Weekly market update - 11th of May 2020
Written and accurate as at: May 11, 2020 Current Stats & Facts
Signs that the US may start rolling back restrictions faster than first thought bolstered market sentiment last week. Further bad news on the jobs front was shrugged off.
Markets remain policy-driven. Continued liquidity injections – and a focus on efforts to restart economic activity – underpinning gains of almost 3% for our local market last week.
Gold and growth stocks continue to outperform, reflecting the impact of policy on markets. Growth stocks are boosted by low rates and ample liquidity. The ultimate impact of current policy settings on debt and currencies is seeing some support for gold.
Market rebound and outlook
The ASX 300 has now rebounded 20% from its low, recapturing just over a third of the drawdown from the February high. This is lagging the 31% bounce in the S&P 500, which has retraced about 60% of its fall. The NASDAQ is up 33% from the low and is three-quarters of the way back to its high. This divergence is partly explained by index composition, given a higher weighting to financials – and less in growth stocks – on the ASX.
It is tough to make a high conviction call on market direction from here. As we have mentioned previously, the scale of the two opposing forces – economic downturn and policy response – is material.
The bull and bear cases for equities at this point can be summarised as follows:
Bear case
Risk of a second wave of infection
There is a widespread view that the US is re-opening too quickly. The risk is that a second wave of infections could prompt a return to restrictions, hitting the economy and market sentiment. There is some mitigation from the scale of testing, which can help identify and contain outbreaks on a localised level. There have been flare-ups in China and South Korea which will provide some indication of how successfully this can be managed. Case numbers, therefore, take on added significance in coming weeks.
The economic rebound is overstated
A US survey suggests 80% of people laid off in recent weeks believe they will soon be re-employed. The usual ratio is 10-15%. This reflects a high degree of optimism that there will be jobs to return to. In the meantime, the government is back-stopping incomes. The risk is that changes in consumer behaviour are reduced, but ongoing social distancing restrictions dampen the rebound. This could mean more precautionary saving, softer demand, business closures and fewer jobs –which could feed through to areas such as housing, creating another feedback loop.
Valuation
The ASX 300 is now down only 18% year to date despite FY20 earnings revisions of -20% to -30%, suggesting that markets are not that cheap. We are also seeing the relative performance of some growth stocks quickly break back to all-time highs. An additional factor to watch here is the view on whether US rates go negative. Various technical factors highlighted this debate last week. However, the two-year note continues to trade at 16bps yield, suggesting it is not yet a foregone conclusion. The prospect of negative rates might provide some short-term support for equities – in the sense that they become relatively attractive. However, there are also implications for an economic outlook which is worse than the equity market is currently factoring in.
Technical resistance
The rapid and almost two-thirds retracement in the S&P 500 has now neared an important technical resistance level.
Politics
While the market is not yet focusing on the US Presidential election, in coming months it may start to pay attention to what is shaping up as a close race. One factor to consider is that if the Democrats do win, they will control the White House and both houses of Congress. We may start seeing talk of tax reform – rolling back Trump’s corporate tax cuts, which could reduce earnings by as much as 20%.
The other factor is China trade. The election is likely to focus on maximising the turnout from a candidate’s base, rather than swaying a marginal voter. This means increased China-related rhetoric and the risk of some issues on trade, which could also feed through to corporate earnings.
It is fair to say the bear case is easier to make, given how quickly the US market, in particular, has run. That said, there is a cogent rationale for the market’s rebound – and the possibility of it continuing.
Bull case
Policy
This is the lynchpin. The Fed’s balance sheet has surged from $US4 trillion to $US6 trillion in short time with more to come. This effectively underwrites the investment-grade credit market and funds government debt. The combination of monetary and fiscal response is estimated at around 25% of US GDP. At a global level, the “free liquidity” – surplus liquidity relative to GDP growth – is estimated at around 9% of global GDP. This is not yet the scale reached the depth of the GFC. Nevertheless, this liquidity is finding its way into financial asset markets and continues to fuel outperformance of long-duration growth stocks. This is important because governments and central banks are effectively saying they will continue to pull the policy lever as long as it is needed.
