Quarterly Market Update – Q1 2021
March Quarter 2021
Market and Asset Class Views
The ASX200 enjoyed a strong December quarter performance rallying circa 15%, with November being the best monthly return since March 1998. Catalysts included: one of the most stimulatory Federal Budgets ever, interest rates cut to the lowest in history, positive advances on multiple COVID-19 vaccines and a constructive outcome in the US Presidential election for equity markets.
As opined in our November C-iNsights the total Australian Government fiscal support has been enormous, with immediate COVID-19 funding such as JobKeeper payments combined with the October budget measures lifting total stimulus to around $350bil or approx. 18% of GDP, one of the largest by any country. The pro-growth budget polices were augmented with the RBA further easing monetary policy at their November meeting to a historic low for official cash rates of 0.10%. The central bank also launched an official QE program to buy $A100bil of govt bonds to increase money supply, lending and investment over a six-mth period and has indicated they will expand if required.
The September quarter GDP data released at the beginning of December, was a positive beat on forecasts coming in at +3.3% QoQ, which not only lifted Australia out of a technical recession but was also the best quarterly number since the March quarter 1976. Household consumption was the key driver, recording the largest increase on record. As Melbourne comes out of its strict COVID-19 lockdown, state borders start to reopen and residential property prices appear to have avoided a crash, many economists including those at the OECD are now upgrading their CY21 growth forecasts to mid-3% levels. The RBA Governors latest testimony signalled their belief that the economic recovery is underway, which will be aided by a lower estimated peak in the unemployment rate of 7 to 8% versus previous estimate of 10%.
Approval of two COVID-19 vaccines and a market friendly outcome in the US Presidential election have augured well for global equity markets. This has pushed the ASX200 FY21 forward PE valuation back to pre-pandemic levels of 21.5x with still conservative earnings growth of ~8%, improving to plus 11.0% in FY22. Whilst fears of a fiscal cliff still remain, combined with operating challenges for some businesses (including insolvencies) and tense Chinese trading relations, a stimulatory environment should remain supportive for risk assets. The AUD rallied strongly to levels last seen in early 2018, courtesy of improved expectations of global growth, higher demand for commodities and a risk-on sentiment. Expect this trend to remain into 2021, which will erode performance of offshore denominated assets.
We move to Overweight.
US equity markets continued to hit new all-time closing highs during the December quarter as the positives of the Presidential election result and COVID-19 vaccine progress (including FDA approval), outweighed the record daily pandemic cases and deaths reported. Investors embraced both as providing more policy certainty, and potential upside for economic and earnings growth in 2021.
With Democratic Joe Biden set to become the next US President, securing a majority in the House of Representatives but possibly not the Senate (result due Jan 5th), this was interpreted as an equity market friendly result. A divided congress outcome, or avoiding a “Blue Wave” reduces the likelihood of implementing the disruptive policies of tax increases and anti-trust regulatory rules. Post-election, the focus returned to a new stimulus package with Congress finally agreeing a $900bil relief package. Expectations remain high that fiscal policy will continue to be expansionary in 2021.
The positive news on development of a number of COVID-19 vaccines which exhibited high efficacy in trials, was a major impetus for risk assets in November. Stellar monthly performance saw all major indices gaining on average +11% as investors rotated into economically sensitive and value stocks. The small-cap Russell 2000 index rose 18.3%, the largest on record. Additional support was provided by a much better than expected September quarter reporting season, with the average S&P500 earnings decline being minus 6.3% versus the minus 22.5% estimated at the beginning of September. For CY21, earnings are forecast to rebound 22%.
Economic growth rebounded in Q3 as personal spending drove the largest GDP increase on record, recording a 33.4% QoQ expansion. Other indicators were mixed with IP rising, but retail sales falling as November unemployment disappointed with job adds only half the expected amount. Economists suggesting that rising coronavirus cases coincided with a considerable slowdown in hiring. Similarly, GDP forecasts for 1Q21 have been reduced as the economy battles with the COVID- 19 resurgence with earlier estimates of +3% growth being cut to circa 1%.
Whilst challenges remain for the economy and valuations continue to trade at elevated levels, the accommodative monetary and fiscal policies augmented with the FDA approving two COVID-19 vaccines for emergency use (which will hopefully be widely available into 2021), continues to support the belief we will see a V-shaped recovery. The Federal Reserve upgraded their GDP estimates for 2020 to -2.4% vs -3.7% and 2021 to 4.2% vs 4.0, biased to 2H21. The more bullish equity strategists are forecasting the S&P500 will be at 4,500 by the end of 2021.
We move to Overweight.
EU equity markets rebounded strongly in the December quarter with the Stoxx600 rallying circa 10% as the EU economic data recorded a sharp recovery from the recession in the first half of the year.
GDP data and industrial production for the broader EU zone and the major economies of Germany, France and the UK all registered a return to positive growth, as economies rebounded from the coronavirus pandemic and national lockdowns. Overall EU GDP growth for Q3 increased 12.5% recovering from the record decline in Q2, although YoY growth still remains minus 4.3%.
