Getting the balancing act right: Stimulus measures vs. economic uncertainty

We have seen most states throughout Australia easing lockdown measures with reported new infection rates dropping to a nominal level and businesses eagerly returning to basic trading using social distancing measures. However with the recent developments in Victoria, everybody is watching the daily infection rate data with a watchful eye. Treasury Secretary Steven Kennedy recently noted a revision to Treasury’s unemployment rate forecast to peak at 8% instead of 10% as previously thought. However, the official unemployment rate will be released in September, when various forms of support, including ‘JobKeeper’, are due to end.

The ABS announced that total payroll jobs increased 1% between mid- May and mid-June. The expected budget deficits for 2019/20 and 2020/21 have now been revised to $95bn (4.8% of GDP) and $240bn (12.2% of GDP) respectively. This significant increase from $80bn and $170bn can be attributed to cyclical deficit.

With all these stimulus measures in mind, Agility Wealth Partners continue to hold a relatively neutral position to risk assets. Some notable changes, however, include the reduction in valuation opportunities within equities, given that share markets (most notably in the US) have recovered since their trough in March. While markets have shown strength, risks remain.

Our valuation model indicates that most asset classes are trading at fair value, except for Government Bonds which continue to look expensive, and Australian Listed Property Securities which look attractive on a relative basis.

Liquidity and policy remain favourable as central banks and governments continue to prop up economies via monetary and fiscal easing measures. Cyclical indicators remain weak, with most economic indicators such as unemployment figures and PMIs showing weakness, although some data coming out for June has been better than expected. Finally, risk indicators such as the VIX (equity markets indicator) and MOVE indices (bond markets indicator) appear to have stabilised.

The extent to which there is a disconnect between share markets and what is happening on the ground remains a focal point. Geopolitical risks, while ever present, continue to impact market volatility. Tensions between the US and China are elevated, and the outcome of the US presidential election in November remains uncertain. Finally, the rise in the number of COVID-19 cases globally continues to create uncertainty as to the shape of any recovery. An important factor in the coming months will be the extent to which governments continue with fiscal measures to support the economy.

Looking back in the last 12 months also highlights how volatile things have been. The chart below shows Asset Class Returns throughout the last financial year (July 1, 2019 – June 30, 2020):

Evident from the market and economic events over the financial year, we saw the first half of the year deliver strong returns across most key asset classes. As the 2nd half of the financial year moved into February, the COVID-19 pandemic precipitated a historical fall in markets, with the velocity of such exceeding what was experienced at the start of the GFC – which eroded all the past years’ strong positive market driven returns by the end of March.

Australian Equities

It is apparent that many investors were ‘voting’ for a sharp rebound once the dark COVID-19 clouds cleared. The S&P/ASX 200 Index ticked past 6,000 points in early July and is once again in bull market territory. Stocks that are leveraged to online retail activity have been standout performers during this isolation period, including Kogan, Temple & Webster, and City Chic. The past three months of hyper growth rates in online sales have been the equivalent of the past three years of cumulative growth. Afterpay (+28.6%) announced an $800 million capital raising and co-founder sell down, while Qantas Airways (-5.3%) provided a post-COVID recovery plan, which focuses on rightsizing the workforce, along with a planned equity raising of up to $1.9 billion. For many, capital raisings have been necessary to bolster solvency and near-term operational liquidity. For some other companies, it has been an opportune time to strengthen balance sheets and thus provide a layer of insurance if the economic malaise continues. Given APRA’s written guidance to the banks that they should be limiting discretionary dividend payments, boards are likely to be conservative with payout ratios. For the banks, the key headwinds are the ultra-low interest rate environment and the risk of impairments.

Global Equities

US equities bounced back strongly in the June quarter on the back of better than expected economic data and re-openings across the country. The S&P 500 Index rose 20.5% over the quarter and is up 7.5% over the year (in US dollar terms). The technology and healthcare sectors led the charge, best illustrated by the performance disparity between the ‘old economy’ Dow Jones Industrial Index and ‘new economy’ NASDAQ Composite Index—up 17.8% and 30.6% respectively during the quarter (in price terms). However, there are concerns about a disconnect between markets and the economy, with earnings for the S&P 500 estimated to have declined by 43.9% during the June quarter—on track to record its largest decline since the December quarter 2008 (-69.1%)—while unemployment remains high and some job losses may end up being permanent. Since reaching their March low, the rebound in global equities has been led by large cap growth companies. While these companies are expected to continue benefiting from persistent low interest rates, in a low growth environment, small cap and value companies are looking more attractive on a relative valuation basis. In contrast to developed markets, emerging market equities have seen less of a bounce back, rising 5.0% in the June quarter and falling – 1.5% over the year.

Fixed Interest

As a result of the excess liquidity in the money market system, the unofficial cash rate fell to 0.14% at the end of June, compared to the official cash rate of 0.25%. This ultra-low interest rate also caused the 90-day bank bill rate to fall from 0.36% at the end of March, following the RBA’s emergency rate cut, to 0.10% at the end of June. The 10-year Commonwealth Government bond yield rose from 0.77% to 0.87% over the same period. The newly targeted three-year bond has been mostly steady around the target rate of 0.25%. Given the RBA expects the three-year yield to remain around this level for quite some time, returns from the bond market will be increasingly reliant on maturities longer than three years to provide yield enhancement, while superior security selection will be needed to add value above benchmark returns and fees. The US 10- year Treasury Note, which had ended calendar year 2019 at 1.92%, finished the March quarter at 0.67%, and experienced material variations over the course of the June quarter to finish at 0.66%. Globally both investment grade and high yield spreads tightened over the June quarter as central bank monetary intervention had a positive impact on credit spreads.

REITs (listed property securities)

As global markets steadied, Australian listed property securities also bounced back over the June quarter, but remain down -21.3% for the year to date, significantly worse than Australian equities (-7.7%). The pandemic has exacerbated and accelerated structural shifts that have been underway in Australian property over the past few years, with different ramifications for each sector. Shopping mall and retail strip landlords have been most affected, with grocery-anchored centres the best placed to weather the storm. Grocery and hardware sales increased as consumers stocked up on staples and other household items during the lockdowns. As Australian states progressively emerge from lockdown, it is anticipated that retail rents will come under pressure as tenants demand either significant rent reductions or incentives. Leading the A-REIT index in June was Cromwell Property Group, which received an “unsolicited and opportunistic” takeover bid from ARA Asset Management. Meanwhile, retail property giant Vicinity Centres (-11.2%) continued to raise money, completing its non-underwritten share purchase plan in July, which fell well short of its targeted $200 million, raising just $32.6 million.

Alternatives

Preliminary estimates for June indicate that the index increased by 1.5% (on a monthly average basis) in SDR terms, after increasing by 1.1% in May (revised). The non-rural, rural and base metals subindices all increased in the month. In Australian dollar terms, the index decreased by 3.1% in June. Over the past year, the index has decreased by 11.4% in SDR terms, led by lower coal, iron ore, oil and LNG prices. The index has decreased by 11.2% in Australian dollar terms.

Please contact Agility Wealth Partners on (02) 8277 4216 or info@agilitywealth.com.au if you would like a chat about your portfolio or a general discussion about your wealth management requirements.

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