Economic Update

September Economic Update

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

New highs on Wall Street:

Earnings season in US beats expectations, noting that expectations were lower due to COVID-19
The US market buoyed by large Tech companies still leading the charge
Australian jobs data show some strength but not out of the woods yet

The Big Picture

Wall Street’s second quarter (Q2) earnings reporting season, held mainly in August, provided a stronger result than expected on bottom line i.e. profits. Companies usually set a ‘low bar’ but this quarter’s ‘beat’ was much bigger than normal.

Admittedly, the main strength was in the tech sector – and mega-caps at that – but there were plenty of other good results. The Nasdaq (tech dominated) index made new all-time highs. The broader based S&P 500 also hit new all-time highs in August but the Russell 2000, representing smaller companies, did not fare so well.

Wall Street is on a roll but is it sustainable? Many argue that its success is largely due the Fed’s loose monetary policy. That is certainly true in part but it’s not the whole story.

Low yields on bonds and low rates on cash – which both come from the Fed’s policy stance – mean that equities are about the only place to earn income. However, massive improvements in technology and their impact on companies’ efficiencies are also at work.

That US earnings were largely under-predicted goes to the notion that many analysts’ views on over-valuation were partially misguided.

At home, our first-half company reports have also thrown up many upside surprises but our ASX 200 index has struggled to keep pace with Wall Street. Perhaps if we had a few Amazons, Netflix and Facebooks, things would be different. But we haven’t (yet?)! However, that doesn’t mean we can’t maintain growth in equities – but not necessarily at the same pace as Wall Street.

Our analysis shows us that only now does Wall Street start to look a little bit “toppy” but that does not mean a correction, or worse, is necessarily on the horizon. But it might mean the big short-term gains are behind us. In the long haul, we fully expect decent returns on Wall Street and at home. We do not think it is a time to sell – particularly when capital gains tax is included in the mix – but pausing between market entries with any excess cash, or dollar cost averaging, might be the way to go.

A lot is being talked about sector rotation and portfolio styles. Value portfolios (which are usually characterised by being cheaply priced relative to current earnings) have gone nowhere in recent years.

Growth portfolios (which are usually characterised by low dividends because companies prefer to re-invest earnings within the company rather than distribute them as income to the investors) have done well in recent years.

Apart from the relative performance in the steep market decline last March and the steep ascent since then, growth has beaten value by a country mile. However, our analysis suggests that these two aggregated sectors might be more on level-pegging terms in the year to come.

Diversification means that prudent investors shouldn’t take big bets on any stocks, sectors or styles. But prudent portfolio managers who have the flexibility in their mandates should try to anticipate changes in performance – but glide to a new position rather than lurch.

We think it is fair to say that much of the macroeconomic data has been corrupted by the impact of the sharp – but necessary – virus-related shut-downs and the consequent rush back to re-opening.

However, there have been a number of bright lights among the sea of data deluges. The US has witnessed some particularly positive housing data. China looks resilient. Indeed, the CEO of BHP just stated that ‘China is in a V-shaped recovery and looking good’.

The Fed held its big annual international central bank conference virtually rather than actually this year in Jackson Hole, Wyoming at the end of August. Nobody seemed to expect any big announcements this year. It was only going to be lower rates for longer but Fed Chairman, Jerome Powel, came up with a headline!

The ’old’ target for inflation of 2% was replaced by an ‘average inflation’ target of 2%’. The Fed had already baked in some wiggle room over slight breaches of 2% but this new target gives them even more room such that they could take a marching band with them!

The Fed does not want to stunt economic or market growth with a quick rate move. More importantly, it doesn’t want the market to try to second guess them so they’ve put this extra barrier around themselves.

In a previous meeting the Fed said they were ‘not even thinking about thinking about thinking about raising rates.’ Now they are not even thinking about the previous statement.

We think we can reasonably conclude that the Fed will not upset the apple-cart again – as it did a few years ago when Powell hiked rates and then had to recant.

So, with rates low for a very long time, what should we fear? We think there is no reason to expect a pent-up inflation boom to build in the near term at least. The only big changes in inflation since WWII in the US followed the Korean war in the fifties and the OPEC oil prices hikes in the seventies.

And what if there is a boom in economic growth? We should applaud growth – unless it causes inflation. There seems to be reasonable evidence that low rates promote growth (greater than it would otherwise have been) but the link to inflation is tenuous.

Macroeconomics is an uncertain science at best – even compared to microeconomics and econometrics. The accepted linkage between growth and inflation is the so-called “Phillips curve”. In 1958, Kiwi Bill Phillips published a seminal academic paper on the relationship between unemployment and wages growth. He pushed the idea no further than that! But acolytes took this empirical study to the limits, even though new data did not support such a stable relationship.

In truth, academic economists and central bankers cannot find empirical evidence to support a stable relationship between unemployment and inflation and – by extension – between interest rates and inflation.

There has also been a growing following for Modern Monetary Theory (MMT). It didn’t exist a few years ago but the thesis of its proponents appears to be – grow the budget deficit with no consequences (unless inflation builds up). It’s interesting to note that academics who support this theory also seem to cover their tenure (i.e. a life-time job no matter what) which means that MMT proponents are safe from any come back if they are wrong!

So, where do we stand? We think we need a modicum of common sense when it comes to printing money and creating debt and that we are currently on a sensible path. Growth is building and is close to being sustainable without central banks.

We think it will be many years before any problems arising from Fed action surface – if at all – so we choose to think in terms of investing in a stable medium-term strategy.

Unlike in the US, our unemployment rate has not yet started to fall. But the last published increase was only from 7.4% to 7.5% and 114,700 jobs were created (of which 43,500 were full-time) in July. The participation rate continues to climb reflecting that people from outside the workforce are being encouraged to look for work.

James Bullard, president of the St Louis Fed, recently stated that the US growth for Q3 will likely come in at the biggest ever (largely because of the sharp fall in Q1/Q2) as we argued earlier in the year. If it does come in at around 20% (annualised) as Bullard suggests, that might be a big boost for Trump less than a week before the presidential election. Since most people probably don’t understand all of the important data and statistical issues it could be some ‘fake news’ that works in Trump’s favour!

Asset Classes

Australian Equities

The ASX 200 posted its fifth straight month of capital gains in August. However, our analysis does not suggest that it is significantly overvalued.

The Consumer Discretionary, Property and IT sectors were the strongest of the 11 sectors that make up the broader index during August. The Telco and Utilities sectors posted big capital losses in August.

The earnings reports for the first half of 2020 that have been posted so far have overall been better than many expected but there have been a number of quite poor results. This patchy success stresses the importance of appropriate diversification strategies.

Foreign Equities

The S&P 500 and the Nasdaq indexes broke all-time records on a number of days where new highs were reached during August. The S&P 500, like the ASX 200, posted its fifth consecutive month of gains but its August returns over-shadowed our (Australia’s) performance.

In contrast to our analysis of the ASX 200 we do find some evidence of the US market having run too fast. That does not mean that a correction is imminent, inevitable or even likely. Rather, the index might move sideways for a while until the fundamentals grow to catch up and erode any over-pricing.

There is increasing optimism on Wall Street that earnings in 2021 will be as big as, or even bigger than, those in 2019.

James Bullard, the St Louis Fed president, claims that the US recession only lasted two months and so its impact on earnings is likely much less than many anticipated at the start of the pandemic.

The world and emerging markets indexes have performed largely in line with the S&P 500 since the March lows.

