key factors informing our market outlook.
• The S&P/ASX 200 Accumulation Index fell 0.4% over the September quarter. In local currency and USD, the Australian equity market underperformed global markets.
• Global equity markets continued their rebound supported by positive economic data surprises, news of COVID-19 vaccine developments and continued central bank and government support. However, the Australian market performance was impacted by Victorian COVID-19 restrictions which weighed on the pace of economic recovery and market composition.
• The best performing sectors for the quarter in the ASX200 were Information Technology (+12.6%), Consumer Discretionary (+8.7%) and Property (+7.0%). The worst performers were Energy (-14.1%), Utilities (-8.1%) and Financials ex property (-6.2%).
• Australian 10-year bonds rose during the quarter with yields falling 8.3 basis points (bps) to 0.79%. Inflation remains soft and central banks continue to communicate that they will keep rates low for an extended period. Low bond yields have supported equity market valuations.
• Commodities rose as the USD fell and economies recovered.
The world economy has steadily improved since the depths of March and April as communities adapt to the virus. Economic data releases have broadly been better than many economists expected. The US market continues to benefit from its higher weighting to Technology stocks which has seen an acceleration in the structural shift toward E-commerce and digitization while Australia and Europe (UK, in particular) have been impacted by their higher weightings to Banks and Energy.
The August reporting period revealed that Australia’s Earnings-Per-Share (EPS) fell 20% in FY20, with the largest fall in banks (-32%) and only a small fall in Resources (-2%). Despite this, results were better than expected helped by fiscal stimulus, cost-out and strong results in the healthcare and technology industries.
Later in the quarter, in certain geographies such as Europe, second wave COVID-19 impacts have re-emerged. This led to a widening of social restrictions which started to impact on mobility and economic data. Fortunately, second wave effects appear to be less harmful than the first due to increased testing, improved treatments and more effective separation from vulnerable groups such as the elderly.
OUTLOOK AND STRATEGY
We believe the medium-term shape of the economic pathway is likely to resemble a Nike “swoosh”. After falling sharply earlier in the year, the June and September quarters have experienced a pointed bounce back from the lows. However, the pace of the global economic recovery will slow from here and potentially take much longer if a vaccine isn’t produced as fast as the market expects.
Some of the key factors informing our outlook are as follows:
• COVID-19 second waves and the development and deployment of a vaccine. A vaccine (expected by the end of the year) should see a boost to economic activity and result in the opening of borders and economies. However, should a vaccine not be found or not have 100% efficacy we expect that economies will gradually recover as they continue to improve how they deal with the virus.
• The Australia economic downturn was milder than originally envisaged and recent economic indicators are trending in a positive direction. A suppression of COVID-19 case growth in Victoria should bode well for a continuation of this trend as that economy re-opens. However, we enter the ‘“fiscal cliff’” in Australia (and in many other countries) where governments must negotiate the withdrawal of very generous levels of support.
• Geo-political risks remain elevated for both the China/US and China/Australia.
• US Presidential election – Should Joe Biden win, Democrat policies in areas such as corporate tax may not be well received by markets but could be somewhat offset by a large fiscal stimulus plan which is still being debated.
• Sustainability of changing trends – COVID-19 has caused a faster adoption of some structural trends such as e-commerce. Companies have also sought to restructure their cost bases potentially allowing for greater leverage during an economic upswing.
• Dividends were cut between 30-40% for the June 20 period. While we expect a recovery from here, dividends aren’t expected to reach FY19 levels until at least FY24.
• Interest rates will stay ‘“lower for longer’” - central banks around the world have indicated an appetite to do “whatever it takes” to provide liquidity and support markets. The RBA may implement a micro-cut to 0.1%, extend yield curve control measures and add to the term funding facility.
• Limited absolute return upside for bonds - we retain our underweight position to bonds. The ‘lower for longer’ outlook mentioned above curtails some of the downside risk for bonds from capital losses that would arise in a rising rate environment, but at the current very low interest rates we see limited upside. We retain a relative preference for equities over bonds.
The market has been heavily influenced by macro events. While this will have an impact on our Australian equity portfolio construction, we reiterate that our Quality at a Reasonable Price (QuARP) investment philosophy is largely a research driven, bottom up process that emphasises stock selection over thematic investing.
Throughout this period, our focus has remained on companies with strong balance sheets and relatively safe dividends to produce a diversified and well-managed portfolio.