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Investment Outlook - July 2020

Written and accurate as at: Jul 28, 2020 Current Stats & Facts

Australian equities

Investor sentiment was on a rollercoaster ride of emotion in the first half of 2020, moving from the depths of an imminent recession to the euphoria of a potential ‘V’- shaped recovery.

The Australian share market as measured by S&P/ASX 300 Accumulation Index experienced a swift 35% retracement from February’s all-time highs to a multi-year low on 23 March, amid heightened fears of a prolonged coronavirus-induced shutdown of the entire economy, which to date has been an extraordinary but necessary course of action undertaken by the government.  Since the 23 March 2020, to the surprise of many experts, the equity market has sharply rebounded, while recent macro data and a number of companies withdrawing profit guidance paints a grim picture of the economic damage mixed with heightened uncertainty.

During this period, the divergence between the share market’s strong rally and our day-to-day reality appeared disconnected. Savvy market participants and ‘robin hood’ punters are looking through the short-term noise of dire predictions and are instead seeing a better environment ahead, i.e. a sharp recovery anchored by significant fiscal and monetary support.  As renowned investors, Benjamin Graham and Warren Buffett said: “In the short term the stock market is a voting machine, but in the long run it is a weighing machine." This is as relevant today as in any other time in history. 

Going forward, economic data in the coming weeks and months may continue to support the market, but there are ever-present risks to the market’s growing expectation of a ‘V’-shaped recovery, including:

  • The potential slowdown in the pace of recovery as some restrictions linger, evidenced by the still stringent lockdowns in many countries.
  • A second wave of viral outbreaks, resulting in further strict lockdowns or a cautious behaviour shift, whereby people no longer feel safe leaving their homes.
  • The return to the US-China trade war as geopolitical rhetoric spills over, undermining the Phase One trade deal signed in mid-January 2020.

There are likely plenty of additional concerns besides those listed above. New economic cycles are usually vulnerable and subject to risks. Like any good rollercoaster, there will be plenty of twists, steep slopes and inversions to amuse thrill-seekers. At this point, however, few investors will be too keen for a second ride.

Global equities

Global equities rebounded from their March lows, which saw the MSCI World ex Australia Index AUD up 5.9% during the quarter and in the black by 5.2% for the financial year. Investor sentiment recovered during the quarter on optimism that the negative economic impact of COVID-19 will not be as severe as initially feared and hopes that monetary policy support will avert a deep, prolonged global recession.

Despite the optimism, spates of volatility continued to hamper global equities during the quarter, exacerbated by simmering geopolitical concerns and fears of a potentially more disruptive second wave.

US equities surged on the back of the recovery, which saw the S&P 500 Index up 20.5% during the quarter and 7.5% for the year (in USD terms). The technology and healthcare sectors led the charge, best illustrated by the performance disparity between the ‘old economy’ Dow Jones Industrial Index and ‘new economy’ NASDAQ Composite Index—up 17.8% and 30.6% respectively during the quarter (in USD terms).

Year to date, only the NASDAQ Composite Index has regained positive territory and continues to close at record highs. The performance of US equities is a far cry from fundamentals, with earnings for the S&P 500 estimated to have declined by 43.9% during the second quarter—on track to record its largest decline since Q4 2008 (-69.1%)—and an elevated unemployment rate of 13.3%.

European equities also rebounded with the MSCI Europe Index up 13.1% during the quarter but down 5.7% for the year (in LCL terms), held back by the large exposure to financials and cyclically sensitive sectors. While the region is slowly emerging from the COVID-19 lockdown, the economy has already taken a significant hit, with the OECD forecasting GDP in the region to contract by 9.1% during 2020.

Despite being the first region to enter and subsequently exit the lockdown, the MSCI Asia ex-Japan Index only managed to finish the quarter 3.8% higher—albeit reflecting the shallower drawdown experienced in the region—and finishing 3.7% higher over the year. The recovery in the region, which began in early March, continued during the second quarter led by the Chinese economy. 

However, the risk of a second wave remains as countries emerge from the lockdown, while the further deterioration in US-China trade relations and uncertain outcomes from the US presidential elections this year will be obvious downside risks to monitor. Conversely, any developments in an effective vaccine could propel global equities significantly higher.


Global real estate securities markets were severely affected by the COVID-19 pandemic, and consumers’ restricted movements translated into the largest falls for retail stocks on record. This was a continuation of negative trends already underway, especially in the mall sector (Macy’s department store bankruptcy) where the outlook remains particularly challenging. 

The pandemic has exacerbated and accelerated structural shifts that have been underway in Australian property over the past few years. The Retail sector is experiencing an annus horribilis. Consumer sentiment was weak given the devastating summer bushfire season and the structural shift towards online retail. The COVID-19 pandemic may be the straw that breaks the camel’s back for retailers that cannot sustain large physical store networks.

As restrictions have been eased, shopping traffic and in-store sales are recovering, yet the online sales avenue received a huge boost worldwide during the lockdown conditions. The disruption to rentals for the lockdown period is likely to be shared between tenants and landlords in different proportions in various parts of the world. Going forward, rentals may continue to be renegotiated and the full extent of economic decline is yet to be seen.

Going into the crisis, Office sector vacancies were at or near record lows in the Sydney (4.0%) and Melbourne (3.4%) CBDs, with solid rental growth and falling incentives. However, the lockdowns saw a shift to working from home arrangements, and while some states have lifted restrictions, this may result in tenants re-evaluating office space needs. While this conceivably reduces the office area required by business, social distancing and spacing restrictions may have a countervailing effect.

While the near-term outlook remains uncertain, the office sector is underpinned by record infrastructure spending over the next four to five years ($90 billion in NSW and $60 billion in Victoria), and the fact that a significant portion of the approximately 685,000 square metres of new supply coming to market in these two cities over 2019–22 has already been pre-committed. Higher-quality A-grade assets with strong national and international tenants on long leases are expected to continue providing resilient income.

With central banks expected to keep interest rates low for some time, the yield spread of listed property to bonds and cash remains attractive (approximately 4–5%), continuing the relative attractiveness argument for listed property.

The Residential sector has received significant government support from the JobKeeper and JobSeeker programs, the launch of the $25,000 Homebuilder program, and other incentives by various state governments. Further easing of lending criteria by APRA in addition to loan repayment deferrals by the major banks has lent further support.  All of this has helped to prevent a home loan default cascade of fire sales. With Australia’s borders currently shut, migration numbers for CY2020 are expected to fall significantly relative to previous years, and with unemployment high (albeit induced by the COVID-19 pandemic), the outlook for new residential property sales is likely to be subdued.

Cash and Bonds

The Reserve Bank of Australia’s (RBA) outlook for the economy and interest rates was recently described by Governor Lowe as a world “where there’ll be a shadow from the virus for quite a few years”, causing “deflationary forces” and “large output gaps.” In other words, slower economic growth and low inflation, with interest stuck “at their current level for years.”

The COVID-19 pandemic caused the RBA on 19 March of this year to not only take the unprecedented step of an emergency intra-month reduction of the official cash rate to 0.25% but also to implement for the first time unconventional monetary policy measures, joining efforts by central banks in other developed economies.  

The Australian bond market, as measured by the Bloomberg AusBond Composite 0+ Year Index, increased by 0.53% over the quarter, driven by the RBA targeting the three-year yield at 0.25%.  Given the RBA expects yields out to three years to remain around 0.25% for quite some time, returns from the bond market will be increasingly reliant on maturities longer than three years to provide yield enhancement, while superior security selection by cash and fixed income fund managers will be needed to add value above benchmark returns and fees.


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