Bonds and Interest Rates

The Fed’s contribution to the annual Jackson Hole meeting of central bankers was more interesting than normal – even if it was a virtual meeting. The Fed made it totally clear that it is not even worth thinking about when rates will go up. Indeed, they have even changed the definition of the inflation target to make the intent even clearer.

They are now targeting “average” inflation meaning that inflation above 2%, the current target, could be tolerated for an indeterminate period of time. Moreover, since the employment target will now focus on low and middle-income people, analysts are taking this to mean there is even more wiggle room for the Fed before it feels the need to raise rates.

The US 10-yr yield rose about 10 bps to around 0.65% and this caused the gap to the 2-yr yield (the so-called yield curve) to steepen.

Australia’s RBA is also ‘on hold’ and likely to be so for a similarly long time.

Other Assets

After some massive volatility in the prices of oil in the first half of 2020, there has been little change in either benchmark Brent or West Texas Intermediate (WTI) oil prices for several months.

The price of gold rose to above $US2,000 but then it retreated. The $A against the US dollar has continued its rise. Analysts are largely attributing this move to the weakness in the US dollar rather than in the strength of ours.

Importantly, iron ore and copper prices gained strength in August – possibly on the renewed strength of the China economy.

Regional Review

Australia

The June labour force data published in July stated that 210,800 new jobs were created but the number of full-time jobs was negative as COVID-19 restrictions changed the nature of business in Australia. In July, another 114,700 new jobs were announced but this time they included 43,500 full-time jobs. Perhaps solid economic recovery is underway. In normal times, only around 40,000 to 50,000 new jobs in a month (with half of that full-time) would be considered a big success.

The unemployment rate did go up one notch (0.1%) to 7.5%. Given that the participation rate – measuring the proportion of the relevant population actually in the workforce – was strongly up, an increase in unemployment from 7.4% to only 7.5% is particularly noteworthy. That is, people not either employed or classified as unemployed in the previous month were optimistic about joining the unemployment queue or got a job straight away.

The NAB and Westpac sentiment indexes painted a gloomy picture and the business indicators were sampled before the re-introduction of restrictions in Victoria. Nevertheless, retail sales were up 2.7% for the month of July.

We do not think the data are strong enough to conclude that the Australia economy has turned the corner and started to recover – but it does look that it might be in the process of recovering!

China

China exports grew at 7.2% in July and were much stronger than expected. The difference was largely explained by an unusual increase in medical supplies, no doubt related to COVID-19.

China auto sales were up 16.4% for the month which was the fourth consecutive month of growth.

The official China manufacturing purchasing managers’ index (PMI) came in as a slight miss at 51.0 – but that was well above the 50 mark that separates expansion from contraction. The services PMI at 55.2 was a big increase on the previous month’s 54.2.

Popular opinion among senior spokespeople for major financial institutions interviewed on business TV channels are calling a strong China recovery. In turn, that recovery has already helped Australia’s resources sector.

The US congress is struggling to find a solution to creating the next virus-related stimulus package. Both sides are in favour of a sizeable package but they cannot agree on how the money should be spent. The people who were getting the $600 supplements have received no more cash since the end of July.

If a solution is not found very soon, there will be no new payments until 2021. It is reasonable to conclude that much of the squabbling is due to politicking before the November election.

Trump was doing very badly in the polls a few months ago but he is coming back strongly – but he still has a long way to go. Democrats might well have fired all of their anti-Trump bullets but the Republicans seem to have some salvos in reserve. With a strong campaign and strong economic data (only because it was so bad before) Trump could make the election close.

It is not for us to take political sides or say which party would be better for the economy. One sage commentator on business TV pointed out that it is foolish to position one’s portfolio on the expectation of a particular candidate winning. Lots of proposed policies get lost after the election or defeated by the opposition. Punting on a candidate’s victory and subsequent policies is not a prudent investment strategy!

Non-farm payrolls were again up strongly in July – this time to 1.8m new jobs against an expectation of 1.6m. The unemployment rate fell from 11.1% to 10.2%.

The Citi surprise index – that measures the proportion of times consensus economic forecasts are beaten by the outcomes – continues to be very high. That is, forecasters in recent months were, in hindsight, far too pessimistic about the US economy.

Core inflation came in at 0.6% for July which is the largest number since 1991. However, as with our most recent CPI reads, there are possible statistical aberrations flowing from the impact of the virus (and the Fed need a lot more evidence of rising inflation to act on this reading anyway!)

Europe

News from Europe has largely been swamped by that from the US and Australia in our investing world. German exports did beat expectations but there were also many negative results – but not to the extent that they will impact in any major way on our market and Wall Street.

Rest of the World

Japan’s Prime Minister, Shinzo Abe, has resigned his office owing to health problems. He had brought stability to government after five years of instability during which five people had taken turns at the helm before his term.

Abe had built a policy, “Abenomics”, with three instruments – known as the three arrows. While it cannot be said that his policies have yet solved the problems of Japan’s economy, his presence on the global stage will no doubt be missed. We wish him well.

Economic Update – August 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The rally in equities continues

– The ASX 200 and S&P 500 both posted four months of positive returns

– COVID vaccines are under development and undergoing trials in many countries, expectations are that they may be available in early 2021

– China economic data are getting back to pre-COVID levels

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact us.

The Big Picture

Equities listed on the ASX 200, Wall Street (S&P 500), the world and emerging markets indices all posted a fourth successive month of positive returns in July – although the ASX 200 gave up much of its July gains on the last day.

The S&P 500 just posted its best July gains in 10 years – an impressive +5.5%. Much of the recent gains on this index can be attributed to the mega-cap tech stocks including Amazon and Facebook. Indeed, if the tech stocks are stripped out of the S&P 500, its performance has only been modest.

Reporting season, when companies reveal their latest balance sheets and outlooks for the future, is well under way in the US for the June quarter. Reporting season is just about to start in Australia for the half year.

There have been some blockbuster corporate earnings reports on Wall Street but also a number of big misses. Success and failure have been roughly aligned with the ‘stay-at-home’ stocks like Amazon and Netflix vs COVID shutdown economies such as Airlines and hospitality stocks. Facebook and other internet companies have largely done very well – as have a number of the drug companies. The obvious suspects for entertainment outside of the home continue to struggle.

With many regions re-introducing opening restrictions on restaurants and bars to counteract the second wave, the global economy will struggle to get back to normal anytime soon. However, there are some bright spots.

China posted a massive 11.5% for June quarter economic growth against an expectation of 9.6%. On an annual basis, the outcome was obviously more modest at 3.2%. China trade data beat expectations on both exports and imports. The purchasing managers indexes (PMI) a measure of input demand, for both manufacturing and services were also strong.

While the US posted a widely expected large negative growth figure for GDP, retail sales are almost back to where they were before the COVID virus spread to the US.

Australia created 210,800 new jobs for the latest month but all of these were part-time. Indeed, full-time jobs actually went backwards. The unemployment rate came in at the expected 7.4%. The Reserve Bank of Australia (RBA) stated that its general economic outlook had been too pessimistic earlier in the year. It still expects unemployment to be 9.3% at the end of 2020 which is well below the peak experienced in the last recession nearly 30 years ago.

Australian inflation was reported to be 1.9% for the latest quarter – the lowest result in over 70 years. However, there were very special circumstances to explain this fall in prices. Childcare had become free for many and oil prices plummeted which created a big fall in petrol prices. Since the price of both of these items will likely ‘return to normal’ in the current quarter, a very large positive inflation figure is likely next time around.

It is important to note that the RBA’s preferred measure of inflation, that removes wild fluctuations in some items, was a much more modest 0.1% for the latest quarter – almost flat.

