The recovery of global equity markets from the depths of the COVID crisis has been rapid and substantial, with the MSCI All Country World index (ACWI) 12.5% above pre-COVID levels. The spectacular rebound has been driven by: i) positive vaccine developments, lifting expectations for a recovery; ii) ultra-aggressive stimulus by the major central banks; iii) aggressive fiscal stimulus; and iv) COVID-19 accelerating the shift to new technologies.
The ASX 200 equity index fell 1.5% YoY in 2020, lagging a 14.1% rise in the MSCI World index. Despite world-leading management of COVID-19, this underperformance largely reflects four factors: i) the ASX 200’s stretched starting point entering 2020; ii) the RBAs less aggressive stimulus than its peers, particularly the Fed; iii) COVID-19 accelerating the shift to new technologies underrepresented in Australia versus the US and Asia; and iv) a sharp 10% YoY rebound in the Australian dollar hitting returns of overseas earners.
Of 12 key Australian leading indicators, 10 have resurged from COVID-related lows and are already materially above pre-COVID levels. In this note, we analyse the implications of these lead indicators for growth, profits and stock selection.
The early rebound in GDP should accelerate into a V-recovery with re-openings, vaccines, unprecedented 2nd-round stimulus by the governments and the RBA, and a huge build-up of private saving in households and SMEs.
After a sharp sell-off in the COVID bear market, corporate credit spreads have fully recovered and appear to be discounting a relatively low default risk. By contrast, major bank share prices have significantly underperformed during COVID, appearing to discount a major bad debt cycle.
A powerful rally has propelled the ASX 200 to within ~8% of its pre-COVID peak. We expect the index to break through to new record highs for seven reasons:
In the early stages of the COVID downturn, corporate Australia raised equity, cut or paused dividends and reduced capital investment to support balance sheets and cash flow. Since then, ultra-aggressive fiscal and monetary support and stimulus and the early stages of a powerful recovery have further supported business.
Whilst there have been wild divergences between winners and losers during COVID, the AGM anecdotes are generally improving and positive, whilst the economic indicators are increasingly consistent with a powerful V-recovery.
Australia’s FY21 Federal Budget is extremely stimulative, adding $82.6 billion (4.1% of gross domestic product) in new initiatives, bringing stimulus over the next 21 months to around $100 billion, or 5% of GDP.
From timely official and industry data, Australia is seeing a V-shaped recovery in retail sales, housing activity and capital goods investment, providing a strong platform for a 2H20 recovery.
Australia’s second wave of COVID-19 infections has driven lockdowns in Victoria and renewed fears of a deep economic downturn. The direct cost of this lockdown is estimated at $7 billion, rising to $12.5 billion with flow-on effects. Many forecasters have cut their forecasts for the recovery, seeing little, if any, recovery in 2H20.
The economic and market implications of a vaccine should be significantly positive, including a surge in confidence, release of substantial precautionary savings by consumers and business, positive wealth effects, the reopening of restricted sectors and an intensified impact from zero rates.
Consistent with current commentary, consumer indicators are generally positive, whilst housing is troughing and finance indicators have stabilised. Business indicators are the laggard, still below pre-COVID-19 levels.
At its meeting on Tuesday, the Reserve Bank of Australia (RBA) significantly stepped up its monetary stimulus, expanding its Term Funding Facility (TFF) by another $57 billion and reporting another $10 billion of bond purchases over August.
Australia’s second wave of COVID-19 infections has driven lockdowns in Victoria and renewed fears of a deep economic downturn. The direct cost of this lockdown is estimated at $7 billion, rising to $12.5 billion with flow-on effects. Many forecasters have cut their forecasts for the recovery, seeing little, if any, recovery in 2H20.
The ASX 200 has rebounded a powerful 32% from the March trough of the COVID-19 bear market. But the rebound has not been helped by earnings growth, with consensus 12-month forward earnings estimates for the ASX 200 index down 20% from pre-COVID-19 levels. Indeed, earnings momentum is very negative at -25% YoY, well below the US and Emerging Markets at -17% YoY.
Bond yields fell to record low levels in the depths of the COVID-19 downturn in March and remain there – G7 and Australian 10-year yields are 0.4% and 0.9% respectively – despite powerful equity market rallies and rebounding key leading indicators. In 2009, 2012 and 2016 bond yields rose when equities rallied and growth indicators strengthened. So who is right, bonds or equities?
Yesterday was a significant day for Australian equities for three reasons:
Following the COVID-19 driven sharp declines in economies and equity markets in March-April 2020, the key now is the signs of progress toward recovery in the leading global economies and Australia, and their implications for markets.
Australia is in the early stages of a strong V-shaped recovery, which we expect to more than offset fears of a fiscal cliff in 4Q20 when the Government’s JobKeeper and JobSeeker programs are set to expire.
Today’s Australian retail sales figures were dramatically better-than-expected, with sales rising a record 16.3% MoM in May and 5.3% YoY (Figure 1). At the May monthly level, retail sales are 4.1% above their pre-COVID-19 level! This is consistent with a V-shaped recovery for Australia.
In our view the Australian economy and equity market should decouple from the US and materially outperform over the next 6-12 months. In this note we find that Australia is better placed than the US on 7 of 8 key points of comparison.