Health breakthrough
There is nothing concrete here yet. However, vaccine trials have been brought forward and we may have a result sooner than many anticipate. There is also mounting evidence that a combination of existing drugs and therapies have had some success in helping reduce the length and severity of infections. This is important in helping manage stress on medical systems for countries pursuing herd immunity.
Economy
There are signs that an increasing number of companies think the economy may have troughed in April. As recently as two weeks, ago only 25% of US companies thought the economy’s trough would be in April. Now it’s 40%. A sense of having turned the corner is good for market sentiment.
Sentiment
The market remains bearishly positioned. Cash levels are as high as during the GFC. Surveys suggest most people expect the market to go down from here. It is not a euphoric market. There is also a sense the market may have accepted near-term earnings will be terrible – and are looking through these to FY21. This means near-term earnings announcements may not be as relevant as usual – particularly given the dispersion in the range of S&P 500 earnings estimates is at 15% versus 3-7% in normal
The analogy here is that we are in the doctor’s waiting room and haven’t yet had the test results. Until then we can choose to be optimistic or pessimistic.
Markets
There was little movement in bond yields last weak.
Oil rose 14%, helped by signs of increased car traffic in China and the US. Trends in car ownership and use will be interesting to watch given the potential aversion to mass transit for a period. In this vein, US auto companies have started ramping up production again, which in turn helped underpin the iron ore price – up 4% last week.
The Small Ordinaries was up +4.9% and has rebounded +33.3% from the low. There are a couple of factors at play here. The small-cap world includes a higher proportion of gold and growth. Its lower liquidity could also see it squeezed higher given the broader liquidity tailwind.
Technology (11.2%) did best as growth stocks surged. REITs were up 4.1%, helped by a bounce on Friday. It has been helped by the expectation that retail will begin to recover on the back of eased restrictions. Anecdotally, mall visitation was very strong over the last weekend. Defensives generally underperformed.
Alumina (AWC, -6.2%) was the worst performer in the ASX 100 last week. Supply/demand dynamics remain unfavourable and it is the least likely to see a bounce from an improvement in demand.
Qantas (QAN, -6.1%) gave a constructive update, which revealed that its monthly cash burn was falling – and was lower than where the market expected. This was not reflected in the week’s move, but we nevertheless believe the airline has done a good job in quickly reducing costs.
IAG (IAG, -5.7%) reported that the hit to their investment book had been larger than consensus expectations. We remain mindful that unlike some peers they have not had to sell these assets. As a result, we may see this revert given the rebound in credit markets. There may be an impact on the near-term dividend, but this is not capital that is extinguished.
There was nothing new on Sydney Airport (SYD, -5.2%), however, the market remains wary of a capital raise.
Afterpay (APT, +36.8%) made new all-time highs on the news of Tencent buying a take.
Qube (QUB) was up +15.9% as its capital raise reduced risks around the balance sheet. That said, there are several examples of companies raising capital, seeing a bounce, and then consolidating. QBE (QBE) and Lendlease (LLC) were down -3.3% and -2.8% this week, respectively.
Evolution Mining (EVN, +14.2%) led the gold miners, followed by Northern Star (NST, +10.9%) and Newcrest (NCM, +9.7%).
REA Group (REA, +12.0%) is a classic example of people looking through the near-term weakness and focusing on the positive – in this case, the easing of restrictions on open homes and auctions. Monadelphous (MND, +10.7%) was another where the market looked through management’s near-term caution to focus on the tailwinds of economic normalisation.
Goodman Group (GMG, +10.9%) gave an update which included cautious tones on medium-term income. However, it remains a long-term winner given an acceleration in the trend towards online shopping.
Finally, Macquarie Group’s (MQG, +8.5%) result was mixed. Profitability was down, but this was due mainly to a number of one-off write-downs. Ultimately the market took comfort from a strong capital position.