The European Union (EU) announced a 750 bn euro stimulus package to support COVID-affected people and businesses. The US senate republicans laid out a $1 trillion package for a similar purpose. Given their system of government, the republicans must now negotiate with the democrats before it can become law. This will delay the outcome somewhat.

At home, our government is extending economic support under a modified JobKeeper and JobSeeker scheme. One problem that was identified here and overseas is that some people were financially better off by not working. Law makers are trying to address this issue so that people are incentivised to go back to work.

Interestingly, in Australia a large number of people entered the workforce as unemployed in the latest data. The opposite of this behaviour is often referred to as the ‘discouraged worker effect’ as recessions loom and people give up looking for work. Perhaps we should refer to recent moves in data as an ‘encouraged worker effect’!

Also, on the bright side, at least three companies in the US are building up a stockpile of COVID-19 vaccines in anticipation of their drugs being validated by current clinical trials for approval by the US authorities. A similar situation is occurring in Queensland and the highly publicised Oxford university project.

Usually, clinical trials are completed before production commences because of the risk of wasting money on the production of drugs that turn out to be unsuccessful. The current ‘parallel production processes’ have been made possible by government financing. No corners are being cut in developing vaccines. The stocks of ineffective or bad drugs will be destroyed if and when appropriate.

Therefore, the 12-18 months minimum lead-time for vaccines that we reported on a few months ago has been dramatically reduced by these public-private partnerships. Given the number of different vaccines being developed, we think it is quite reasonable to expect one or more vaccines to be on the market from the end of this year. If that happens, we also expect stocks markets to rally from wherever they are at the time.

In the interim, governments are only seeking partial lockdowns; stockpiles of masks and respirators are being built; and medics are better informed about tracking and treating those so infected. We are hopeful that further success in vaccine trials in conjunction with ongoing government support will see the second half of 2020 faring better economically than the experience of the first half.

Asset Classes

Australian Equities

The ASX 200 had a positive month in July (+0.5%) in spite of losing more than 2% on the last day! Normally companies ‘confess’ in the weeks before the reporting seasons of August and February so that they cannot be accused of misleading investors when adverse figures are expected.

Confession season has been relatively quite this time around as much of the ‘confessions’ were made earlier in the year as the lock-down came into force. Therefore, we do not expect as much short-term volatility from any poor results as we might normally expect. Weaker results have largely been priced in.

Growth stocks, as opposed to value stocks, continue to dominate ASX 200 returns. We think that this momentum will continue at least for a little while.

Foreign Equities

The S&P 500, the world index and emerging markets all performed well in July – for the fourth month in a row. Indeed, July’s +5.5% on the S&P 500 marked the best July result in 10 years! The tech sector continues to dominate Wall Street’s performance and this is likely to continue as most of the big tech companies beat expectations at the end of July.

Interestingly, at just over half way through the year and after a sharp sell-off in March, the S&P 500 index is already close to where the consensus expected the market to finish 2020.

Bonds and Interest Rates

The US Federal Reserve (Fed) concluded its major meeting at the end of July with interest rates on hold and a statement that policy will err on the side of expecting poor results. Markets liked this, and initially rallied. The shorter-term US interest rates are now quite depressed with maturities out to 3 years all about the same, close to zero. However, for 10-year government bonds the yelled is 0.55%.

The RBA was also on hold and stated that, in hindsight, it was too pessimistic about the economy earlier in the year. Rates continue to be expected to be lower for longer.

Other Assets

The major commodities did quite well in July. Gold prices rose to close to $2,000 largely on the back of a weaker US dollar. Copper, iron ore and oil prices firmed which bodes well for the Australian resources sector. The Australian dollar firmed against the US dollar but not against other key currencies such as the UK pound sterling.

Regional Review

Australia

210,800 new jobs were created when ‘only’ 112,500 were expected. All of the new jobs were part-time. Full-time jobs were lost in June. These data points are consistent with restaurants and bars re-opening at less than full-capacity.

93,600 more people were unemployed at the end of June compared to the beginning. This figure is not at odds with the 210,800 jobs created. The participation rate, being the percentage of the population in the workforce, jumped sharply. People are classified as unemployed either if they are employed people who lose their jobs or if they enter the workforce from outside in search of work. This increase in participation from the latter source is considered to be a positive for the economy.

The June quarter inflation figure came in at a more than 70-year low at 1.9%. The trimmed mean, preferred by the RBA because it strips out volatile items was less dramatic at 0.1%. As the price of oil and childcare comes back to previous levels, the next read should be strongly positive but of little concern on its own. December 2020 quarter inflation should be a better indicator of underlying demand.

Victoria has re-imposed strong lock-down restrictions on its residents. Queensland has instituted travel bans from most people outside of that state. Hot spots are emerging in parts of Greater Sydney.

China

China’s PMI for manufacturing came in at 51.1 against an expectation of 50.7 and the services PMI continued to be very strong at 54.2. These data, released at the end of July backed up the recent stronger GDP growth data.

China’s March quarter growth was 6.8% on an annualised basis and this jumped strongly to +3.2% in the June quarter against an expected 2.5%. The quarter-on-quarter growth in June was an impressive 11.5%. Both exports and imports beat expectations. It would appear that China is already coming out of its first quarter slowdown.

US June quarter growth came in at a massive 32.9% but some of this figure is due to a statistical aberration. In the US they calculate the quarter on quarter growth rate and scale it up to an annualised figure (using the compound interest formula). It does not mean that GDP is 32.9% less than it was a year before! Rather, Q2 was approximately -9.5% quarter-on-quarter growth. We fully expect a bounce back in the September quarter.

US Non-farm payrolls data reported 4.8 million new jobs created but that leaves a lot of US people who lost jobs in recent months still on the sidelines. The latest unemployment rate is 11.1% but this rate is less than the previous month’s rate of 13.1%.

Of great importance to us is the latest Citibank surprise index. This bank collates consensus forecasts and outcomes for many important economic data series. The surprise index measures the proportion of times the outcomes were better than the consensus forecasts. The index was close to 100% near the end of July indicating forecasters had been far too pessimistic.

We continue to believe that the US and other countries are coming out of the effect of the lock-down more quickly than many, including ourselves, however, there is a long way to go particularly as hot spots flare up and policy responses react accordingly.

Europe

The European Union has agreed on a 750 bn euro package to compensate members for the impact of COVID restrictions. There was an extensive debate because different member states wanted a bias towards loans over grants or vice versa.

Economic Update – July 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The recovery is happening sooner than we expected!

– End of quarter market volatility might have blurred the underlying strength of markets

– There are strong signs that many investors were too pessimistic a few months ago

– The US Federal Reserve continues to support markets

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our office.

The Big Picture

The bumper rally in Australian equities starting from the March 23rd 2020 low appears to be pausing as we enter a new financial year. There are many unknowns – not least of which include how the COVID-19 pandemic will playout, and how the November 2020 US presidential election will influence markets.

The financial year just ending (FY20) did produce a moderate negative return of -7.7% for Australian shares even after including dividends being re-invested. But, to put that loss in perspective, it is only the second loss in the 11 financial years since the post-GFC rally started in mid-2009! Moreover, it does not appear to us that the longer run rally will end anytime soon as many central banks are still operating under very loose monetary conditions.

It is very difficult to predict how the COVID-19 pandemic will play out given there are no vaccines or cures yet available – and may not be for another 12 months. There are signs in some regions, and some of the southern US states, that a material second wave is taking hold. Australia has fared comparatively well, however the state of Victoria has placed 30 suburbs of Melbourne back into lockdown due to a rapid increase in localised infections.

