Market Update: June 2020

Equities finished the financial year in style, extending an impressive three-month run. We summarise the main indices below:

 

All up the ASX fell 10.9% in FY20 (7.7% after accounting for dividends), which was the first down year in four years and the worst financial year since 2012. It is hard to believe that it was only February when we were celebrating a new record high!

As the old adage goes, markets like to go up the stairs and down the elevator, and never has this been more evident than the 36.5% crash we experienced in March. To the government’s credit, they unleashed an unprecedented $150bn worth of stimulus which fuelled the biggest quarterly rally in Aussie stocks since the GFC, surging over 16% in the June quarter.

The COVID-19 pandemic dictated the year’s winners and losers, with healthcare, consumer staples and fast-growing tech stocks among the best performers, while energy, banks, property and stocks exposed to travel and service exports took the biggest hit.

The upcoming reporting season looms as a major test of the durability of the current rally, with earnings guidance for the 2021 financial year key to sustaining investor optimism.

The consensus seems to be that earnings growth has declined about 20% versus a year ago, and whilst broad market segments have shown impressive resilience (look at resources for example), there are significant moves in other categories. Expectations for bank earnings have fallen circa 30% in anticipation of rising bad debts and prolonged low interest rates. Due to low oil prices, earnings expectations for oil companies have fallen by 68% compared to a year ago.

So what do short-term disruptions to earnings mean? Well, dividend expectations for Australian shares have fallen 30%, with the worst-affected groups being banks and oil. An “abundance of caution” by boards has been behind most decisions to deny, defer or diminish dividends and this, in our view, is a necessary evil. Short-term pain for long-term gain.

With economic growth set to reaccelerate, massive policy stimulus, continuing low interest rates and high levels of savings, notwithstanding the risks of a “second wave”, equity markets look poised to continue moving higher on a 12-month view. As such, we would expect the ASX200 to register gains of 10%-15% in FY21.

While the tech sector continues to show strong earnings growth, the sector’s Price/Earnings ratio has skyrocketed. This is easy to comprehend, given a lot of these companies don’t actually make any money! Afterpay (APT) for example has displayed remarkable resilience to an economic downturn, with its shares rising almost 143% over the financial year. All this for a company that isn’t expected to make any money until 2022!

And has anyone seen Tesla lately? It is now the most valuable car company in the world with a market value of USD $224bn.

By comparison, GM is worth $36bn, Ford $24bn, Fiat Chrysler $15bn, VW $78bn, BMW $41bn, and Daimler Benz worth $43bn. All of the above combined amount to $237 billion. Tesla has 375,000 cars versus Toyota’s 10.6 million! Simply extraordinary.

Irrational exuberance is rife and finding value is at times challenging in these conditions, particularly in the tech sector, but one area that you are not going to find it is in government bonds. Last week Austria issued a 100-year bond which matures in June 2120 at a yield of 88 basis points (0.88%)! Better yet, what’s the yield on 50-year Swiss government bonds at the moment? MINUS 0.34%!

That being the case, investors have rushed to snap up gold. Many argue that gold is a terrible investment on the basis that it doesn’t generate any income, and we tend to agree. Now though, given that no investments are offering income, the case for gold doesn’t look so bad! Given its safe-haven status it offers a hedge against both inflation and deflation. It has been on a tear lately and has now broken the US $1,800 per ounce ceiling. This has been a boon for gold producers and also very positive for our local economy.

With the new financial year now in place, we turn our attention to the ongoing pandemic and what implications this may bring. Let’s turn to the ‘experts’, below is a survey of expectations from 341 institutional fund managers on where they think the US stock market will finish by the end of the year……

So that is very unhelpful….

The recent breakout in Melbourne and subsequent lockdown puts significant pressure back on our economy, given Melbourne is responsible for 25% of Australia’s growth (not that you’d find anything positive about them in our local paper!). Globally we see surging numbers in key US states California, Texas and Florida. Airline, travel leisure and tourism stocks have taken another dive from already beaten up levels. Qantas has tapped markets for a huge $1.9 billion capital raise, as it continues to leak $40m per day. It is hard to find positive news but stock markets are not the economy and continue to rise. We are mindful of growing risks of a further pullback/correction, and remain cautious. However, with reserve banks around the world underwriting economies with stimulus galore, investors don’t seem too worried about it for now.