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Weekly market update - 23rd of March 2020

Written and accurate as at: Mar 23, 2020 Current Stats & Facts

The weekend brought a raft of new measures to enforce social distancing and contain the COVID-19 virus spread, in response to the continued acceleration of Australian cases. At this point, there is a high degree of uncertainty over the economic impact of containment measures on one hand – and the ability of fiscal measures to mitigate this effect on the other.  The “gap” between these two poles of uncertainty is driving the extreme volatility in markets.  Estimates of the possible effect are emerging. In the US some are suggesting the GDP decline next quarter could be as much as 20-30% on an annualised basis. Some models are showing a 5-8% decline in global GDP for 2020.

This would manifest in a dramatic earnings decline of 30%+ - bearing in mind that in the GFC corporate earnings fell close to 50%.  The simple fact is that only time will reveal the full impact – and the key determinant here is the rate at which the virus continues to spread. Given that governments are prioritising health over the economy, infection rates will determine how stringent containment measures become and how soon they can be relaxed. Monitoring the delta here remains crucial.

At this point, Australian federal government advice around the closure of non-essential services is limited to entertainment – casinos, pubs and clubs. The effects will be material – but an order of magnitude higher if they are extended to retail and construction. This can’t be ruled out. Again, the rate of new infections will be a key indicator, as will observation of the degree to which people are social distancing. The government does not want to see thousands flocking to Bondi Beach.  One counter to this uncertainty is that each day brings greater colour on the scale and nature of the policy response. In the US the current package under negotiation could involve Treasury making US$400-$450 billion of risk capital available to the Fed to lever up — backing a program of up to US$4 trillion which could be used to provide loans as well as liquidity to credit markets. The scale is unprecedented.

There are long-term consequences for government balance sheets. But for the moment the sheer size and relative speed of fiscal programs suggest governments appreciate the importance of ensuring that a health crisis does not morph into a systemic financial crisis.  The money markets are often a weathervane for system health and there was stress here last week.  There are some signs of improvement here – and in FX markets – as reserves are released and liquidity flows into the system.  Governments and central banks remain focused on this area.

People are adapting to containment measures, while trying to understand and measure their economic effects, in an environment of negative news flow. We may be in for several weeks of unsettling headlines.  The only certainty is that there will be a material negative impact. The degree of this impact is up for debate, however, we are mindful the market has been quite efficient in pricing in a material hit to earnings and now reflects a very negative scenario. Markets can and do overshoot both ways – we may be set for further downside.

But there will be an unprecedented degree of policy support for those parts of the economy that are suffering. The banking system, too, is signalling that it will take a more lenient view on loan repayments and debt covenants to help businesses through this period. Governments and central banks have also signalled they will do whatever it takes to prevent the financial system seizing up.

The upshot is that having priced in a huge drop in earnings, there is a chance the equity market has entered a phase where we could see a rebound as it starts to factor in the effect of fiscal measures feeding through. There is an elevated risk of investors being ‘whipsawed’ here – selling out in an attempt to buy in at lower levels and missing a material bounce.

In terms of the economy, the speed of containment measures is driving a high degree of pain in a short space of time. However, there is also a view that a sharper fall may mean a shorter period of pain, in contrast to the more typical 2-3 years of a cyclical downturn. There are good reasons to expect that a recovery could be swifter than in a normal cycle.

The S&P/ASX 300 dropped -13.0% last week. There was significant volatility in bond markets until central bank announcements brought a degree of calm. US 10-year yields ended the week almost unchanged at 0.96% after blowing out at one point. Australian 10-year sovereigns went from 0.97% to 1.14%.  Bond market volatility, coupled with concerns over the potential for mall closures and a natural wariness towards leverage saw the S&P/ASX 300 AREIT sector fall -27.1%. Stock selection is paramount within this sector.

Metals & Mining (-2.3%) proved resilient. Iron ore prices remain robust and, at this point, mining operations are unaffected. However, industrials metals, such as copper, are starting to reflect the expected hit to demand.  Banks (-12.4%) were broadly in line with the market. Announcements from the RBA and APRA have helped underpin bank capital positions and allowed them to take a supportive role in cushioning the economy. Nevertheless, we have to expect a pick-up in bad debts. This is likely, in conjunction with the rate cuts of recent months, to have an impact on dividends.

Flight Centre (FLT, -48.3%) was the worst ASX 100 performer last week as investors anticipated a capital raise.  Afterpay’s (APT, -46,5%) fall reflected the twin issues it faces: maintaining access to funding and demonstrating its business model remains viable when faced with a business-cycle downturn.  Stockland (SGP, -46.2%) was the worst-performing REIT. Fellow mall owners Scentre (SCG, -37.9%) and Vicinity (VCX, -35.1%) were also weak. GPT Group (GPT, -36.3%), which is among the most rate-sensitive REITs, was also down materially.  Challenger’s (CGF, -42.0%) fall reflected uncertainty over the values of illiquid assets and the degree they will fall when marked-to-market.  The stoush between Russia and the Saudis continued to weigh on the oil price and the energy names such as Worley (WOR, -40.1%), Santos (STO, -33.4%) and Oil Search (OSH, -32.8%).

Few companies posted gains. Metcash (MTS) gained a remarkable 31.7%. This perhaps reflects the valuation differential between it, Woolworths (WOW, +1.1%) and Coles (COL, +4.6%) while all three continue to benefit from a surge in sales. This could have been exacerbated by a short squeeze.  Insurer NIB (NHF, +24.9%) is seeing one, slightly perverse, benefit from the current situation in that people are deferring elective surgeries, driving down private health insurance claims.

Otherwise, it was typical defensives such as infrastructure —Spark Infrastructure (SKI, +7.5%), AusNet (AST, +7.2%) — and the staples — A2 Milk (A2M, +2.9%), Treasury Wine (TWE, +1.4%) — that did well.  Fortescue Metals (FMG, +4.2%) did the best of the miners, although both BHP (BHP, +1.1%) and Rio Tinto (RIO, +1.1%) held up well.  Finally, Amcor (AMC, +7.2%) bounced back following the short-selling attack as the market recognised the innately defensive nature of its business model.

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