Since we now have far more knowledge and available resources than when the virus first struck, we think it is reasonable to assume that authorities will be able to better manage the spread and impact of the virus from here without the almost global shut-down of economies witnessed in the second quarter of 2020.

As restrictions are being relaxed, there are signs that economic recoveries are under way. We argued that the sharp negative growth figures we saw earlier this year – and still in some regions – should not be overly dwelt upon. We take the same measured view about the magnitude of the recovery figures.

In June US retail sales grew by 17.7% for the month and house sales by 16.6%. Australian retail sales grew by 16.3%. And China posted a 6% monthly gain in industrial profits – the first positive results since November! These are, of course, historically very high numbers. Our take-away is not the magnitude of these data points, but the timing. The recovery has started a couple of months before we and most others thought likely. And that is very welcome news indeed.

If the pick-up is faster than most expected, it is no surprise that we infer the market sell-offs into March were likely over-done. Some commentators are saying that the June quarter (Q2) rally was too strong. That is only the case if the over-sold notion is not taken into account. Either way, a strong rally into the end of a quarter (and our financial year) tempts fund managers to lock in some gains for window dressing and tax management purposes.

Until our company reporting season starts in August (and the US second quarter results start soon) we do not have much insight as to what companies really think the future looks like.

It is true that the US has called that their economy went into recession in February of this year. With our 0.3% result for quarter one growth and a likely big negative number for quarter two, we can reasonably conclude that we are in recession too.

However, US and Australia unemployment numbers are lower than one might expect in a ‘normal’ recession. These shut-down induced recessions are very different from the traditional ‘standard’ recession. The IMF has predicted global growth for 2020 to be 4.9% but that needs to be analysed in conjunction with the possible speed of the recovery.

With two new relevant COVID-19 drugs announced from Oxford University in June, some sensible re-opening of economies, and the nascent signs of economic recovery, the future is brighter than most thought only a few months ago. The US Federal Reserve has ramped up monetary stimulus and our government has announced further fiscal stimulus. It is often considered unwise, in a market context at least, to ‘fight the Fed’! i.e. don’t bet against the central banks (US Federal Reserve mainly), such is the strength of their influence that their actions can have a material influence on direction or state of markets.

Asset Classes

Australian Equities

The ASX 200 had a strong June posting a capital gain of +2.5% which was in line with the world market. However, capital gains for the financial year (FY20) were down 10.9% or 7.7% when re-invested dividends are included.

While FY20 was poor for the Australian index, two sectors stood out as very strong pockets of growth. The health sector gains were +25.7% and the IT sector gains were +18.0%.

We judge the market to be modestly under-priced but that call must be considered in the light of company earnings forecasts and outlooks seemingly lagging behind actual events. This situation should become clearer as our August reporting season gets under way.

Foreign Equities

The S&P 500 gains in June slightly lagged behind the ASX 200 with a gain of +1.8%. However, the US Dow Jones Index had the best Q2 since 1987; the S&P 500 had the best Q2 for 22 years; the Nasdaq broke through 10,000 for the first time and recorded gains of 24.4% in the last 12 months (our FY20). Europe posted the best quarterly gains for five years. Of course, Q1 (the March quarter) was very bad for most indexes so Q2 should not be viewed in isolation.

Bonds and Interest Rates

There has been little movement in official rates because they are effectively at the floor (at zero or negative). However, central banks have been trying to influence longer rates with quantitative easing (QE).

From June, the Fed is now able to purchase individual corporate bonds and it is committed to at least $120bn purchases per month of Treasuries and Mortgage Backed Securities until the end of 2022. That is much bigger than the QE during the GFC. It has also stated that the reference rate will not be increased at least until after 2022.

The governor of the Reserve Bank of Australia (RBA) stated that the official rate will be low for years to come.

These actions by central banks make investing in equities more appealing than they otherwise would be. Some call it the equivalent to a ‘put option’ (or floor) on the market. Volatility will still persist but money has to find a home that will pay a yield. Equities currently have the best chance of producing a reasonable income stream out of the standard asset classes.

With global official rates in the short term almost locked into near 0% for the major economies and the middle durations (such as 3-year bonds) heavily influenced by QE, the yield curve looks stable and accommodating.

Other Assets

Although there is still price volatility in commodities, prices are far more stable than they were a month or two ago. There has been increased commitment to controlling the supply of oil helping those prices stay well away from the May lows.

Copper and oil prices had a very strong month in June – and iron ore prices were marginally up.

Regional Review

Austrailia

First quarter GDP growth came in at 0.3% signalling the probable start to (at least) two quarters of negative growth which would be enough to call a ‘recession’ using the simplistic rule of two consecutive quarters of negative growth.

However, it should be stressed that growth over the year was still positive at +1.4%! All is not yet lost.

However, the unemployment rate is still only 7.1% which is well below the levels of previous ‘standard’ recessions. With the economy starting to reopen, unemployment may not worsen much more.

With Prime Minister Morrison launching $1.5bn worth of ‘shovel ready’ infrastructure projects in June, and it seems likely that ‘Job-keeper’ and other such schemes in some form are likely to continue, the government fiscal policy is aimed at supporting economic recovery.

China

China is flexing its muscles over Hong Kong and the US is getting involved. While it might be laudable to come to Hong Kong’s assistance (even trying to bring in Europe) there could be some very bad consequences for trade and global growth should this situation escalate.

Industrial production up +6% bounced back in the latest China data – the first positive since November. Hong Kong re-opened its Disneyland facility – albeit with some restrictions.

Both the manufacturing and services PMIs (Purchasing Managers’ Index) beat expectations. The manufacturing sector expanded for a fourth straight month at 50.9. The services sector PMI was up one point at 54.4 over the previous month.

While the impact of COVID-19 on New York seems to have been managed reasonably well, many of the ‘holiday’ and oil producing states that relaxed restrictions are now experiencing a very strong second wave. There seems to be little appetite for a second lock-down so it is unclear how this situation will pan out.

President Trump has slipped well behind Democratic contender Biden in the early election polls. However, Trump leads in ‘dealing with the economy’ so it is hard to predict who will win the election when ‘the chips are down’. If Biden wins, tax increases are on the agenda to address the widening income and wealth inequalities. However, it is unlikely anyone would try to raise taxes while the economy is so fragile.

Europe

There is little doubt that the fortunes of Europe are not as important as they once were considered to be. The possible fallout from a Grexit or a Brexit are no longer major issues. The UK even seems to be in a position to do a trade deal with Europe in July – well before the December 31st 2020 deadline.

Europe’s economic data has been as bad as elsewhere. But Europe is not as key to US and Australian economic success as it was previously. When Europe looked likely to implode (in around 2001-2013), it mattered a lot more.

Rest of the World

Japan was forced to reconsider the re-opening of its economy. The latest industrial output data was 8.4% for the month. Japan has not yet turned the corner as possibly the US and Australia have economically.

China passed laws to control certain aspects of its security relationship with Hong Kong to take effect from July 1st. The US is unlikely to remain quiet on this point and an adverse trade response is quite possible.

Iran has issued an arrest warrant for President Trump and a large number of other US citizens! It is no more than a political statement and it does not reflect well on Iran.

Economic Update – June 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The recovery continues

Equities continue to climb the wall of what appears to be ‘less worry’
Economies are starting to re-open which is providing further support for equities
Central banks and Governments continue to apply rescue measures as COVID-19 continues to see increased infections dampening social and economic activity.

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.

The Big Picture

We started last month’s update with the thought that the worst could be behind us but that volatility might still spook markets for a while to come. A quick look at key equity markets tells a more positive story for May with the ASX 200 adding 4.2% to the 8.8% gained in April. The S&P 500 added 4.5% to the 12.7% gained in April.

