Weekly market update - 30th of March 2020
Written and accurate as at: Mar 30, 2020 Current Stats & Facts
The Australian equity market ended last week up very slightly (+0.6%), but took a wild path to get there.
The announcement of further containment measures weighed on the first couple of days before a raft of policy measures fuelled a sharp rebound. But by the week’s end, it seemed attention had returned to the possibility of further containment measures.
Some of the key risks now are around
- Earnings
- Dividends
- Capital Raisings
Earnings
We think talk of the impact of further containment measures — which seemed to spook the market on Friday — is a largely moot point. Most large retailers are effectively already shutting down and cutting staff. The economic data will be awful over the next few weeks and we are effectively on the path to 15% near-term unemployment.
The earnings effect is hard to dimension yet, but at an index level, it could be in the order of 25-30%. It is important to differentiate between companies which will be able to bounce back relatively quickly and those that may continue to be impacted long after other parts of the economy have normalised. International travel restriction is likely to remain in place longer than domestic social distancing measures, for example, which has implications for the travel and casino stocks.
Dividends
Given the scale of policy support and relief measures being provided by banks, there’s an expectation dividend are likely to be cut and capital conserved in this half. Again it is important to distinguish between companies where the dividend proceeds may just be deferred to the next half, as opposed to extinguished.
Capital Raisings
Cochlear (COH, +5.1%) has gone early, raising about $880 million in a well-supported placement. The cash is required to ensure the company can rise out of a period in which elective surgeries are deferred. It will also help meet USD damage payments it must make as a result of a patent dispute ruling made last week. It was interesting to note the placement was entirely taken by existing shareholders — the amount was increased from an initial $800 million on the back of demand. COH’s experience shows two things. First, at current market levels, there is plenty of support for companies that are well placed on a medium-term view. It also shows investors need to think carefully about which registers they want to be on, given that only existing shareholders had the chance to buy the discounted stock.
Infection rates
We have previously mentioned the importance of monitoring the global spread of the virus as an indicator of how long containment measures will persist. This informs the economic impact and the speed of a rebound. Italy looks like it has plateaued in terms of new daily cases — although the plateau is lasting longer than it did in China and Korea. The US is accelerating but an increase in testing is a key factor here. The outlook is for at least a couple of weeks of further exponential growth.
In Australia, the number of new daily cases is falling. This may reflect the fact that local authorities were quicker to move on containment than those in Europe. But the lagged effect of the pre-shutdown period may come through in the next week. The next three weeks are critical —once we get through that period, social distancing measures will have started to kick in. The severity of cases is also important to watch. So far Australia is seeing far fewer serious cases than other countries. This determines the ultimate load on the hospital system. Most models are indicating a peak for Australia around April 15 to 20.
Policy response
We continue to see unprecedented developments on the policy front. The US support package is far larger — and an agreement was far swifter than anything seen in the GFC. It currently equates to 10% of GDP. Germany’s package is also in the 10% region. But we believe more will need to be done.
Australia’s initial package of 5% of DGP will need to be doubled — or even close to tripled. There are also questions over how quickly funds can flow to where they are needed. However, as a statement of intent, the policy response is important. It demonstrates governments are willing to do “whatever it takes” — regardless of longer-term debt consequences — to limit the extreme downside of economic damage.
Liquidity injections by the Fed also seem to have repaired some of the plumbing issues in corporate funding markets, which are showing some signs of stabilisation.
Oil
The oil sector remains ugly. There is excess oil production in the order of 10 million barrels per day. This is keeping the oil price low — Brent ended the week down -7% at US$25.76 a barrel. But if oil storage runs out of capacity it could push even lower.
There are signs the US may be pushing for some sort of deal with the Saudis. This demands attention. We saw in 2016 how quickly the sector can rebound from oversold levels. But at this point, near-term outlook remains grim for oil.
Markets
Bonds continued to rally, with US 10-year Treasury yields falling 20bps to 0.68%. Their Australian equivalents fell 22bps to 0.91%. The Australian dollar rallied from US$61.77 to US$57.70. Gold was up 8%, copper flat and iron ore down -1% for the week.
