Weekly market update - 1st of September 2020

While the local market was flat last week (-0.23%), the US market (S&P 500) broke through its pre-COVID highs with a +3.3% gain.

This was seen as a possible point of resistance and prompted some excitement. But the very narrow nature of the market’s recovery prompts caution.

At the annual Jackson Hole economic policy symposium held (virtually) in Wyoming last week, the Fed gave greater detail on its shift in philosophy towards inflation — which implies lower rates for longer.

The other key development last week was US FDA approval for Abbott Laboratories’ rapid COVID test.

Key short term factors:

• US cases: Having fallen in recent weeks, new daily cases held steady at about 40,000. The return-to-school seems to have had some impact
• Australian cases: No material shift in recent trends
• Vaccine & therapeutic developments: New rapid test from Abbott allows 15-minute response
• US policy & economy: Despite a material fall in government payments, real-time indicators continue to improve
• US election: The race is tightening up with ten weeks to go
• Australian policy & economy: There are some signs a Super-induced spending surge may be tapering off

Covid update

Trends in the US remain reasonable, but the return of students to school and university is definitely seeing increased cases. At the University of Alabama, 1000 students tested positive in the first week out of a total of 31,000.

Confirmed cases continue to pick up in Europe. France reported its largest number of new daily cases since the lockdown. This highlights how difficult it is to keep the virus suppressed. There is a need to find as many ways as possible to mitigate the effects – such as the new Abbott tests – until a vaccine arrives. 

In Australia, Victorian cases continue to trend lower under the lockdown. NSW cases remain low, though they picked up last week with a cluster emerging in Sydney’s CBD. Previous clusters have been manageable, but this needs to be closely watched.

Vaccine and therapeutic developments

The US FDA approved a test from Abbott Labs which is cheap (about $5) and swift. Results are available in 15 minutes. It is not quite as accurate as of the existing polymerase chain reaction (PCR) test but still delivers about 96% accuracy.

The new test must be delivered by a health care professional (it’s not a home kit) and is only approved for people showing symptoms. That means it can’t be used as a screen test at public places such as airports.

Nevertheless, rapid testing will help support activity levels and overall levels of testing. Abbott’s test will be produced on a mass scale – the US government has ordered 150 million kits. Production is expected to reach up to 500 million units per annum. It will take a month or two before it is widely available. Nevertheless, it is another meaningful factor in the overall effort to mitigate the effects of COVID until vaccination is available.

US policy and economy

US Fed governor Jerome Powell gave more detail on a well-flagged shift in philosophy towards inflation. The previous target of 2% will now be viewed as an average over time.  This means it will not pre-emptively tighten rates and will allow inflation to run at more than 2% for a period — meaning lower rates for longer. There was no guidance on how far — or how long — they will allow inflation to run.  While this is an important signal, it does not automatically entrench the return of inflation. This will be determined by the interplay of fiscal and monetary over time.

If we continue to see fiscal expansion in the US, underwritten by Fed balance sheet expansion and suppression of yields, then we are likely to see inflation. However, it is too early to call this a definite outcome – particularly with uncertainty growing on the fiscal side.  Powell did achieve a 10bp rise in 10-year bond yields, to 0.73%. There was also a small sell-off in the USD, which fell 1% against the EUR. Both markets are holding previous support levels.

The narrative of a weaker USD is pervasive and well-expected – similar to the likelihood of some sort of market correction. Given the market’s often perverse propensity to behave contrarily to what everyone expects, we remain mindful that the weaker USD story may not play out as expected.

On the fiscal side, the Republicans want to spend about US$1.3 trillion versus the Democrats’ US$2.2 trillion packages. Bridging the US$900 billion gap might mean we are still weeks away from resolution.

The Trump administration’s Lost Wage Assistance package is starting to flow through — but it is a drop in the ocean of concluded programs. It needs to be approved at a State level. This is taking time, though most states are working through the process.

The conclusion to several support packages means there is about US$15 billion less money each week in the hands of households. The key question is whether this will stall the recovery in the US economy.

At this point, there is no sign of this. Real-time indicators such as dining statistics and mobility data are not turning down. There is an argument that scaling back support packages is helping support better employment growth. It will be important to keep tracking economic momentum, but at this point, it is not concerning.

US Presidential race

Since the national party conventions, Biden’s lead over Trump has continued to narrow — shifting from 60-40 to something closer to 55-45.

Polls remain correlated with case numbers. If the return of university students results in a material spike this may affect the race. It also emphasises the importance of timing on any vaccine news and continued momentum on jobs and economic growth into November.

There is a clear focus on the eight States of historically Democrat voters that swung to deliver the White House to Trump in 2016. At this point, Biden is ahead in six of the eight. But pundits note Clinton was polling ahead of Biden in those same States at this point in 2016.

Polling is regarded as more accurate this election. But the numbers suggest a far closer election than was expected a few months ago. This also raises the risk of a contested election, which would likely be negative for markets and for the USD.

Australian policy and economics

The rate of growth in household cash flow, while still material, has waned in recent weeks as early Super withdrawals wind down. It will be important to track how this – in combination with the drop in JobKeeper and JobSeeker payments in late September – feeds through to economic momentum in the next few months.

Real-time activity indicators have levelled off in recent weeks under the influence of the Victorian shutdown and more cautious behaviour in NSW.

The easing of support may not trigger a material slowdown in consumption if job growth compensates – as seems to be happening in the US. However, it remains a risk to strong sales growth in the retail sector.  It’s been interesting to note that online sales haven fallen back to around 15% of total retail sales, having surged from sub-10% of aggregate sales to about 25% based on feedback from mall Real Estate Investment Trusts and retailers.  It seems likely there has been a structural increase in online sales. But there’s also a risk the market got ahead of itself here. This may be reflected in the expectations implied in the valuations of some online-focused sellers.

