Backing the ‘winners’ or picking the bargains
Throughout August there were varied levels of confidence across economies globally. While there are positive signs of recovery, the fear remains as we continue to see a ‘second wave’ of COVID-19 cases. The effectiveness of new stimulus introduced by Governments and Central Banks will weigh heavily on the success of the global economic recovery going forward.
The US Market reached 12-month highs with markets brushing off March’s COVID-19 panic. There have been many discussions about how narrow the rally has been in that a handful of stocks have driven the sharp rebound. The primary driver of returns has again been the ‘FANMAG’ stocks – Facebook, Amazon, Netflix, Microsoft, Apple and Google (Alphabet). These stocks have collectively grown their market capitalisation to over 25% of the S&P 500 Index. Consequently, returns have been positive YTD for these companies as they benefit from the social and economic changes that COVID-19 has introduced across the world’s economies.
Essentially, growth and quality stocks have been rewarded and the impact of COVID-19 on such companies has been minimal relative to other sectors. In some instances, the pandemic has accelerated growth for online retail businesses such as Amazon. On the other hand, there have been notable losers. Airlines, retail property and infrastructure assets such a toll roads and airports have been losers on the back of COVID-19. This divergence has been reflected in the recent Australian reporting season with companies such as JB Hi-Fi reporting record annual profits, while Qantas continues to cut more jobs as it prepares for a $10 billion revenue hit.
A key challenge for investors now is whether to continue to back the ‘winners’ and pay more for growth, or to look for value amidst some of the ‘losers’ and try to identify a bargain. From a portfolio perspective we have taken the view that the current market conditions are favourable to quality/growth companies particularly given the low interest rate environment. However we also continue to have some exposure to the value part of the market, as we believe that some of the bad news has lowered the price of some of these sectors and that over the medium to long term there is an opportunity for these stocks to rebound.
While the current market dynamics are different to what we experienced during the tech bubble what is similar is some of the narrative. I recall prior the collapse of the tech sector we were in a ‘new paradigm’ where value investing was dead and growth companies prospered. History generally does not repeat but it can rhyme. Ensuring that your portfolios are not anchored to one part of the market and they remain diversified, particularly in an environment where uncertainly persists, remains important.
Close to home Treasurer Josh Frydenberg commented on the ‘staggering’ impact the virus has had on GDP around the globe, such as in the UK – where GDP fell by 20%. Despite the devastation seen across the global economy, Australia is expected to see a significantly smaller decrease in GDP compared to other countries. Even with Australia’s stronger performance, the RBA have noted that the restrictions in Victoria are likely to offset any of the potential uplift in GDP growth over the next quarter.
Uncertainty remains for the JobKeeper and JobSeeker ‘’2.0’’ payment schemes as they are set to be the main topics of debate when parliament sits in September. Legislation is needed to pass through the senate prior to the current scheme’s expiry at the end of the month. It is expected that employers will need to re-apply for the scheme, with the flat rate payments also being lowered. The RBA commented that the effect of a less supportive JobKeeper scheme will likely lead to job losses that weigh on the labour market and offset any potential employment growth across the country.
Market developments during August 2020 included:
Australian shares rose 2.8% in August. IT and Consumer Discretionary were the top returning sectors. Once again earnings season was dominated by the dire effects of COVID-19 as companies cut dividends and increased cash holdings. Appen (-2.6%) reported 1H20 results in September, with revenue growth of 25% on the same quarter last year. Relevance was the largest contributor, with revenue growth of 24%, however Speech and Image revenue fell 20% following a breakout result in 1H19.
IOOF Holdings (+1.5%) announced the acquisition of MLC for $1.44 billion, which will be partially funded via an entitlement offer and placement. A2 Milk Company (-11.8%) reported revenue and EBITDA growth of 33% on the prior corresponding period. Infant formula was the main driver of the result, supported by a 65.1% increase in Chinese sales. CSL (+5.9%) announced in September it had signed Heads of Agreements with the Australian Government and AstraZeneca to supply two potential COVID-19 vaccines within Australia following successful clinical trials, however AstraZeneca has halted the trial to investigate an adverse reaction from a study participant in the UK.