We still think it’s too soon to assume normal reliance on macroeconomic data. We expected the numbers to remain volatile and we were not disappointed.

The big picture we are focusing on is the mood in the markets about re-opening economies. In one month, we have gone from dire predictions of nothing opening to what looks like an orderly opening in Australia, the US and Europe. Yes, there are pockets of confusion but the stock markets seem to have been buoyed by the fact that an orderly return to work is already beginning to happen.

So long as there is one person carrying the virus there is a chance for others to contract it. There is a very high probability of a second wave. The question is – what form will that wave take?

In Australia, the shut-downs seem to have been largely successful. When someone in a newly opened bar or café contracts the disease, quickly responding to those exposed can minimise the spread. If left unchecked we can easily get back to the problem we had a month or so ago.

Of course, the systems and equipment we now have in place are better to deal with a new outbreak. Australians, by and large, appear to be reasonably responsible. Contrast that with the situation in the USA. There seem to be large clusters of vocal groups claiming all sorts of rights regarding employment and social mobility. It does not matter whose philosophy is correct, viruses only react to people close at hand. We would not be surprised if the relaxing of containment measures proves to be premature and a fresh outbreak occurred in the US and it might be big enough to unsettle markets. In light of the recent social unrest the potential for further outbreaks has likely increased. This will weigh on investment decisions.

Governments and central banks are still applying fiscal and monetary support in amounts that should assist to avert a further escalation of the economic impacts of the COVID-19 crisis. However, at the individual level some groups might be relatively disadvantaged.

Going forward, we are naturally keeping an eye on fresh outbreaks of COVID-19, potential vaccines and cures. They are all potential games changers.

Given the speed of the re-opening of Australia and the US we might expect to see some meaningful data on unemployment from July (to be reported from August). Until then our focus is more on intuition as meaningful forward looking data remains scarce. As economic data releases and in particular corporate earnings estimates stabilise, we will again be able to produce a more informed outlook.

Asset Classes

Australian Equities

The ASX 200 posted a strong +4.2% gain over May with a few sectors standing out. IT (+14.5%), Materials (+8.0%), Property (+7.0%), Telcos (+6.0%) and Financials (+4.7%) were the strongest sectors.

Based on the growing belief that we at least appear to have COVID-19 contained, then the market from a relative value sense is somewhat attractive but with ongoing uncertainty volatility will remain elevated.

Foreign Equities

The S&P 500 posted a +4.5% gain in May which followed a +12.7% gain in April. However, the S&P 500 is down ?5.8% on the year-to-date.

Many analysts have been quick to point out that the gains in recent years have been mainly concentrated in about 6 or 7 big tech stocks. Without those stocks, they say Wall Street would have just moved sideways.

Index investors need not overly worry about the concentration of strength in stock returns. Others need to be more careful about how they construct portfolios as COVID-19 and the respective Government and Central Bank responses to it have increased the relative attractiveness of some stocks and in particular, some industry sectors over others.

Bonds and Interest Rates

With most national bond rates close to zero, there is not much room for rates to move. We do not expect any of the major countries will be raising official rates any time soon.

With rates low, investors still have to consider deriving some yield from equities.

Other Assets

April was clouded by wild gyrations in the price of oil. West Texas Intermediate (WTI) prices even went negative mid-month as people got caught with the ending of the May futures contract.

We flagged that a repeat situation might occur in mid-May but no such disruption happened. Indeed, WTI oil prices (the relevant US price) were up 88% over May while Brent (the world price) was up 39.8%.

The OPEC problems and shortage of world demand are still big issues but the issue with the futures contracts seems largely contained for now.

After big changes during May the prices of iron ore, copper and oil finished May close to their intra-month highs. It is important for global stability for these commodity prices to stabilise at reasonable levels. At last, that seems to be happening. The Australian dollar (against the US) also finished May at near the intra-month high.

COVID-19 Review

The chart below is the latest from Johns Hopkins University Coronavirus Resource Centre.

The message is quite clear, the reported cases of COVID-19 continues to rise globally while we here in Australia have fared better than most, if not all. The reporting of COVID-19 cases is now escalating in the emerging economies of Brazil, India, Russia and counties in the middle East. Notwithstanding the US has reported circa 1.8 million cases which is in excess of three times that of Brazil in second place at 514,000.

While we in Australia are beginning to see a relaxing of containment measures, the real challenge is that other countries are also heading down this path. Whilst they have achieved apparent containment (i.e. they have flattened the rate of increase in infections), they are still dealing with many actual cases. Consequently, the risk of a second wave is statistically higher for them. While we hope the relaxing of restrictions more generally is successful and does not lead to a second wave of the virus, it is too early to tell and the situation will remain dynamic, despite the more positive experience we are having in Australia.

Regional Review

Austrailia

Australia’s process of gradually returning to work is becoming politicised after several months of apparent bipartisanship. RBA Governor Philip Lowe highlighted that the September quarter proposed unwinding of Job Keeper and Job seeker payments may be premature. The market appears to be running ahead of the economy at this point.

China

China and the US are at it again but Trump’s end-of-month speech did not bring up the possibility of an escalation of the trade war.

China’s relationship with Hong Kong is still being thrashed out. COVID-19 did little to distract the protagonists.

Pockets of the US economy are aggressively re-opening. We are not filled with confidence that the whole process will go smoothly. US citizens seem fixated on their constitutional rights rather than what might be good for the economy at this point.

Europe

The EU has proposed another $1.2 billion recovery fund to assist member countries to weather the recession resulting from the Covid crisis as virtually all member countries have broken EU deficit limits as they support healthcare and businesses to try and sustain their economies.

Rest of the World

Perhaps by next month, news on the rest of the world will match the importance of news on a global pandemic. For now, we focus on how restrictions are relaxed and how lagging economies will be funded.

Economic Update – May 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The recovery begins?

– Equities bounce back strongly in April as unprecedented fiscal and monetary stimulus applied
– Economies in early stages of starting to re-open as the COVID-19 rates of infection have slowed
– Oil prices face turbulent times and demand falls dramatically absorbing OPEC production cuts

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.

The Big Picture

After a really tough month for stock markets in March, the bounce back in April gave investors a chance to catch their breath. Of course, it is possible a new low will be formed at some time in the future but the news on COVID-19 is starting to get better.

It was quite rational for markets to have fallen as sharply as they did in March. After all, no one knew the extent of the devastation that the virus would cause. As soon as governments and central banks responded with stimuli, lock-downs and social distancing, markets realised that they had sold off too much.

We think the major markets are still cheap based on reported earnings but volatility and fear are elevated. As a result, the rate of price appreciation going forward over the longer term versus what we think of as fair pricing might be slower than what we experienced in April.

There have been so many stimulus packages and healthcare innovations, it is an impossible task to report all. And new changes are coming through with such speed that any attempted comprehensive report would rapidly be out of date. In the space of a month, global sentiment seems to have gone from doom and gloom in markets to ‘it’s not that bad’ after all.

We think the important take-away is that almost all major countries are rapidly responding to the challenges – unlike in the wake of the GFC in 2008 and 2009. Health authorities and scientists are seemingly working tirelessly to develop vaccines and provide cures. We think we are in safe hands! But Trump did take issue with the World Health Organisation (WHO) over their early responses (or lack thereof) to the onset of the crisis.

There are questions about whether or not people who have experienced a COVID-19 illness can be re-infected. As finance experts, we have nothing to offer on that question but we do take this uncertainty into account.

