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Weekly market update - 14th of September 2020

Written and accurate as at: Sep 14, 2020 Current Stats & Facts

The waning probability of agreement on the next tranche of US fiscal support — coupled with the suspension of AstraZeneca’s (AZ) vaccine trial — prompted a market wobble last week.  The Australian sharemarket fell -1.0% and the broader US market was off -2.5%.

New developments on key issues

  • Australian COVID cases: Numbers continue to improve, but nothing to change the level of restrictions
  • US COVID cases: Trends distorted by Labor Day holiday. We continue to watch for the impact of school return and the onset of colder weather.
  • Vaccines & therapeutics: AZ vaccine issues highlighted risks in timing and success. But expert consensus remains confident in approval by year’s end.
  • Australian economy: Data suggests we are underperforming other developed markets in H2. The budget will be important. The significant stimulus is likely but there is a potential issue with timing.
  • US economy: There was limited new data with real-time measures due to the holiday. Fiscal stimulus impasse continues.
  • COVID cases

New daily cases in NSW are trending down to mid-single digits after an uptick around the Sydney CBD cluster.  Victoria continues to trend down under the impact of lockdown. It is nearing a range of 30 to 50 cases a day, which would trigger step two of the restriction roll-back.

It remains unclear how the third step of a more material re-opening will be triggered any time soon under the current approach. This requires a moving average of fewer than five new cases a day — a level NSW has been unable to achieve despite a successful track-and-trace approach. Given the material economic impact from the current situation, the framework may require review.

The US remains broadly in a holding pattern. The Labor Day holiday caused some volatility in testing and case numbers. Hospitalisations and mortality rates continue to grind lower.

Vaccine outlook

AZ suspended its vaccine trial after a patient developed transverse myelitis (spinal cord inflammation).

Safety watchdogs gave a green light for the trial to restart — but progress may be slower. This highlights the risk in assuming that a vaccine will be ready by year’s end.

There are four potential scenarios around the AZ incident:

  1. The patient’s illness is unrelated to the vaccine
  2. Risk is linked to the vaccine, but it’s not common enough to halt the trial. If the vaccine works it would require a warning label, similar to other current flu vaccines.
  3. There is an issue with the vaccine delivery mechanism, which uses an adenovirus sourced from chimps to trigger a response that fights COVID. There is evidence that similar adenoviruses can trigger a rare condition in a small number of patients which in some instances can present as transverse myelitis. If this is the case it will be specific to the AZ vaccine
  4. There may be an issue with the “spike” protein used to penetrate cells in the patient. If this is the case, it will be an issue for all vaccines.

Scenario three is considered most likely at present. This may be an issue for Australia because of our government’s commitment to the AZ vaccine. Regardless, scrutiny of possible side effects may serve to slow down trials.

This is a reminder not to assume a vaccine will come by year’s end.

US economic outlook

Real-time US activity data remains in a holding pattern and needs to be watched as the holiday period comes to an end.

The US fiscal agreement remains at an impasse. The funding of state and municipal governments is proving to be a significant barrier. Many Republicans are reluctant to fund what they see as recalcitrant state authorities.

The political element becomes increasingly important as this drags on. As the election nears, Democrats may be less willing to agree to a package, fearing it will give Trump a pre-election boost.

The president’s “Lost Wages Assistance” unemployment insurance (UI) program is gaining some traction as it passes through state legislatures. Some 40 states are going through the process. This is much smaller than previous UI packages but it has scope for “catch-up” payments. This is leading to a bump in disbursements, helping close some of the gap on previous total payments.  

Commercial real estate in the US should be watched as a potential negative factor. An oversupply of malls and reduced demand for office space could exacerbate rental delinquencies.

The big global banks have substantial provisions against this but some smaller regional banks may be at risk. This may impact broader credit provision and the multiplier effect of the stimulus.

While not an issue at this point it’s another risk that bears watching.

Australian economic outlook

Australia has the highest level of restrictions versus economies such as the UK, US, Canada, NZ, Germany and China due to border closures and Victorian measures.

This has an important potential impact on economic recovery.

Australian GDP fell -7% in 1H CY20 compared to about 10% for other countries. But the rest of the world is now experiencing a good rebound off a lower base — while there is risk Australia may disappoint with flat growth in 2H.  This is not a given outcome. A rethink of restrictions may alleviate this risk — particularly if combined with fiscal stimulus in the October federal budget.

However, there is a challenge in the timing. Policymakers seem reluctant to replicate some of the blunter measures used earlier such as broad cash payments. But more refined measures may take longer to have an effect.

This is compounded by concerns over the impact of a “fiscal cliff” as JobSeeker, JobKeeper and superannuation access are rolled back.

This cliff is a complicated issue. The impact is difficult to quantify given the interplay of further stimulus, cash payments and the savings rate.

Key questions are:

  1. Savings have surged as payments have increased and consumption has fallen. How much does a fall in savings rate offset the reduction in household cash flow?
  2. How much additional stimulus occurs to boost household income?
  3. How much additional superannuation will be pulled out before the deadline?
  4. Will there be extensions to the interest deferrals on loans?

There is some near-term risk around domestic recovery and, by extension, the stocks leveraged to it.

There are several levers can be pulled which might see sentiment switch quickly and stock prices surge. Retaining some exposure as part of a balanced portfolio is important.

Market outlook

Markets were generally quiet last week with thin volumes due to holidays in the US and Europe.  Tesla’s non-inclusion in the S&P index continued to weigh on growth stocks, although they ultimately found some degree of support.

There was a 6-7% drop in oil prices which bears watching. There has been some rumbling over OPEC supply as well as disappointment at the AZ vaccine trial. Anything more prolonged may indicate deeper concerns about underlying demand.  There was minimal dispersion at a sector level in the Australian market outside of the oil-related fall in Energy (-5.3%) stocks. Origin (ORG, -10.3%) was the worst performer in the ASX100, followed by Beach (BPT, -8.4%) and Oil Search (OSH, -8.4%).  Continued wrangling over borders weighed on Sydney Airport (SYD, -6.6%).

Rio Tinto (RIO, +4.5%) was — somewhat ironically — the best performer in the ASX 100. It is clearly disappointing that governance issues deteriorated to a point which culminated with three senior executive departures.  It is preferable that mistakes of this severity don’t happen in the first place. But when they do, it is critical companies are quick to acknowledge the error and act decisively to address it. In this instance, RIO’s initial response was not robust and lacked accountability. Without accountability, issues can fester and snowball as the recent Royal Commission demonstrated.  The executive departures raise uncertainty over the medium-term strategy.  One factor in RIO’s favour is that, operationally, their existing operations are well established and supported by cyclical tailwinds. This buys time to restructure management and repair cultural issues that led to this juncture.  This is in contrast to the banking sector, which has had to deal with the fallout of the Royal Commission in a much tougher operating environment.

Elsewhere, there was outperformance from the gold miners, led by Northern Star (NST, +2.6%) and Evolution (EVN, +1.8%).  Virgin Money UK (VUK, +4.4%) and Nine Entertainment (NEC, +4.0%) also caught a bid.

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