Crispin Murray’s weekly Australian equities outlook (Apr 14)
Promising health data is underpinning stronger investor sentiment in the wake of COVID-19. Here’s the latest Aussie equities outlook from Pendal’s head of equities Crispin Murray, reported by portfolio specialist Chris Adams.
MANY now believe we have seen a peak in COVID-19 infection rates.
At the very least, the scenario of an uncontrolled global pandemic now appears to be off the table. In Australia, case growth continues to slow substantially and debate has shifted to the best exit strategy from containment measures.
Encouraging data on the health front is under-pinning stronger investor sentiment.
Last week the S&P/ASX 300 gained +6.4% — its best performance since the crisis began. By Friday the index had bounced +21% off its lows and was down -18.7% for the year to date.
The week saw significant developments on the policy front, with a remarkable support program unveiled by the Fed. The oil producers also agreed to try to constrain supply and support prices.
Capital raisings have thus far been well supported.
Total global new cases of the coronavirus have been decelerating and the outcome in New York has not been as bad as many had feared.
While this is undoubtedly positive, we still face uncertainty over a potential second wave of infections as restrictions lift.
Both Singapore and Japan have shown signs of this. There are perhaps some idiosyncratic factors at play here. Japan had a very low level of testing, which suggests that perhaps the spread wasn’t as well controlled as previously thought. In Singapore a return of foreign workers may have had an effect.
There have been some secondary breakouts in China – notably in Harbin – but they tend to be in areas where perhaps there has been some cross-border spread.
This all has implications for Australia.
With the initial spread now seemingly well under control, the question becomes whether the government pursues a strategy of elimination, suppression or mitigation.
• Involves keeping containment measures in place until there are no new untraced cases for a period of time. Domestic activity can then return to normal, while international borders remain locked, with constant testing in place to ensure no new outbreaks.
• In contrast to other strategies, the downside is initial containment measures remain in place for longer. The upside is the domestic economy can regain a normalised level faster once the restrictions come off.
• This is a more viable option in Australian and NZ than in other countries, given the geography.
• Similar to elimination, but with a tolerance of ongoing cases and continued widespread testing to trace and quickly contain new outbreaks.
• The upside is initial restrictions come off sooner, but the risk of ongoing disruption and potential for periodic reinstatement of measures.
• This is the approach taken in China and South Korea.
• Effectively looks to build herd immunity by allowing parts of the population to get infected while attempting to manage the rate of infection and shield vulnerable community members.
• This has the soonest end to initial restrictions, but an even greater risk of ongoing disruption and potential for further lockdowns and disruption. There are likely to be ongoing restrictions in terms of social density – eg the number of people allowed on planes, in bars and cinemas.
• This is the approach effectively taken by Europe – given the difficulties in controlling borders – and in the US.
In term of a vaccine, the initial Remdesivir trial showed some signs of success, but was inconclusive given the limited scale (53 patients over 28 days) and uncontrolled data set.
The results of larger, more specific trials are due in late April and May.
The Fed’s US$2.3 trillion program – leveraged from the US$454 billion granted by Congress – signifies a material departure from its usual stance towards risk.
It aims to provide the liquidity to underpin funding markets for the following areas:
1) Small-to-medium enterprises: There is $600 billion targeted at supporting lending to small businesses. This is in conjunction with banks, which will assess the borrower, but will only take 5% of the risk, with the Fed assuming the remaining 95%. The loans are for four years, with no interest in the first year. Available to firms with up to 10,000 employees and US$2.5 billion in revenue.
2) The municipal bond (muni) market: A number of US states, large counties and cities were facing the threat of insolvency; $550 billion of the package provides funding, with no credit rating threshold.
3) Investment grade credit program: Expanded to $750 billion. The major change here is that it applies to companies that were investment grade on March 22, so it covers subsequently downgraded “fallen angels” such as Ford and resolves the funding issues they faced.
4) Indirect support to orphan assets: The Fed has expanded what it can buy to include some sub-investment grade bonds, certain high-yield ETFs and parts of the commercial mortgage-backed securities (CMBS) and collateralised loan obligation (CLO) markets.
This effectively underwrites these asset classes, helps ensure companies can access funding and reduces the risk of wide scale bankruptcy. In doing so, the Fed is buying assets and assuming risks it has never previously taken on.
The only area of conservatism is that they have persisted with charging premium rates for access to the borrowing. The Fed’s balance sheet has expanded by a third in the space of one month.
The Fed has also signalled that if this is not deemed sufficient, there will be more. The unprecedented liquidity injection has seen a rapid response in asset prices. Investment grade credit indices have almost recouped all their losses since the health crisis began.
The key risk to all this is if the underlying economy fails to recover, leaving some asset markets mis-priced due to the wave of liquidity. Nevertheless, it is hard to overstate the importance of this move in terms of underpinning confidence in funding and the fundamentals in some key asset markets.
The key players have cobbled together a deal to address oversupply in the oil market, with a headline agreement to reduce daily production by 9.7 million barrels per day.
The reality is closer to an 8.6 million barrel cut, which won’t come into force until May. This leaves several more week of gross overproduction and inventory build.
Historical observation suggests there will be patchy compliance with the agreement. The issue is that oil demand looks to be down by close to 30 million barrels per day – and global storage could be full by May. The deal may provide some short-term relief, but we remain wary of the sector’s outlook.
History suggests markets bottom when there is a sense that the bottom for the economy is in sight. However it’s more complicated this time with unprecedented stimulus and liquidity, which has seen markets rebound.
This could either signal optimism over a far quicker recovery from the pandemic than first thought — or that the market is getting far ahead of itself.
We may now be entering the fourth phase of the crisis.
Phase 1: Coronavirus concerns limited to China and the effect on supply chains
Phase 2: The realisation that this is a global crisis – peak fear and uncertainty over the rate at which the virus spreads and the ability of governments to respond.
Phase 3: Upside surprise in terms of the policy response.
Phase 4: A dawning appreciation of the scale of uncertainties we still face: how long do measures stay in place, how are they rolled back, what is the economic impact and how does that affect company earnings. This is a bit of a waiting game. We think it could present challenges for the market as some of the numbers become apparent. Though the liquidity response helps offset some of the pressure.
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