Many countries have already started to relax the lock-down restrictions – mostly in a phased fashion. It makes sense to respond in this fashion as it would be imprudent to run economies into the ground to ensure, like smallpox, the disease has been eradicated. That means that there will be future waves of infection in much the same way that there are usually weaker aftershocks following an earthquake. Because different regions are loosening restrictions in different ways there is a chance to learn from one another.

All economic data will likely be really bad for many weeks and possibly months – so there is no point in dwelling on them. If we look for a medical analogy, economies are experiencing ‘self-induced comas’ to allow doctors to deal with the patients’ needs in a timely fashion – rather than dealing with a recession-like trauma rapid-fire scenario in the ER.

Another point worth noting for less experienced readers is the bias that most forecasters put into some of their forecasts. It is well known that forecasters often indulge in so-called ‘rational cheating’ to use an academic term. It is often not in the best interests of the forecaster to publish their ‘honest’ best forecast but rather modify it in the light of the consequences of being wrong.

In the current situation, a forecaster who believes economies will be back to normal in short order would be well-advised not to say so. If the economy actually takes a longer time to recover, the optimistic forecaster is likely to be the object of much scorn. If the optimist is right, there are no particular prizes to win. On the other hand, a forecaster who overstates the time for recovery (at least by a little) will lose nothing if, indeed, it takes a long time. If a quick recovery happens, everyone is so happy that they ignore that the forecaster was, in fact, wrong.

With this bias in mind, we suggest that the consensus view for recovery that is published might be biased towards the longer run. Recall all of the eminent economists (including Nobel Laureates) who said, following the GFC, that a depression longer than the Great Depression was likely. How wrong they were – but can you now name them?

The impact of COVID-19 was more than enough for analysts to try and work through during April but oil prices also went into a tail spin! The timing of the two phenomena might be related as it is thought Saudi Arabia has been waiting for the opportunity to run the relatively new US shale-oil producers out of business. What better time is there to attempt such a price war than one in which people were already hurting?

There is always the incentive for independent oil producers to compete for market share – which is why OPEC was formed in 1973. Since Russia and the US are big oil producers that are not OPEC members, price control by OPEC is limited. In an attempt to become self-sufficient in oil, the US has turned to extracting oil from shale as well as oil wells. We ‘passed’ on such ‘fracking’ in Australia.

Shale oil is now such an important component of US production that its output had a depressing impact on global oil prices.

OPEC+ (i.e. including Russia and a few smaller independent players) agreed earlier in April to a material supply cut to start from May 1st. However, the massive lack of demand due to COVID-reduced travel on land, sea and air has made even that cut insufficient to stabilise markets.

The US has a massive underground oil storage facility in the centre of the country (Cushing, Oklahoma). It is nearly full so that there is nowhere for more US oil (known as WTI or West Texas Intermediate) to be stored. As a result, many players had to sell their forward contracts at negative prices to prevent being forced to take delivery! This is a phenomenon that is likely to recur monthly as each forward contract nears expiry (the next is due on May 19).

The global price of oil (known as Brent) has been more stable but it has still been impacted through interdependencies. The Saudis reportedly can withstand these price gyrations for many months if not longer. However, the newer shale-oil producers are less cost effective and the first bankruptcy proceedings have already started.

The oil price war is unlikely to have a major detrimental impact on the market in the longer term but these oil price spikes do seem to cause excess volatility in stock market indexes along the way.
With regard to COVID-19 and oil prices, we believe that the prudent investor who started the year with an appropriately diversified portfolio should probably stick with it. Even experienced fund managers find it difficult to pick the right time to buy and sell. And this suggestion brings us to the opportunity many people are now faced with in super funds as some are able to withdraw up to $20,000.

Super is a wonderful, tax-effective way to save and should be preserved if possible. For many people, $20,000 is a sizeable chunk of their savings. Assuming a balanced rate of return of 7% pa on investments with an inflation rate of 2.5% pa, a 30-year old person due to retire at 67 would be forgoing $244,472 at retirement (or $101,937 adjusted for inflation). Compound interest is a powerful force! Early exit can be massively expensive in the long run for the young.

Of course, some people might have no option but to withdraw the $20,000 or part thereof but it would be wise to look for alternative solutions first and, perhaps, not taking out the maximum amount even if alternatives are not available.

The withdrawal is reportedly more problematic with some industry super funds. The TV adverts often point to the superior returns of industry super funds over retail funds. In making such a comparison and in considering the maximum $20,000 withdrawal, it is important to take into account the reported fact that many industry funds are more heavily invested in ‘unlisted assets’ such as property and infrastructure that are not listed on the stock exchange – some funds reportedly have allocations of up to 40% in such unlisted assets.

The price of, say, CBA shares is priced by the second during the time the stock exchange is open and the stock is not in a trading halt. If any average investor sells all of their CBA stock the impact of the sale on the latest price is minimal. However, if the same investor tried to sell all of their stock in a company outside of the top 300, there could be a material price fall. This price fall in ‘illiquid’ stocks should be considered when considering a sale and it is why many investors should only consider the top 50 or top 100 stocks.

An unlisted asset, such as a large (unlisted) building has no transparent market price. Rather, a valuer infrequently makes a judgement as to what price could be realised. Unlisted assets appear to be less volatile because no one is valuing them often enough to detect the true pricing volatility!

Also, when an investor attempts to sell a part of an unlisted asset there is no ready market of buyers. At any point in time, one can view the ‘order queue’ of what potential buyers and sellers will trade a listed share on the ASX.

If one super fund, industry or otherwise, is heavily invested in one particular unlisted asset and a large number of members want to redeem capital, the potential sale of the unlisted asset could destabilise the value of the fund as the price ultimately realised may be less than the value of the asset reported by the super fund. Given that some industry funds are reportedly as much as 40% invested in unlisted assets, those funds might be forced to sell just their liquid assets instead making the resultant asset allocation even more skewed to the illiquid, unlisted side. We think it is important to take proper financial advice whenever possible concerning such withdrawals.

We hope to be able to paint a clearer picture next month as the dust on COVID-19 settles. The current company reports for quarter one in the US are giving little guidance to the future. Therefore, we must rely on our broader macro view of the longer term as we have presented in this section.

Asset Classes
Australian Equities

The ASX 200 posted a strong gain over April (+8.8%) but this should be considered in conjunction with the ‘bear market’ sized fall in March.

Financials did relatively poorly in April in part due to the NAB trading halt – when they announced a cut in dividends and a dilution of capital through a capital raising. ANZ announced that it will defer its dividend. The other big banks also took capital losses as investors anticipated similar behaviour elsewhere in the sector – as we foreshadowed might happen in last month’s newsletter.
In spite of the oil price war, both the energy and materials sectors – making the combined resources sector – performed very well.

Market volatility has fallen sharply since the March high but it is still nearly double what we might expected in normal times.

Foreign Equities

The S&P 500 performed even better than the Australian market (+12.7%). Other major markets moved more in line with the ASX 200.

The VIX so-called fear gauge remains quite elevated but far below its record highs in March.

Bonds and Interest Rates

Several central banks have committed to continue to support government and corporate bonds. The Bank of Japan (BoJ) went so far as to state that it has an unlimited target of what QE (quantitative easing) it is prepared to use.

The US Federal Reserve (Fed) is also being creative in trying to support bonds of all maturities. At its April meeting it reiterated its plan to keep rates low at least until the economy returns to full employment.

We still expect our rates to be lower for longer and for longer-dated bonds to have a higher yield than the short-dated.

