Markets continue to roar ahead despite declining consumer sentiment

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.

In Australia, the Westpac-Melbourne Institute Consumer Sentiment Index fell 6.1% to a reading of 87.9 in July, the first decline after rising for two straight months. While July’s reading was 16.2% higher than the record low in April, the index remains 8.0% lower than pre-pandemic levels. Concerns over rising cases of COVID-19 in Victoria were largely behind the deterioration in overall sentiment. With daily infections surpassing 700, Victorian state borders were closed with Greater Melbourne finding itself facing Stage-4 restrictions. Meanwhile, NSW is implementing softer restrictions for weddings, funerals and venues as well as strongly encouraging the voluntary use of masks when in public.

There continues to be a question as to whether markets are reflecting economic reality as they continue their upward trajectory. We remain focused on assessing asset valuations, where we are in the cycle and shorter-term sentiment indicators. We have observed a reduction in valuation opportunities within equities, given that share markets, most notably in the US, have recovered since their trough in March.

Our valuation model indicates that most asset classes are trading at fair value, except for government bonds, which continue to look expensive, and A-REITs, which look attractive on a relative basis. However, within A-REITs we believe that being selective on a sector and security level is important. Liquidity and policy settings remain favourable as central banks and governments continue to prop up economies via monetary easing and fiscal 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 and MOVE indices appear to have stabilised. Indeed, the MOVE index, which measures implied volatility within bond markets, has returned to pre COVID-19 levels.

We have not changed our asset allocation settings and remain relatively neutral to risk assets. While markets have shown strength, risks remain. 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.

A spotlight on employment and Government support in Australia:

Wage data is expected to show a 0.4% increase in the June quarter and annual growth is predicted to slow from 2.1% to 2.0%. Furthermore, labour force data is likely to reveal a 40,000 increase in employment throughout the month of July, following the 210,800 labour surge in June. The increase in employment failed to prevent the unemployment rate rising from 7.1% in May to 7.4% in June, the highest since November 1998. The lift was a result of a large proportion of people returning to the workforce. The participation rate jumped from 62.7% in May to 64.0% in June. Consensus is that the July unemployment rate is expected to reach 7.8%, propped up by an increase in the participation rate to 64.4%.

Chart: Australian Unemployment (Annualised)

The Federal government also announced the extension of both the Job Keeper and Job Seeker programs over July. Job Keeper has been extended to the end of March, with companies needing to reapply and meet the revenue test every quarter. The new model adds a tiered payment approach, with provisions made for full-time and part-time (less than 20 hours weekly) workers. The new payments are $1,200/$750 and $1000/$650 for the December and March quarter, respectively. The renamed ‘Job Keeper 2.0’ that will come into effect at the end of September will cost an additional AU$16 billion. Additionally, ‘Job Seeker 2.0’ will reduce the coronavirus unemployment supplement from $550 to $250 per fortnight. There is also a mutual obligation to accept jobs when offered a position. This extension comes at a cost of AU$3.8 billion.

Market developments during July 2020 included:

Australian Equities

The recovery in Australian shares was cut short in July amid reports of growing Covid-19 cases and anticipation of harsher restrictions in Victoria. Early in August, the Victorian government announced a state of disaster and moved to stage four lockdown, which will see an estimated 1 million people restricted from going to and from their workplace for at least six weeks, while only essential businesses including supermarkets and pharmacies may remain open. The S&P/ASX 200 Index gained 0.5% over the month, dragged down by the energy and health care sectors.

Materials performed well over the month, with strong returns from Fortescue Metals Group (+25.7%) and Oz Minerals (+24.4%). In early earnings reporting, Rio Tinto (+4.2%) announced that 1H 2020 EBIDTA fell 6% on the prior corresponding period due to lower commodity prices during the half but reconfirmed its 2020 production guidance across all commodities.

Wesfarmers (+3.8%) gave a Covid-19 update following Victoria’s lockdown announcement citing all the group’s retail businesses will continue online operations through home delivery and contactless click and collect, while Bunnings will remain open for trade customers only. In FY20, Wesfarmers derived approximately 17% of retail sales from stores within metro Melbourne.

Global Equities

Global shares continued their march higher in July, rising 0.6% in Australian dollar terms and 3.5% in local currency terms. With around half of S&P 500 companies having reported at the time of writing, it is clear earnings have been severely affected by the pandemic, although not as badly as anticipated. The US share market has been supported by the ‘big four’ tech giants (Amazon, Apple, Facebook, and Google), all of which beat estimates. Amazon (+14.7%) was arguably the biggest winner, reporting the largest quarterly net profit in its history, nearly double that of the corresponding quarter in 2019. Apple (+16.5%) reported revenue of US$59.7 billion, above estimates of US$52.2 billion, while every major product line saw year-on-year growth and beat analyst expectations. Microsoft shares (+0.7%) posted modest gains as the company tried to salvage a deal to buy TikTok’s US operations. Across the Atlantic, EU leaders have been relatively successful in containing the Covid19 virus and providing much-needed fiscal support. In July, the European Council approved a €750 billion package to fund fiscal transfers between member states. Since March, the euro has been on the rise against the US dollar as investors see European assets as increasingly attractive.

Fixed Interest

July saw further compression in yields and a tightening in spreads as central bank liquidity continued to flood the market. In the US, the Fed intends to hold the funds rate near zero until the economy has weathered the pandemic. Broad support from the Fed and its presence in the ETF market have helped to tighten spreads across both investment grade and high yield segments. The Fed also includes ‘fallen angels’ in its corporate bond purchases, while the European Central Bank has been more targeted in its approach, resulting in euro high yield being more exposed to volatility.

A hunt for yield in the US market has also seen investors shift up the credit curve. The return on US high yield corporate bonds was 4.7% in July in US dollar terms, the highest monthly return since October 2011. According to the RBA, Australian government bond markets are functioning normally and have seen a solid increase in issuance. The yield on 3-year government bonds has been mostly in line with the RBA’s 0.25% target, although it has been slightly higher in recent weeks, prompting the Bank to resume purchases in the secondary market. The yield target will remain in place until the RBA is satisfied it has brought the inflation and unemployment rates in line with its objectives.

REITs (listed property securities)

Australian REITs were mixed over July as the economic pain from the pandemic rolled on. Shopping centres, which play a prominent role in the A-REIT index, remain affected by reduced foot traffic and struggling tenants. Scentre Group (-6.0%) gave an update on its half year results, noting that the carrying value of its property portfolio as at 30 June 2020 will be down approximately 10% from the end of 2019, with Covid-19 impacts the overriding reason. Meanwhile, some diversified and industrial funds have held up reasonably well during the crisis. Charter Hall’s Long WALE REIT (+8.2%) has been spared the worst despite one of its tenants, Virgin Australia, vacating its Brisbane headquarters.

Centuria Industrial REIT (+3.8%) has similarly weathered the storm, reporting funds from operations per unit of 18.9 cents in FY20, in line with its revised guidance. Centuria will launch a $341 million rights issue to fund the purchase of the Telstra Data centre in Clayton, Melbourne. In the US, REITs returned 3.6% in US dollar terms, boosted by warehouse and industrial REITs (+12.5%) and dragged down by shopping centres (-10.2%) and hotels (-7.8%). Globally, developed market REITs returned 1.4% in Australian dollar hedged terms.

Alternatives

Preliminary estimates for July indicate that the index decreased by 0.9% in Australian dollar terms, after decreasing by 0.2% in June (revised). The non-rural and base metals sub-indices increased in the month of July. Over the past year, the index has decreased by 12.1%, led by lower coal, iron ore, LNG and oil prices.

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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