Fuelled by the most extraordinary fiscal and monetary stimulus, global share-markets staged an incredible rally of between +15% and +30% during the June quarter, to recoup 60-70% of the losses sustained during the COVID-19 outbreak in Q1.
In Australia, the government committed to extraordinary lengths to support the hundreds of thousands of workers stood down from regular employment by doubling unemployment benefits and providing a one-off $750 stimulus check.
Major Australian banks and landlords have fallen into line by offering borrowers and tenants forbearance or rent holidays as a means to provide households and businesses with much-needed liquidity.
Governments around the world have followed suit with generous temporary increases to unemployment benefits for the tens of millions of workers furloughed by necessary quarantine actions aimed to slowing the spread of COVID-19.
Beyond the fiscal support, and more relevant for asset markets, central banks around the world have unleashed a wave of monetary stimulus again targeted at ensuring liquidity and the functioning of the global financial system.
The U.S. Federal Reserve has injected US$3tln into the global financial system in the space of a mere 3 months, contributing the same total stimulus that was contributed in 3 separate bouts of quantitative easing over the space of 8 years in the wake of the GFC.
Not only have the Federal Reserve injected capital into treasury and interbank markets, but the key trigger for asset markets to rise was the announcement that the Fed would begin purchasing corporate bonds, including those downgraded to non-investment grade status by virtue of the COVID-19 demand shock as a means to ensuring that corporate America remained able to access business finance throughout the pandemic.
The sum total of this stimulus is such that U.S. money supply has surged a whopping +23% annually through May, trouncing even the +10% growth witnessed in the wake of the GFC.
In Europe the stimulus has been equally impressive and money supply there has rocketed by 9% - its fastest rate in a decade.
Here in Australia the RBA has been active, offering cheap liquidity to the banking system to support measures of forbearance, but it has also actively targeted the 3-year government bond rate to ensure it holds 0.25% - a measure known as yield curve control and designed to anchor the medium term reference rate for corporate and government borrowing.
This extraordinary stimulus has heavily influenced fixed income markets and once again forced investors deeper into the equity market as a means for achieving high portfolio returns.
Following the +16% jump in the ASX200, the market now trades at its highest valuation since the dot-com era on 21x a still very uncertain 2021 earnings estimate.
Unsurprisingly the sectors hardest hit in Q1 rebounded back the best in Q2.
Information technology names blasted higher by +49% in the quarter led by a remarkable +224% jump in payments platform Afterpay, whilst consumer discretionary stocks doubled the index returns rising +30% and oil stocks bounced a similar amount.
Despite the massive forced unemployment, stocks exposed to the consumer durable sector posted excellent gains as consumers, stuck at home with time on their hands spent up heavily online and on goods associated with the home.
Outdoor leisure retailers such as Kathmandu and Super Cheap Auto saw strong sales growth as did Bunnings and Officeworks for Wesfarmers.
Underperforming sectors proved to be defensive in nature, such as healthcare, utilities and consumer staples all of whom rose a rather pedestrian +2% to +7% in the quarter, though after admittedly having led the pack in the sell-off.
Capital raisings were everywhere during the quarter as the collapse in demand forced management teams to address liquidity issues, but despite the substantial supply of stock from names including QANTAS, Lend Lease, QBE, Challenger, Vicinity Centres, Super Cheap Auto, National Australia Bank, Invocare, Blackmores, Metcash, NextDC, Reece, Cochlear, Auckland airport, Oil Search, Newcrest, QUBE, Flight Centre and Webjet, the broader equity market continued to make gains.
Beyond the equity market, oil prices doubled from $20 to $40 in the period, helped by collective supply cuts aimed at addressing the enormous over-supply created by grounded airline travel and curtailed car usage.
The Australian Dollar surged from under 60c to close the quarter near 69c, supported by the rebound in Chinese commodity demand and the resultant bounce in iron ore prices to $100/ton.
Australia has managed to deliver consecutive record trade surpluses through April and May, buoyed by the strength in export demand and the collapse in domestic import consumption.
Further assisting the currency bounce is the simple fact that in spite of nearly $50bn in support for bond markets by the RBA, this level of money printing pales into insignificance relative to that done by their international peers as flagged above, which also helps support demand for the AUD.
U.S. economic update
Unsurprisingly, the impact of shelter-in-place orders aimed to containing the spread of COVID-19 across the United States had a detrimental impact on end demand with the all manner of economic indices witnessing drops of unprecedented size and scope.
The headline unemployment rate jumped from a post-war low in early 2020 of 3.8% to 13% in May, but note that this number would be several percent higher were it not for a significant number of former workers exiting the work force.
The measure of labour supply, the participation rate, collapsed to its lowest levels since the 1980’s.
As at the end of June, there were still 20m Americans claiming ongoing unemployment benefits, a staggering 13% of the workforce, whilst even more concerning, counting those still with a job but on reduced hours saw the underemployment rate at 18% in June, down from an all-time high of 23% in May.
