Weekly market update - 24th of August 2021
Written and accurate as at: Aug 24, 2021 Current Stats & Facts
It feels like we may be approaching a key juncture for equity markets. The constructive case for equities is based on the view that we are near a nadir of sentiment regarding Delta cases and the sell-off in cyclical stocks. From here, policy supports, signs of peaking cases, resilient economic momentum, earnings growth and liquidity will drive markets higher into year-end. The negative take is that markets are extended on the back of excess liquidity. Coupled with some early warning signals in the data, deteriorating market breadth, more speculative sectors rolling over, growth risks from Covid or inflation, and policy tightening, it could spell a softer period for equities.
In Australia, resources fell 10.7% last week, driven by lower commodity prices and exacerbated by BHP’s plan to consolidate its Australian and UK listings. The rest of the market held up reasonably well. The outcome was a 1.94% fall in the S&P300 last week. The S&P 500 was down 0.55%.
Five issues played on the minds of investors last week, leading to a weaker equity market:
- ASX earnings season: Last week’s results were more mixed than the previous week. But it was still a net positive. Management teams continue to indicate that lockdowns are not having as harsh an impact as many feared.
- Domestic Covid situation: A deterioration has led to greater restrictions and more economic growth and earnings risk.
- Vaccines: New studies suggest vaccine effectiveness in preventing Covid fades relatively quickly, leading to calls for booster shots.
- US Fed: Signalled a more hawkish stance about tapering Quantitative Easing.
- China: Beijing continues to reinforce the notion of “common prosperity,” seen by some as a risk of further market-unfriendly regulation.
Australia’s Covid situation
The rise in Melbourne cases is concerning. Extended restrictions will mean about 40% of the national economy is now locked down. The acceleration of cases in Melbourne will provide insight on whether lockdowns can achieve Delta variant elimination. Either way, we are discovering lockdowns now need to be harder and longer to get the desired effects. The focus on vaccinations is yielding results, particularly in NSW. The seven-day moving average of daily vaccination rates is now running at 1% of the population and 1.4% for NSW. This is similar to peak rates in Israel and Canada. In NSW, 57% of people have had one dose and 30% two doses. Assuming current vaccination rates persist, we should hit 70% of the population with one dose by early September and 80% three weeks later. There is about a five-week lag to achieve the same proportions for two doses. The debate now is about how far lockdown can pare back restrictions once we reach these levels.
International Covid situation
National case numbers continue to rise in the US. But there are signs of stabilisation in States that COVID19 numbers hit first. The key question is whether we see evidence of US cases peaking in the next two weeks — as occurred in India and the UK. Return to school is a risk to that outcome. The US hospital system is under some strain. The daily rate of new hospitalisations continues to climb, albeit at a slowing rate. Several southern states are now in a critical position in terms of ICU capacity. This is beginning to affect people’s behaviour and sentiment.
Israel’s experience offers an important perspective for Australia. With a high degree of the population vaccinated, new cases were negligible in June. But as soon as they opened the borders — even with strict controls — the Delta strain took hold, and new cases surged. Hospitalisations have also risen dramatically in Israel, although not to the extent of previous waves (despite similar case numbers). This highlights the challenges Australia faces in the next phase, especially since Delta is already established here.
Vaccine effectiveness
Israeli data suggest that vaccine immunity to Covid wanes at about 20 per cent per month for Pfizer and 7-8% for Astra Zeneca. Protection against severe infection seems to remains in place, however. A booster program for over-60s appears to be working. But we don’t know whether the waning immunity issue will persist or if boosters will be necessary for younger people.
The key point is that ongoing management of Covid remains difficult — especially once restrictions are removed, and borders are even partially re-opened. Until we see a Delta-specific vaccine — or we can demonstrate boosters do not wane — we are set to see only limited re-openings, particularly in countries like Australia.
Economics and policy
US sentiment surveys show a marked shift in people’s behaviour in response to the growing Delta wave. Interest in restaurant dining, for example, has fallen 33.5% since July. The US economy remains strong, however. The Atlanta Fed GDP predictor is still implying 6% annualised growth. The Fed’s minutes were more hawkish than expected.