Within Aussie equities, the more defensive sectors such as Communications (-1.7%), Staples (-5.5%), Real Estate (-3.7%) and Utilities (-1.4%) underperformed.
Vicinity Centres (VCX, -15.0%) was the worst performer in the ASX 100, while Scentre Group (SCG, -6.5%) also fell. This reflected the ongoing debate over leasing and who will bear the brunt of the cost for retailers who are unable to unable — or unwilling — to pay rent. This is likely to be a key issue in the coming days and weeks.
Bank of Queensland (BOQ, -14.0%) and Bendigo Bank (BEN, -7.0%) were down on concerns over funding and uncertainty over how high bad debts would rise. The bank sector as a whole was off -4.2%.
Elsewhere there were concerns over the impact of social distancing on Lendlease’s (LLC, -12.2%) ability to sell apartments. JB Hi-Fi (JBH, -11.9%) has been delivering very strong sales, but the market started to look through this to the effect of having to close physical stores for a period.
Downer (DOW, -10.8%) announced some prosed asset sales had been cancelled. Uncertainty over the outlook for domestic demand and construction weighed on BlueScope (BSL, -8.6%) and Boral (BLD, -8.2%). Coca Cola Amatil (CCL, -8.5%) faces the twin headwinds of reduced restaurant trade — which is among their highest margin businesses — as well as exposure to Indonesia which is facing a surge in virus infections.
Several winners of previous weeks gave back some gains. Woolworths (WOW) was down -7% and Coles (COL) -6.3%. Fortescue Metals (FMG, -7.3%) was down despite the iron ore price holding up reasonably well — with some talk of the impact of a lack of European demand.
On the positive side, Afterpay (APT, +53.4%) continued its wild ride. The outcome here remains uncertain. The potential positive of people spending stimulus cheques may be balanced by the risk of an uptick in bad debts.
Qantas (QAN, +31.8%) effectively announced it had stopped flying. With additional funding secured against some of their planes — which will allow it to survive an extended shutdown — the focus is now on minimising cash burn. We think the Australian airline industry structure is likely to re-emerge from the period in a different form, using this period to assess operations and cost bases. There are signs some of the market concern over Virgin have stabilised. But it could look very different in the future, with scaled-back operations.
Sydney Airport (SYD, +24.7%) is one of that business likely to face a longer disruption than others. International departures may not normalise for 12 months. We continue to prefer other names within the infrastructure space.
There were bounces from several stocks that had suffered large falls, including Star (SGR, +23.8%), Wisetech (WTC, +22.8%) and Reliance (RWC, +17.7%). Santos (STO, +11.8%) also saw a rebound. It delivered a cost-out and CAPEX reduction plan designed to demonstrate it can survive with the oil price in the US$20-$30 range.
Outlook
In terms of the near-term outlook four key factors could help stabilise the market:
Medical breakthrough
Nothing tangible here yet. Testing results from a number of interesting initiatives are due in the next couple of weeks.
Policy response
Efforts thus far have helped put a floor under how low GDP goes, but we expect more to be done. Australia’s package equates to 5% of GDP. We expect it will ultimately need to be 10-15%. There may be a hiatus this week given the scale of last week’s response. However, we are expecting something specific around private hospitals to ensure they retain enough revenue to maintain the capacity to support the public system.
Oil stabilising
At this point, there are rumours of a possible US-Saudi seal, but nothing tangible.
Confidence that health systems can cope with the flow of cases: At this point still too early to call.
The market is now becoming more rational, which is good for active managers. Coupled with a view on which capital raisings are best supported — and which are likely to require early positioning — it is an environment driving abundant opportunity.
One new area of debate to watch is a discussion of how long a society can tolerate lockdown — and what is the structural damage caused. GDP declines in China in Q1 are estimated to be 30-40% (quarterly annualised). Similar numbers are possible for Europe and the US. The scale of unemployment and business closures will take years to unwind.
How do you manage this?
This debate will continue, but it is worth noting banks are likely to shoulder a larger burden than other sectors. This could ultimately see the sector with more utility-like returns than has been the case in past years.