Markets

In recent times bond-yield increases have quickly reversed – so it will be worth watching what happens this week following the Fed-induced fall in bond prices.

Commodities continue to grind higher, helped by a more positive view on real assets in response to increased inflation risk. This saw the AUD gain +2.7% against the USD this week. Despite this, resource stocks and energy underperformed as the market became more nervous on iron ore rolling over towards the week’s end.

Poorly-received results

• Ampol (ALD, -8.8%) – The worst performer in the ASX 100. The fundamentals were probably not as bad as the market’s reaction suggests, but a complicated result made it harder to fathom. There was no detail on plans for capital raised from asset sales. Although a takeover deal fell through earlier in the year, the stock probably retains some corporate appeal. 
• APA Group (APA, -7.7%) – FY21 guidance was weaker than expected, disappointing many who hold APA for its defensive qualities. 
• Sonic Health Care (SHL, -6.2%) – SHL’s result was reasonable. But a full valuation began to catch up and the Abbott Lab COVID test may have a negative impact on its medium-term outlook.

Well-received results

• Reliance Worldwide (RWC, +32.8%) – The best performer in the ASX 100. The trading update for July and August was better than expected, prompting a short squeeze. While RWC is focused on maintenance spend — and is therefore not as leveraged to US housing strength as JHX — it is a reminder than when sentiment turns on some cyclical stocks it can do so very quickly.  It underpins the importance of having some cyclical exposure in a portfolio.
• Afterpay (APT, +12.4%) – Continued its relentless re-rating, driven this week by the acquisition of small European and Asian businesses factored into a material uplift in “total addressable market”. The result itself was mixed. Gross margin was good but there were some signs of momentum slowing in US - this could be a significant issue in the next 3 months.
• Scentre Group (SCG, +3.9%) and Stockland (SGP, +7.7%) – Property results were generally taken well. SCG revealed a large decline in re-leasing spreads, but the market feared worse. SGP is seeing retail improve and is well-positioned for the housing recovery.
• Atlas Arteria (ALX, +3.6%) – Delivered a higher distribution than the market expected and indicated traffic was back to flat versus the prior comparable period (PCP); also better than expected.
• Worley (WOR, +6.9%) – Another complicated result, particularly around accounting for recent acquisitions. Ultimately delivered better cash flow than consensus expectations. 
• Cleanaway (CWY, +15.0%) – Demonstrated management strength in continuing to hold up better than expected despite a material impact on its commercial and industrial waste business.

Other results and news

• A2 Milk (A2M, -4.9%) – An announced expansion from marketing and distribution into manufacturing of dairy products with the acquisition of a New Zealand business. Part of its “resilience” strategy and an important defensive move. 
• Nine Entertainment (NEC, +2.2%) – The market’s initial reaction was negative given a worse-than-expected update for TV ad numbers in July. However, signs of improvement are coming through, while the result delivered good cash flow. Potential structural improvements in revenue – from Stan subscriptions and social media payments – coupled with cost-out, place NEC in a good spot when the cycle improves.
• Ramsay Health Care (RHC, -2.0%) – Nothing major in results. Seeing a catch up of deferred procedures, but this is happening slowly. Contract negotiations with Medibank Private (MPL) are ongoing.
• Woolworths (WOW, +0.5%) – Sales remained strong but with higher costs. Seems to be doing better through this period than Coles (COL, -2.0%). 
• Boral (BLD, +7.4%) – The market is looking for some indication of BLD’s strategy under a new CEO and the outlook for troubled US businesses.

August Australian equity market recap

The Australian equity market was up +3.1% for August at the end last week. The big winners have been a tech and consumer discretionary – which are also the sectors with the highest expectations. REITs, healthcare and small caps also did well.

Resources were flat, lagging the market despite the continued strength in iron ore. Defensive sectors such as telecom and utilities were weakest. Banks had a couple of strong periods but also ended lagging the market.  Overall, value continues to struggle.

Stock winners

• Unloved names, where the worst may be over – Reliance (RWC, +42.2%), Wisetech (WTC, +36.3%), Nine Entertainment (NEC, +24.0%), Stockland (SGP, +22.3%), Qantas (QAN, +20.3%), Star Entertainment  (SGR, +16.7%), Worley (WOR, +15.6%).
• Stocks where strong momentum did enough to live up to the hype: Afterpay (APT, +29.5%), Domino’s Pizza (DMP, +15.2%), JB Hi-Fi (JBH, +14.0%), Carsales.com (CAR, +11.9%), James Hardie (JHX +7.8%), Xero (XRO, +11.1%).

Stock losers

• Defensives that were not defensive enough – IAG (IAG, -3.9%), APA (APA, -6.6%), Transurban (TCL, -3.7%), Spark Infrastructure (SKI, -3.1%).  Growth stocks that didn’t deliver enough – Seek (SEK, -5.6%)
• Companies facing structural challenges – Reporting season reminded the market that Bendigo Bank (BEN, -5.4%) and Challenger (CGF, -5.5%) face headwinds form low rates, while AGL (AGL, -8.0%) faces lower power prices.
• Gold stocks consolidated after a strong period – Saracen (SAR, -14.0%), Northern Star (SNT, -12.9%), Newcrest (NCM, 10.2%), Evolution (EVN, -5.7%). 
• China trade exposure – Treasury Wine (TWE, -13.6%).

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