Concern over inflation may see Quantitative Easing tapering start in November with the aim of completion by mid-2022 (rather than late 2022). This would allow the Fed to raise rates by the end of 2022 if inflation warranted it.
There was little in the way of new economic data last week.
Markets
The high degree of uncertainty makes markets hard to call near-term. The bull case is built on strong economic growth and earnings revisions, coupled with muted expectations. There is some technical support for this case since the market has pulled back to a trend line that has been a buying opportunity eight times in 2021. The more cautious view is that the market is not as healthy as it may appear.
Market breadth has deteriorated, though it remains high by historical standards. An equal-weighted version of the S&P 500 — removing the distortive effect of the largest stocks — actually rolled over in May. There are early warning signs in credit markets as BB spreads have widened, though this is small. We have also seen the US dollar break higher, weighing on commodities and potentially reflecting some risk aversion. Bond yields remain low. The question is whether this is the result of central bank buying or a harbinger of disappointing growth as inflation throttles demand and stimulus effects wear off.
Australian equities
Earnings season is still going well, although there were a few more disappointments than the previous week. Overall, the proportion of companies beating expectations is running above historical averages, although disappointments are in line. Resources have performed best in terms of earnings. But similar to February, this hasn’t been reflected in stock moves since commodity price falls have dominated. Financials have so far done better than industrials.
Capital management is positive. About 41% of companies have beaten dividend expectations versus a 27% historical average. There have been $12.7 billion worth of buy-backs announced, which is supportive for markets.
Earnings downgrades are lower than historical averages, but upgrades are running at average levels.
This reflects falling commodity prices and lockdowns.
Stocks
Domino’s Pizza (DMP, +11.1%) delivered in line with expectations. Management’s confident outlook and a market looking for growth saw it perform best in the ASX 100.
Investors were content to look through the impact of lockdowns on listings and instead concentrate on Domain’s (DHG, +7.1%) strong outlook for housing activity and its ability to drive revenue through pricing and product mix.
BlueScope (BSL, -8.3%) is enjoying very high margins and delivering strong cash flow. The market initially reacted well, though the stock sold off on news that automakers are curtailing production due to chip shortages. Management was mindful not to get the market too excited, flagging that they may retain more cash plus some rising capital intensity in the next couple of years.
Amcor’s (AMC, +6.1%) result was solid, with better cash flow than expected. Management was more confident in the outlook for organic growth than in recent years. An uplift in Bemis synergies also helped.
Star Entertainment’s (SGR, +2.6%) result was as expected — and affected by lockdowns. However, management pulled the REIT rabbit out of the hat, planning to spin off 49% of their property assets at a materially higher multiple than the broader company. Proceeds are likely to be used to pay down debt and fund some capital management.
CSL (CSL, +3%) had small downgrades for FY22 due to supply constraints on plasma collection. Looking forward to FY23, the big question is how quickly margins can recover; given demand remains strong.
Orora (ORA, -6.8%) demonstrated that its US volumes continue to recover. The CEO is delivering cost savings, and the business is generating good cash flow. The question is whether the market is in favour of more bolt-on acquisitions.
Santos (STO, -6.4%) delivered in line with expectations. Management focused on opportunities stemming from a merger with OSH and for carbon capture.
Treasury Wines (TWE, +7.8%) managed a solid response to the huge challenge of Chinese tariffs. Management continues to focus on developing opportunities in the US and Asia to offset lost Chinese volumes.
BHP (BHP, -16%) delivered a record result and announced a plan to merge its oil and gas business into Woodside (WPL, -11.2%). The halo effect was overwhelmed by the falling iron ore price and planned to collapse the dual-listing structure. The latter creates a technical overhang of a substantial amount of selling in the UK, coupled with an unwinding of the Australian premium.
Cochlear’s (COH, -5.4%) outlook was disappointed. Muted revenue growth and the need to invest in innovation means near-term margins may be lower.