Using several measures of current demand, including a well watched indicator compiled by the New York Federal Reserve, at its worst, the U.S. economy was seen to have lost approximately -11.5% of demand at its worst in mid-late April, but through both May and June activity improved as citizens gradually regained their social mobility.
The significant and timely fiscal stimulus afforded by the CARES legislation, notably the US$600/week supplemental unemployment insurance, was a godsend for many families and has helped to protect consumer demand from falling even further.
Encouragingly, and interestingly, despite the worst unemployment rate since the Great Depression, reports from many charity groups have suggested that poverty levels have actually improved in the United States as the US$600/week unemployment supplement is in addition to the typical US$400-500/week state unemployment insurance.
Sadly it seems highly likely that this support will cease at the end of July and that the Federal Government will seek to support the economy via supply side measures such as payroll and other related tax cuts, which though helpful, will prove far less stimulatory than the recent handouts.
As we stand now, current demand looks to be running down -7.5% still on the previous year, which is still significantly under the base-line and indicative of a likely long grind back to what was perceived to be normal.
Unfortunately the early re-opening of many southern states has led to a significant spike in infection rates which has seen many states including three of the largest being California, Texas and Florida reverse course on the re-opening of many service sector industries and in doing so, looks to be quashing the nascent rebound in consumer spending.
As has been widely reported, international equity markets staged a historic bounce during the June quarter, including in which the S&P 500 had its biggest 50-day rally ever.
In the end, the U.S. S&P 500 rallied +20% for the period in what was its largest quarterly jump since 1998 and the 4th biggest rally since the 1950’s.
The NASDAQ rallied an even more impressive +30%, trouncing the -11% loss in Q1.
Less impressive were gains in the U.K. and Japan, where the FTSE rose +8% and the Nikkei +17% - both still well off the levels they started 2020 at.
European indices too bounced, by +17%, but remain down on the year.
Within the major stock-markets, the trend toward so-called ‘growth’ stocks remained strong, with technology and biotech continuing to lead all-comers, whilst traditional economically cyclical sectors of the economy such as industrials, transport, retail and the like lagged.
The gap that has now opened up between the valuation of the ‘growth’ sectors and the wider market is at historic levels and demonstrative of investor willingness to believe the narrative of consumption having accelerated its shift to online channels.
Apple, Netflix, Amazon, Google and Facebook were all leading stocks during the quarter and now trade at all time high share prices and valuations.
Australian market outlook – September Quarter 2020
Following the rapid-fire rally back in global equity and corporate credit markets which leaves valuations at multi-decade highs and beyond even the elevated levels of February 2020, it is hard to be excited by the prospect for share-markets in the remaining months of this incredible year.
Equity valuations in both Australia and the United States are now significantly above the February 2020 peaks which themselves were the highest this century.
The ASX200 now trades on 21x forward earnings and the S&P500 is on 25x and almost as rich as it traded in the tech-boom.
Price is what you pay, and value is what you get.
Making it even less appealing is the still enormously uncertain outlook for future demand and for corporate earnings.
Swathes of the economy, across service industries such as tourism, retail and hospitality will likely be severely curtailed for at least the remainder of the year or longer, whilst the domestic construction industry will likely witness soft demand for not only the remainder of 2020, but deep into 2021 as well.
May building approval data was the weakest in 6 years and apartment construction approvals the lowest in absolute in over a decade.
Collectively these industries account for a quarter of the Australian workforce.
Whilst the government support via Job-keeper has been exceptional, its extension is likely to occur only with diminished benefits after its targeted September 2020 expiry.
Bank loan forbearance and landlord rental deferrals have been welcome respite, but though these are likely to be extended modestly from their scheduled September end also, these costs are not being absolved of creditors and continue to accrue as liabilities for business and households.
Personal income tax cuts will likely be brought forward, but this will still largely be a 2021 phenomenon.
International travel and international inbound tourism appears to be a 2021 factor also.
Whilst we think Australia has done an exceptional job thus far in combating the virus, until it is contained and society is able to regain typical mobility, it is incredibly difficult for fiscal stimulus to do much more than provide much needed ballast to an economy rapidly taking on water.
Job security is vital to any sustained rebound and this seems unlikely until at least the new year.
Whilst bank sector stocks have been heavily sold we think that bad debts are yet to peak and we believe there is a high likelihood that second half dividends are deferred.
Mining stocks have been a welcome outperformer as Chinese iron ore demand restarts, but prices are currently being inflated by supply issues in Brazil, themselves created by COVID-19, meaning that the sustainability of profits looks weak.
Healthcare stocks have been a safe port in this storm also, but are at risk from a likely change in U.S. politics come early November with the Presidential Election.
A Biden Presidency would see a sincere effort from Democrats to lower healthcare costs and would likely lead to an impact on U.S. revenues at each of CSL, Cochlear and Resmed.
For now, we believe the ASX200 is likely to consolidate lower by approximately -5% to 10% during the September quarter, but that clearly this is highly dependant upon news relating to COVID-19 and its containment both here and abroad.
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