Crispin Murray’s weekly Australian equities snapshot

Pendal's Head of Equities, Crispin Murray

 

Here is Crispin Murray’s weekly insight into Australian equities, reported by portfolio specialist Chris Adams. Crispin is Pendal’s Head of Equities. 

 

LAST WEEK’S +4.7% gain in the ASX 300 reflected a more positive mood.

On one hand, there are signs the pace of COVID-19 case growth is decelerating globally. On the other, we continue to see a meaningful policy response to help economies cope.

Australia is doing a better job than many countries in containing the spread — and the fiscal support from the government is massive.

There is a possible scenario where Australia serves as something of a relative safe haven, with less investment uncertainty, in the near term.

Investor sentiment has improved but we remain wary of an ongoing flow of data which can deliver sharp sticker-shocks. US employment data, for example, has generally been coming in worse than expected.

We are not convinced yet that the market fully appreciates some of the second and third-order impacts on other parts of the economy not directly touched by the containment measures.

We will also see substantial capital calls likely in coming weeks, which will absorb liquidity and hold sentiment in check.

While the market is acting more rationally than was the case in the initial stages of the crisis, we think the current saw-tooth sideways pattern with high volatility could persist for the moment.

Infection rates

While the overall number of coronavirus infections is staggering, there are some positive signs emerging on infection rates.

Europe looks like it is flattening. Even the numbers coming through in New York are not as bad as some models predicted. This suggests measures to contain the virus are having some effect.

It demonstrates governments have the ability to exert some degree of control over the rate at which the virus spreads, depending on the measures they implement.

This is particularly so in Australia, where the daily percentage increases in new cases has fallen from more than 20% (NSW) in the third week of March to below 5%.

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Authorities have had success identifying clusters and acting to contain them. The most recent data gives confidence that the Australian health system will cope with the virus.

It also lends authorities a greater degree of control over how and when containment measures are rolled back. This could mean structural damage to the economy may not be as bad as some fear.

It’s still unclear whether the government is going for a suppression strategy — which would lead to measures continuing through June — or whether a persistent low level of new cases would lead to an earlier roll-back of measures. It is interesting to note that Singapore reinstated some containment measures as case numbers began to pick up again.

Policy response

The federal government’s JobKeeper program is a material positive — and a larger response than many expected at this point.

Analysis suggests governments will need to spend 10% to 15% of GDP to adequately mitigate the economic effect of containment. This package equates to 6.5% of GDP which, in conjunction with previous measures, takes Australia’s total fiscal response above 10% of GDP.

It is important to remember the economic impact will still be very negative.

At this point the technical unemployment rate could still reach 10% — though without JobKeeper it could have been closer to 15%.

There is also the question of how the economy looks once we start to roll back measures. For example, it’s possible the hospitality industry has to keep some form of social distancing in place even when it re-opens – effectively allowing fewer patrons.

The six-month timeframe for JobKeeper still presents a risk factor for the economy if some industries take longer to normalise than others – which is likely to be the case.

Nevertheless, this package helps reduce the worst-case scenario in terms of unemployment and structural damage to the economy, better positioning it for a rebound.

It also signals the government’s intent to do whatever it takes.

Market observations

The JobKeeper announcement was the most significant development for Australian equities last week and helped underpin the market.

Lower correlations within the market suggest investors are allocating capital more rationally, as opposed to the “sell everything” mentality of a few weeks ago.

We are starting to see capital calls coming through. While the hardest hit companies are tapping markets early given more immediate stress, there are also signs of less-affected companies going early in order to get capital at reasonable prices.

They are reasoning that discounts may need to be larger if they wait longer. The market’s bounce and improvement in sentiment has also helped on the capital front.

There has been better support for some stressed companies than might otherwise have been the case, eg Webjet (WEB) -0.7%.

We expect a steady flow of cash calls will absorb some liquidity and have a limiting effect on any near-term market gains.

It is also important that companies are realistic in the amount of capital they are raising. They will want to be one-and-done. The market will be unforgiving to companies that come back twice.

Management will have to think through some of the more extreme outcomes. Auckland Airport, for example, raised enough capital to support liquidity to the end of 2021. On this basis they are expecting a scaled return in domestic traffic while international flights are disrupted for more than 20 months.

Brent crude oil rallied +35% last week on speculation of a deal between the US, Russia and Saudis to limit production. Thus far, nothing has emerged beyond a few Tweets.

Energy stocks rallied, but we believe the scale of the demand shock on sentiment will continue to overwhelm the likely supply side response. Any reprieve here may be short lived.

It is still too early to get a handle on the likely effect on corporate earnings. Most estimates range between 30-50%, with a bounce-back towards the end of the year.

While many are focusing on the near-term hit, we are also considering what the pace of recovery will look like. A company that sees a 30% fall in earnings – and then a 20% rebound – is still worse off than they were before the crisis.

It may not be until 2022 that we see some normalisation in earnings. It is too early to make this call, but it will have a material impact on valuations and must be assessed company by company.

Outlook

In terms of our list of four areas to watch which can help stabilise the market:

1) Medical breakthrough: Nothing tangible here yet. Testing results from a number of interesting initiatives is due in the next couple of weeks.

2) Policy response: Last week’s developments provide much better clarity and the scale of JobSeeker has helped reassure the market. However there is still a great deal of uncertainty over the degree to which it will soften the economic effect.

3) Oil stabilising: Some sort of deal looks more likely, but will still need to contend with hit to demand.

4) Confidence that health systems can cope with the flow of cases: There are signs of growing confidence here – particularly in Australia.

 

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