks to offer protection and upside across a range of outcomes, rather than making a binary call.
We see the following as key factors when gauging the trajectory of economies and markets:
1. Risk of a second wave in the US
The overall trend in case growth in the US is flat. But there is a dispersion between some southern and western States where cases are rising – and the harder-hit north-eastern States where numbers are falling.
There is also concern about hospital capacity in specific areas and talk that Houston may be close to renewing a lock-down. However, it is important to remember:
- The worst-trending affected States represent 15% of the population
- The uptick partly reflects substantially more testing
- Case increases tend to be clustered in nursing home, packing facilities and jails – making them easier to contain
- Hospital capacity stats also reflect the return of elective surgery and are not comparable with the earlier situation
Nevertheless, this remains a key area to watch. The recent outbreak in Beijing – where there are 50 new cases related to the city’s largest food market, potentially tied to imported salmon – demonstrates that the virus can lay dormant and then return.
Our current view is that the combination of testing, more use of masks, improved medical management, continued restrictions on mass events and less use of public mass transit should keep this issue localised and not impact the re-opening process. Nevertheless, the risk here is material and we continue to reflect it in protection within our portfolio construction.
2. Medical developments
There is continued positive news flow on therapeutics. Trials are beginning on an antibody cocktail that could mitigate the worst consequences of the virus. Updates on other vaccine trials are due in the next few weeks.
3. Economic impact of re-opening
This continues to look positive, particularly in Australia. Australian restaurant bookings on the OpenTable service are now down -17% year-on-year compared to -80% a month ago. In the US, surveys indicate gathering momentum in retail, restaurants, autos and housing. Continued strength here can support markets.
There was little new to note here last week. As expected, the Fed signalled their intention to remain highly accommodative – but no new measures may have disappointed the market at the margin.
Political wrangling over the next tranche of fiscal stimulus is likely to feature in coming weeks. It’s expected to be in the range of US$1 trillion to $US1.5 trillion and focused on incentivised hiring and investment.
This is necessary in order to replace expiring packages from the end of July. Any risk to it will not be well received by the market.
5. US Politics
We expect the US Presidential risk could start to drive markets from August. A key factor is the potential for Democrats to take both the White House and Senate – increasing the chance of tax increases and regulation changes. The odds of this have been steadily increasing in recent weeks.
Several short-term technical factors suggested an over-bought market – some of which unwound a little in response to last week’s sell-off. The put/call ratio has fallen but still remains at extreme levels, suggesting we may see some more consolidation. However medium-term technicals still remain generally supportive. There are no warning signs in credit spreads.
A key difference between now and January is that – outside of the well-publicised day traders – market positioning still remains quite cautious. The day traders certainly seem to have helped the rebound in certain highly-leveraged sectors such as airlines and autos – and in individual stocks such as Hertz. However we do not agree it is a major force driving overall markets.
7. Value/growth debate
Last week the value stocks unwound some of their gains relative to growth. The risk of a second wave of infections appears to play a role in this. The effect should be weaker in Australia given this risk appears lower here.
The growth-style premium remains at very high levels historically – and we are mindful that low rates continue to provide a material degree of support here.
8. Other asset classes
The spread between US 10-year and 2-year government bonds gave back the week’s previous rise, reflecting concern over a second wave’s impact on the recovery trade. However movement in other assets such as the EURUSD and copper/gold ratio was marginal.
Oil fell 7%, however demand signals remain supportive. Iron ore continues to remain surprisingly strong – helped initially by Brazilian supply disruption – and more recently by improved Chinese demand.
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and a strong track record leading Australian and European equities funds. He manages a number of our flagship funds along with one of the largest equities teams in Australia.
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