As countries started to re-open, optimism is abound, prompting a rotation towards cyclicals and the worst affected by the lockdowns. At the time of writing, the S&P/ASX 200 has risen over 8% in the past four weeks as banks went on a run.
The U.S. S&P 500 rose 6.2%, at one point erasing year-to-date losses before the Federal Reserve (Fed) jolted markets back to reality with dour forecasts for the recovery over the next few years. The Euro STOXX 50 benefitted hugely from the cyclical rally as banks and industrials drove the index up nearly 14% but remains one of the poorer performing major indices year-to-date.
Commodities followed cyclicals higher as oil continued to rebound, with U.S. West Texas Intermediate Crude price over $36 per barrel as producers continue to control output levels. Copper also bounced over 10% as markets look forward to an economic rebound coinciding with the easing of lockdown measures. Meanwhile, gold was largely flat.
U.S. 10-year bond yields rose to 0.7% whilst Australia’s 10-year bond yield remained largely flat at 0.9%. Riskier areas of the bond markets like credit, emerging market, Italian and Greek government bonds all rallied as spreads tightened with the risk-on tone.
The Australian Dollar rose to 68 U.S. cents as the greenback weakened materially.
Economic data from April and May, the most severe periods of lockdowns globally, have started rolling in. The results offered points for both optimists and pessimists to hang onto, showing sharp and steep downturns but with many readings better than forecast.
Australian GDP came in negative for the first quarter at -0.3%, all but confirming the end to the record streak of continuous economic growth without recession. Retail sales fell by a whopping 17.7% in April but was better than expectations. Meanwhile, the trade balance was buoyed by a collapse in imports whilst exports held up thanks to China’s demand for commodities.
In the U.S., personal spending and factory orders collapsed by 13.6% and 13% respectively in April from the previous month. The headline employment figures surprisingly rose by 2.5 million as temporarily unemployed started to return to work, shocking economists that had predicted a fall of 8 million jobs for May. However, the unemployment rate remains a massive 13.3% and inflation readings also turned negative, prompting the Fed to provide a dour outlook with rates expected to be on hold until 2022 and the unemployment rate likely to remain elevated.
European data followed the trend of dismal but better than expected, with an unemployment rate of 7.3%, retail sales falling 11.7% and industrial production falling 17.1% in April, all of which were better than expected by a decent margin.
Meanwhile, Chinese activity data indicate that the rebound continues. Positively, results for the services sector which has been sorely lagging on the rebound is showing some strength. Although the rebound trajectory for other countries will differ based on their own unique circumstances, the speed and shape of the recovery in China has been encouraging.
Looking forward, there is plenty to drive market sentiment so expect volatility to continue. Newsflow on COVID-19 and the easing of lockdowns will continue to dominate headlines but the U.S. quarterly earnings season is also looming, whilst the annual reporting season for Australian companies also kicks off in late July. A large swathe of poor earnings is expected as consensus earnings expectations have been trending downward for months. The key will be whether expectations are too low or too high, and whether guidance is positive, or for many companies, whether guidance can just be reinstated as uncertainties abate.
Earnings expectations have been falling since it became clear that COVID-19 was not contained to China. The U.S. S&P 500’s expected earnings for the next 12 months is expected to fall over 20% from just under $180 in February to $142 currently. At a broad index level, Australian earnings are also expected to be down double digits.
Given the scale of the lockdowns globally and the uncertainty of the impact on direct demand but also supply chains, earnings expectations could change materially, along with expectations for a V, U, W or some other letter shaped recovery. With Q2 earnings in the U.S. and Australian financial year earnings kicking off next month, it is likely that we get a little more clarity on the true impact on earnings.
What is clear though is that companies in different sectors will be impacted differently, with utilities, technology and consumer staples all likely to be resilient. The chart below shows the change in earnings revisions for the first five months of 2020 in the U.S. S&P 500. Differentiation in the earnings of the Australian sectors will largely be similar with the exception of materials, where China has been keeping steel mills running at full steam whilst Brazil has been tripping over itself in trying to get iron ore supply online, boosting the domestic miners.
If the earnings downgrades prove somewhat accurate, markets have largely recovered to valuations above pre-COVID-19 levels across the board. Interestingly however, earnings have not been driving returns this year. Sectors such as utilities and consumer staples where earnings have held up well, have not been the best performers with negative returns, though technology did benefit, posting a positive year-to-date return along with the tech heavy NASDAQ index. Consumer discretionary, with the second worst change in earnings expectations, are actually posting positive returns at the time of writing.
Of course, there are many other factors in play contributing to the dispersion. Predominantly the amount of monetary and fiscal stimulus being doled out by governments globally that have driven bond yields, and therefore the risk free rate and discount rate for risky assets, lower. This drives the value of future earnings higher, and therefore, those with higher growth prospects like technology benefit whilst valuations of slow growing earners like utilities and staples are less affected.
Given the uncertainties around earnings, results season in July and August will be important in driving equity markets. With the rebound over the past couple of months, forward P/E estimates are well above pre-COVID-19 levels and long term historical averages, with the S&P/ASX 200 at 19x and the U.S. S&P 500 at 22x. At these prices, it looks like investors are optimistic that earnings are due for an upward revision so a disappointing earnings season could well drive equities to retrace lower.
Want more information?
This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.
If this article has raised questions regarding your personal situation, please contact your Partners Wealth Group advisor directly or on 1800 333 143.