This is an extremely fast-moving cycle: in the space of just three months Australia has experienced a spike in COVID-19 new cases, lockdown restrictions, deep declines in employment and spending, an unprecedented policy response, and world-leading containment and restart successes. In such a cycle it is more important than ever to stay abreast of current indicators and anecdotes and to avoid relying on outdated commentary.
Last Friday the Australian Treasury and Taxation Office announced a $60 billion error in the forecast cost of the Federal Government’s leading JobKeeper program.
There are three major implications of this major revision.
Despite significantly outperforming global peers in navigating the COVID-19 pandemic – for details please see our note, ‘Ranking recoveries: aVstralia, aVia, Usa and eUrope’ – the Australian equity market has materially underperformed.
Find out about our resilient and restart stocks here:
We use four criteria to assess the responses of different countries and regions to the COVID-19 shock:
Find out about our overall rankings here:
The differences between the U- and V-recovery scenarios are dramatic: in the U-, earnings fall 25-30% in 2020 and then rebound 30-40% in 2021; in the V-, they fall 5% in 2020 and then boom about 50% in 2021.
In contrast to the IMF-U, RBA-U and Treasury-u, we see Australia tracking the EL&C Baillieu V-shaped scenario for five reasons. Read about them here:
Australia is beginning to restart sectors deeply affected by measures to contain COVID-19. We expect Australia to achieve a successful, V-shaped recovery for five reasons: i) world-leading success containing COVID-19; ii) the satisfaction of rigorous criteria for a safe restart; iii) the unprecedented fiscal and monetary support and stimulus that is beginning to flow; iv) the windfall from the oil price crash; and v) the support from Asia’s FIFO recovery.
These 10 stocks should benefit…
Australia is the most successful Western economy in containing COVID-19. With safe restart capabilities in place, a restart is underway – starting with elective surgery and some retailing. In this note, we analyse the implications of a V- or U-shaped recovery.
The COVID-19 shock is driving a sharp fall in economic activity. In our view, at a macro-level Australia is making solid progress toward an effective response, given: i) containment measures slowing the growth in cases below 5% per day; ii) monetary stimulus, with rates at effective zero and RBA asset purchases of A$36 billion in twelve days; iii) unprecedented fiscal support measures of ~10% of GDP; iv) fiscal stimulus measures of ~1.5% of GDP; and v) the oil price windfall of ~1% of GDP.
This year’s sharp bear market and the Federal Government’s unprecedented fiscal response provides an attractive entry point into the Australian equity market. We see six positives for the Australian market:
The Reserve Bank of Australia’s (RBA) March 2020 50bps of rate cuts and 0.25% target yield for the 3-year Commonwealth bond has been overshadowed by rate cuts of 65-150bps and quantitative easing (QE) programs of 3.3-8.5% of GDP by the world’s major central banks.
The Brent oil price has fallen ~50%, or ~US$30 per barrel (bbl), year-to-date (Figure 1), driven by three factors: i) the impact of COVID-19 on China, with the Government lockdown driving a sharp decline in China oil demand; ii) the global spread of COVID-19, with a substantial hit to global travel and oil demand; and iii) the collapse of the OPEC plus Russia oil cartel and their subsequent moves to increase production and take market share.
| Global equity markets have fallen sharply over the past 20 days, declining 27.0% from record levels (or 22.4% in AUD-terms). For Australia, this sharp bear market is now the fourth worst in the past 40 years. |
A rapid correction on COVID-19 concerns has erased a large part of the global equity rally of the past year, despite the positives of easy monetary policy, the US-China trade deal, the resolution of Brexit and persistent low inflation. Bond yields have fallen sharply to new record lows, whilst industrial commodities and the Australian dollar have weakened. In this note, we provide our regular update of key investment themes, major asset class views and the implications for tactical-dynamic asset allocation.
| The ASX 200 equity index rose 18.4% YoY in 2019, driven by a strong global rally, the surprise Morrison Federal Government re-election and 75bps of Reserve Bank of Australia (RBA) rate cuts. The rally occurred despite consensus earnings estimates falling 2.9% YoY, lifting the ASX 200 forward PE ratio to 18.2x; a level only exceeded briefly in the equity bubble of 1999-2000.
Looking into 2020, we introduce five investment themes. |
| Looking back to a year ago, we had success with our four global themes: a US soft landing over a hard landing, an inflection point in central bank policy, trade and political uncertainty to moderate, and valuation extremes (then relatively cheap) to moderate. Looking in to 2020, we introduce five global themes.
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Australia’s Reserve Bank continues to deploy a pre-emptive policy strategy, easing policy when expecting below-trend growth and/or below-target inflation. In a speech last week, RBA Governor Philip Lowe indicated that official rates, already cut from a record low 1.5% to 0.75%, could be lowered to a mere 0.25%; though he set a higher bar on adoption of quantitative easing.
The ASX 200 remains robust, trading just below its record high and on an unusually high forward PE of ~16.5x, ~14% above average. But the earnings picture looks very different, with the trends of the FY19 reporting season –where earnings fell ~2% YoY – appearing to continue into the AGM season.
Asset Allocator
Global equity markets have rebounded sharply in 2019, retracing 4Q18’s correction. The US Federal Reserve has driven the rebound, moving to an extended rate pause. Signs of a trough in China and, until this week, easing trade uncertainty have added to the rebound. Bonds have continued to rally, oil has rebounded sharply, and the Australian dollar has moved sideways. In this note, we update our Tactical-Dynamic Asset Allocation views.