The S&P 500 Index rose 7.2% in US dollar terms, ending August at record highs and fully recovered from its March low. The rebound in global equities has been led by large cap growth companies, which have benefitted from the persistent low rate, low growth environment. However, the start of September saw some pressure taken out of extended valuations, especially among US technology shares. In the first week, the NASDAQ fell 6.4% in price terms from Wednesday’s record high. Electric car manufacturer Tesla gained 74.2% in August and fell 16.1% in the first week of September but was still 400% higher on the start of 2020.
One of the heroes of remote work, Zoom Communications, released its June quarter results at the end of August, which included a 355% rise in revenue on the prior corresponding period, soundly beating expectations. Zoom’s share price rose 28.0% in August but fell 19.2% in the first week of September. The MSCI World Ex-Australia Index gained 3.5% in Australian dollar terms in August, while the MSCI Emerging Markets Index fell 0.9%. European shares pushed higher, albeit not as strongly as their US counterparts, with the STOXX Europe 600 Index posting a 4.2% gain.
In Asia, Japan’s Nikkei 225 Index rose 6.6%, Hong Kong’s Hang Seng Index rose 2.5%, and China’s CSI 300 Index rose 2.8%. Fixed Interest Yields rebounded from fresh record lows in August as risk-on sentiment prevailed over the month. The US 10- year Treasury yield hit a low of 0.51% before rising to end the month at 0.71%, while Australia’s 10-year yield rose from its low of 0.82% at the start of August to 0.98% at month end. As widely expected, the Reserve Bank of Australia left the cash rate and yield curve control target unchanged at 0.25% at its September meeting, but increased its Term Funding Facility (TFF) to $200 billion and extended its availability until the end of June 2021. The TFF was established in March to provide up to $90 billion of credit to banks at a fixed rate of 0.25%. Commenting on the outlook, the RBA noted the government has balance sheet scope for continued fiscal support while also stating it is considering further monetary policy measures to support the economy.
The US Federal Reserve issued a revised Statement on Longer-Run Goals and Monetary Policy Strategy, which introduces flexible average inflation targeting (coined FAIT by some) to compensate for periods where inflation runs below the 2 percent target (such as following an economic downturn). Yield curve targeting, which is used by some central banks including the RBA, went unsupported, with the consensus view that it “would likely provide only modest benefits in the current environment.”
REITs (listed property securities)
Australian listed property gained 7.9% in August but remains down 17.7% over the past 12 months. Scentre Group (+10.8%) announced 1H20 results, reporting a statutory loss of $3.6 billion, largely due to property devaluations of $4.1 billion. Excluding devaluations, EBIT fell 32.7% to $637.4 million after accounting for an expected credit charge of $232.1 million in relation to likely uncollectable rents and additional credit risk associated with tenants due to COVID-19. While not in a position to provide guidance, Scentre outlined trading activity is showing signs of recovery, with 93% of stores trading and customer visits up to 84% on the prior corresponding period (both figures excluding Victoria). Charter Hall Group (+18.9%) was another of the top gainers in August, reporting a jump in operating earnings of 46.3% to $322.8 million with net profit climbing 47% and distributions up 6% to 35.7 cents per share. Globally, developed market REITs returned 1.8% in Australian dollar hedged terms. In the US, REITs were flat over August, with hotels (+10.8%) and regional malls (+6.7%) the biggest gainers. Despite near-perfect rent collection through the pandemic, office property (- 3.1%) is battling the ‘work from home’ paradigm, which is putting pressure on the long-term outlook.
Preliminary estimates for August indicate that the index increased by 0.5% (on a monthly average basis) after increasing by 0.1% in July. The non-rural and base metals sub-indices increased in the month, while the rural sub-index decreased. In Australian dollar terms, the index decreased by 0.4 % in August. Over the past year, the index has decreased by 9.2%, led by lower coal and LNG prices.
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