Other Assets

The WTI futures contract price of oil for May delivery even went negative at one point during April but both WTI and Brent prices, while highly volatile, have recovered somewhat.
The Australian dollar has continued to be unusually volatile fluctuating in a range from US60.35c to US65.66c in April.

Iron ore prices have been relatively stable but copper prices rose by 6%.

Regional Review
Australia

The rate of new COVID-19 cases has slowed to a mere trickle in Australia. As a result, governments are starting to relax some of the lock-down restrictions. Since the rules vary by state, and they keep changing within states, there is seemingly much confusion about what is legal and/or wise.

Although new cases are few and far between, there are plenty of people with the virus to infect others as restrictions are relaxed. Undoubtedly there will be future (hopefully much smaller) waves of infection.

The March unemployment rate published in April surprised many as it fell from 5.3% to 5.1%. However, the data are gleaned from a survey conducted in the first two weeks of the month (March) – before the lock-down started.

China

The China economy is starting to gear up again but at a slower pace than many expected. One reason could be the lack of demand and logistics in other countries. For the second month in a row the Purchasing Managers Indexes (PMI) for both manufacturing and services were above 50 – the cut-off between expected expansion and contraction.

Both the US and Australia are in heated discussions with China over how it handled COVID-19 during the early stages.

The weekly initial jobless claims have ramped up sufficiently to make some predict the unemployment rate will exceed 16% at some point. Since many of these unemployed people will be receiving additional benefits, 16% does not mean the same at 16% at some other time. Moreover, there will be many more job vacancies than normal in a recession when restrictions are lifted.

Europe

The UK prime minister, Boris Johnson, was in intensive care with COVID but he is already back in the office. The UK is still aiming for completing the exit from Europe by the December 31st deadline.

Rest of the World

Kim Jung-un, the North Korea premier, has not been sighted for over two weeks and fears for his health abound. As they have an unusual hereditary premiership, and he has no son, the choice of a new leader is, indeed, problematic assuming such transition is required.

Economic Update – April 2020

Within this month’s update, we share with you a snapshot of economic occurrences both nationally and from around the globe.

The new economy

– COVID-19 causes markets to tumble
– Governments act swiftly with relief packages
– Central banks co-ordinate significant monetary policy stimulus

We hope you find this month’s Economic Update as informative as always. If you have any feedback or would like to discuss any aspect of this report, please contact our team.

The Big Picture

The world is very different from when we last filed this monthly update. What was then seemingly largely a Chinese health problem that was largely under control has blown out to a full-scale pandemic.

It is important for all investors to realise the broad manner in which viruses are transmitted if we are to understand how to invest during such a health crisis.

At one extreme, governments could have let the virus run free and contaminate most people with consequent poor health cases – and worse. At the other extreme, all people could have been quarantined – as they did in China – so that the spread would be controlled and slowed down.

South Korea took a different route with lots of success. They had testing ready by early February and monitored the movement of infected people using credit card activity, CCTV cameras, and mobile phone tracking. That really worked but most countries might struggle with such a ‘big brother’ approach.

Without a rigorous approach to quarantining, most people who are not immune might get the virus. But, by taking a partial approach to quarantining, the speed with which the virus spreads can be controlled.

The reason to slow down the spread is to help hospitals cope with the maximum number of cases needing treatment at any one time. All countries will have experienced an increase in the number of cases to be followed by a fall in this rate. The timing of these peaks depends on the health policy among other personal factors.

Slowing down the spread is the so-called ‘flattening the curve’ approach. Britain started off by allowing the virus to take its own course and then very much implemented a ‘flattening’ policy. The US, to some extent, upped its game after a slow start.

The biggest danger in the flattening policy is to lift restrictions too early that then allows a second round of contagion. As long as there are ‘carriers’ in the community, a new pandemic could always start – that is, until there is a vaccine or cure.

It is impossible for any group of people to accurately predict the length of this crisis because different regions are taking different approaches and, importantly, changing those approaches over time.

The health statistics are easily misread. It is a relatively simple task to count the number who pass away from the virus. There would be some misclassification – especially in countries with lesser quality testing facilities. It is also relatively simple to count the number of people who recover as a proportion of the number who were deemed to have been infected.

What is extremely difficult to assess is how many people have been or are infected. Apparently, many younger, very healthy people could be infected and not even realise it – often by thinking they have the regular flu. To date the testing facilities in Australia and the US has been confined to people who have recently travelled or been in contact with someone who tested positive (or possibly the at-risk groups).

Since mortality rates and rates of infection depend very much on this ‘wobbly’ estimate, we may see differences across regions that are more due to the ability to test rather than health characteristics.

A new testing machine – apparently about the size of a toaster – became available from the end of March in the US. It can draw a conclusion about having the virus or not in 5 to 13 minutes – as opposed to the current far more intrusive testing process that takes three days.

If this new machine (or other better procedures) can be rolled out quickly we can have mass testing and work out who has recovered and, therefore, less likely to be re-infected (the US and UK authorities have stated that there is minimal chance of re-infection but some cases of re-infection have been reported in some other countries). Also, knowing who is infected can better alert people to self-isolate.

The Australian health authorities have said that there is an early indication that our new cases may have peaked! Of course, that is only possible if the current policies are maintained or tightened. Australia is slightly better off than our Northern Hemisphere friends. Many flu-type viruses are less rampant in warmer weather.

All life is precious but it is worth noting that the Spanish flu crisis of 1918-20 is reported by Wikipedia to have infected one quarter of the world’s population and killed 17 – 50 million people (with some reports as high as 100 million). That the current numbers are so low by comparison might be attributable to the action taken by governments around the world. It’s not easy to conform to social distancing and self-isolation but the impact of not so doing could be massive!

So, with that layman’s overview of how the health crisis has evolved to this point – and how it might develop going forward – we can now address the economic and investment implications.
Quarantining and related restrictions mean that some industry segments must close down for an indefinite period. Some people can work from home and some might be paid (at least in part) even if they are not actively working. The rest must rely on savings and/or government relief packages.

The current situation is very different from a recession. It is a self-imposed shutdown for health reasons. Recessions happen for a number of reasons but they usually build up in intensity and take ages to get out of. Once the virus is under control, our economies can bounce back to strength.

Of course, some people and businesses might never recover. That is why the government should, and is, preparing for that eventuality.

That brings us to how much relief (it is not really stimulus because it is partial replacement funding) is enough. Our answer is that no one knows, so why pretend we can say the Australian government’s $17.6 bn plus $66 bn plus $130 bn is appropriate? Rather, the question should be, “Is it enough to get the ball rolling and will the governments produce more if and when needed?” We think the answer to both is a resounding yes.

Along the same lines, it is pointless trying to work out whether data such as that on unemployment, retail sales or GDP is good or bad in the coming months. Ignore them. But when the virus is over, we will get some bumper numbers as the economy returns to normal and catch up spending takes place.

The US economy was quite strong going into the crisis and our economy was strong enough. The latest (pre-crisis) Australian data releases were 5.1% for unemployment and 2.2% (annualised) for GDP. What’s more the RBA has also acted swiftly and strongly.

The main thing to us is that we help each other as a community. Let’s not leave anyone behind!

So, what of the markets? Wall Street achieved an all-time record as recently as February 19th and we followed suit the next day. Both markets then sank the quickest into bear-market territory since 1987 and bottomed (for the first time?) on March 23rd. Wall Street made one of its quickest ever recoveries – gaining 17% in three days. Then volatility then kicked in again.

It seems far too late in our opinion to start selling unless forced. It is equally too soon to dive back in. Depending on risk tolerance, it might be the time for the brave to start dipping their toes in the water. Again, the big lesson to be learnt from this crisis is that these things keep happening so it is always important to try and stay on top of keeping our portfolios in shape when times are good! It is always too late when markets have crashed!

We will start to know it’s over and safe to watch markets again when volatility indexes return to normal levels. All of the standard volatility measures were higher in March than they were in the GFC! In 2009, it wasn’t until the beginning of March that the market started to build in a base in stable fashion – and that’s when volatility returned to normal.

We argue this scenario because a volatile market shows heightened uncertainty and so all news – particularly negative news – can cause another run down.

When we think of the fundamental value of companies and market indexes, we usually try to take a long-run view of earnings and dividends. If that is the case, a quarter or two of bad earnings would not typically play a big part in long-run considerations – especially as we expect a big bounce back above normal levels when the virus ends.

We have not yet witnessed any downward adjustment hence our reluctance to increase exposure to equities now on the basis that they are cheaper. It is worth remembering that the price of a security is primarily driven by the expected level and certainty of its future cash flows. While the stimulus measures and containment strategies are clearly positive, we still do not know what the ultimate impact on corporate earnings will be and hence we have sufficient visibility on earnings to determine the value of the securities and therefore the market on which they trade.

Next month we expect to have a much clearer picture of the economic consequences of COVID-19. With 24×7 news and self-isolation, it is too easy to get caught up in what is going on. Moreover, comparing fund performance is fraught with problems today. With such a short-sharp sell-off in bonds and equities, funds with a large allocation to illiquid assets that might not have yet been re-priced could look overly good. Don’t be fooled!

Asset Classes
Australian Equities

The ASX 200 reached an all-time closing high of 7,163 on February 20th 2020 and then fell sharply into the end of the month. It fell even more sharply into March 23rd. After that weekend, Wall Street bounced strongly as the $2.2 tn relief bill worked its way through the US Congress. Although our market rose too, we lagged Wall Street and many other indexes in the recovery.

All sectors were hit hard in March but, unsurprisingly, the Staples sector, including the big supermarket chains, fared best of the losers!

One needs to be careful with the big banks at the moment. The relief measures and rate cuts may well supress earnings which may, in turn, force some banks to cut dividends. It’s too early to say but we will keep an eye on the situation.

Foreign Equities

The S&P 500 reached an all-time closing high of 3,386 on February 19th 2020. The index fell sharply into March 20th but then had a stellar three-day recovery (the best on record) of +17%. Some say it is the quickest entry and exit from a bear market ever. Either way, it was quick but volatility then returned.

Bonds and Interest Rates

Several central banks including the Reserve Bank of Australia (RBA), the US Federal Reserve (Fed), the Bank of England (BoE) and the ECB made out-of-cycle rate cuts on top of those at the normal meetings.

The new RBA rate is now 0.25% while that for the Bank of England is 0.1%. The Fed quotes a range which is now 0% to 0.25%. Since we do not expect these banks to try negative rates, it looks like the end of the easing cycle. The next rate hike looks a very long way away.

These central banks also announced action similar to Quantitative Easing (QE) to allow markets to function properly while uncertainty runs high. The Fed has even gone the extra mile in announcing it will purchase corporate bonds as well as (government) Treasuries.

The US 10-year T-note went on a roller coast ride in recent weeks. It fell below 0.40% and then broke through 1.00% to finish between the two extremes at around 0.7%.

What is more important than the actual rate is the so-called bid-ask spread in the secondary market. If that gap gets too wide markets will not function as well. So far it is just manageable. Central banks are supplying sufficient liquidity.

The yield curve from the 2-year to 10-year Treasury-notes is now quite steep after “inverting” in the middle of 2019. The current slope is far from what one expects before a recession but the play book is out of the window.

Earlier in the year we believed rates were going to be lower for longer – as did most other analysts. We now say even lower for even longer. As risky as they may seem now, many investors will need to consider equities to boost their portfolio yields.

Other Assets

The price of oil went into free-fall over March ( 50%+). Some of this fall would be due to decreased demand from China and elsewhere. But the big problem is the price war between Saudi Arabia and Russia over supply restrictions.

Current oil prices are unsustainable but no one seems to have a clue when the price war will end. Until it does end, the energy sector of most stock markets is in trouble.

The Australian dollar has been unusually volatile fluctuating in a range from above US65c at the start of March to below US56c and finishing the month of March just above US61c.

Regional Review
Australia

The Labour Market Survey for February reported in March showed a decrease in the unemployment rate from 5.3% to 5.1%. Jobs’ growth was strong at +26,700. The labour market was strong before the onset of COVID-19.

Economic growth came in at 2.2% (annualised) against an expected 1.9% for Q4. But the forward-looking Westpac consumer sentiment index hit a 5-year low at 91.9 (firmly below the 100 cut-off between pessimism and optimism).

The government has launched two relief packages ($17.6bn and $66bn) with a third worth $130 bn under construction. With strict controls on social distancing and (currently) a low level of COVID-19 cases compared the usual countries we are in a position to deal with the crisis better than many.

Naturally, some poor economic data will be released in the coming months but we fully expect the economy to recover when all is done. We believe the notion that we will be heading back to normal within six months to be plausible. However, such things as a deeper economic malaise and mutations of the virus and other microbiological complications would change things. Moreover, in relation to the virus itself break-throughs on testing could shorten the down time.

China

The coronavirus outbreak started in China but, already, there are reports that the China economy is starting to get moving again. The problem they now face is that the countries that they would normally be exporting to are not yet ready to take them!

The monthly Purchasing Managers’ Index (PMI) was released on the last day of March – just as the lock-down in Wuhan was being lifted.

The manufacturing PMI came in at 52.0 against an expectation of 45.0 and a previous month of 35.7. Since 50 is the cut-off between ‘expansion and contraction‘, this outcome was a major positive.

The services PMI came in even higher at 52.3 compared to the previous month’s 29.6. Another massive beat.

We are less surprised than the interpretation widely seen on TV. The PMI survey asks a question similar to ‘are things getting better or worse than now without stating what now is’ (with 50 being neutral) and not about the predicted level of growth. Since things were bad at the middle of the shutdown, this number only indicates things are getting better. This stage is the first in what we anticipate to be a recovery.

The US labour data remained very strong just before the COVID-19 outbreak. New jobs totalled 273,000 for the month which was well above the expected 175,000 and the two previous months’ data were revised sharply upwards. The unemployment rate was at the 50-year low of 3.5% and the wage growth was a healthy 3.0%.

The latest weekly initial jobless claims data came in at 3.28 million which is four times the previous high. This figure was the first of what we see as a sequence of numbers that are impossible to interpret.

Trump has signed off on a $2.2 tn relief package and the daily briefings on the virus continue to report problems being overcome. Of course, the toxic feud between the two political camps continues to fuel conflict from time to time.

At the start of the month, Joe Biden effectively became the Democratic nominee to take on Trump in November. Trump’s popularity is at an all-time high in his presidency. There was even a 60% approval rating of the manner in which he is handling the pandemic.

Europe

Italy was the epicentre of the outbreak in the Western world but New York has since taken that unenviable spot.

Germany has pledged a relief package equal to about 30% of its GDP – or about three times what the US and Australia have so far each committed. It seems everyone is trying hard to get through this period with minimal political bickering. Wonderful!

Rest of the World

The Tokyo Olympics has been pushed back to 2021 as have other major sporting events. These are enormously expensive events to stage but, hopefully, the infrastructure and the athletes will come though. The latest Japan data on retail sales and industrial output were pleasingly better than expectations. Next month cannot look so good.

Economic Update

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