The resurgence of COVID-19 infections through November and December as the region entered the winter flu season, has seen many countries reintroduce restrictions. Multiple countries entered one- month national lockdowns during the quarter in an attempt to restrict the spread of the virus into the Christmas holiday period. The largest economy Germany, has recorded new peaks in both infection rates and deaths and lifted partial restrictions to a full lockdown for a month, until January 10th. Additionally, much of the UK moved back to the toughest tier of restrictions/lockdown, as a new more highly transmissible COVID-19 variant was identified in the south east of the country.
Governments and the ECB have continued to provide fiscal and monetary stimulus, with the ECB increasing its QE programme by €500bil to €1.85tril and extending the duration by 9 months to March 2022. EU member states have also finally approved July’s €750bil Recovery Fund and the proposed €1.074tril Budget, adding fiscal support to the region. Germany with offer fiscal assistance to affected companies during the current hard lockdown, vowing to spend €11bil per month in aid, whilst the UK has extended its job support scheme by 6 months to April 2021.
The ECB upgraded its CY20 GDP estimate for the region to -7.3% from September’s -8.0%, but has cut its CY21 estimate to +3.9% vs. previous +5.0%. Likewise, the OECD expects similar growth outcomes at -7.5% and +3.6% respectively. The consensus still remains for a V-shaped recovery, with earnings estimates for CY21 expected to rebound by around 30% from a comparable sized fall in CY20. Equity valuations remain attractive, with the region trading on a 26% discount to the US market with a far superior earnings outlook.
The UK approval and distribution of two COVID-19 vaccines in December is supportive of the 2021 recovery, as is the EU Commission similarly approving conditional vaccine usage in late December. A final agreement by the UK and EU on a post-Brexit trade deal is likewise positive, however strict lockdowns and travel restrictions across the region present challenges for growth in 1Q21.
We maintain our Neutral stance.
Emerging Market Equities:
The performance of emerging market economies during the December quarter followed the general trend from the previous quarter; China’s post COVID-19 rebound gathered momentum while the economies of India and Brazil remained mired in a pandemic induced recession.
The Chinese economy advanced 4.9% YoY in Q3 2020 versus a 3.2% expansion in Q2 but below forecasts of a 5.2% growth. Retails sales rose3.3% YoY and manufacturing PMI climbed to 54.9 in November 2020 from 53.6 in October. The Taiwanese economy also posted solid economic data; GDP YoY expanded 3.92% in Q3 2020 higher than an initial estimate of a 3.33% rise and reversing the -0.6% contraction from last quarter. Exports grew by 3.64 %, driven mainly by strong foreign demand for parts of electronic products, information, communication and audio-video products. Furthermore, the IMF recently raised its 2020 GDP growth forecast for China and Taiwan to 1.9% and 0% respectively. Contrasting the buoyant picture were the economies of India, Brazil and South Korea which contracted -7.5%, -3.9% and -1.1% respectively. The regions are also expected to report negative GDP growth for the full year 2020, as per the latest IMF forecasts.
An equity market friendly U.S. presidential election outcome and successful vaccine candidates have renewed investor enthusiasm for this asset class. The MSCI EM index was up 9.71% for the 3-month ending November 2020 vs the MSCI World which was up 5.55% during the same time period. The EM markets also continue to hold compelling valuations. On a P/E basis, the MSCI EM index is trading 19.86 compared to 27.72 for the MSCI World index as at 30 November 2020.
Unprecedent stimulus measures in most advanced economies and expectations of a weaker US dollar going forwards are also positive for EM assets. Recovery in global demand will likely spur capital flows to EM, buoy commodity prices and support EM currencies going forwards.
However, emerging markets is a very heterogeneous asset class. Each country has its own unique political situation, government policies, and is facing its own individual challenges with the global pandemic. Regions such as China and Taiwan have contained the virus and are ahead in the economic restart. Whereas, markets such as India and Brazil are continuing to struggle with the virus and hence are expected to see a much slower path to recovery. Also, risks such as delays in vaccine rollout and a less than stable US-China trade policy under the Biden administration will continue to impact EM growth outlook in the near term.
We upgrade from a Negative to a Positive +1 stance on the sector for the next three months and urge investors to exercise due diligence when allocating between the various emerging market economies.
A-REITs rebounded strongly over December quarter up 13.3%, which was largely attributed to the recovery of Retail assets.
It has been an especially encouraging quarter for the Retail assets, with support from a range of factors, including positive vaccine news, continued policy support as well as significant improvement in foot traffic as economy gradually reopens. Consumer confidence has shown a strong recovery from its trough in April and is now back in the positive territory, as is evidenced by the recent retail sales data. Occupancy and rent growth remain relatively stable across Office and Industrial assets. Worth noting that in comparison to many other parts of the world, the health crisis is currently deemed to be more under control in Australia where labour force has mostly returned to the workplace, thus the Office sector is facing less concerns with regard to the structural impact from the work-from-home theme.
Looking offshore at I-REITs, performance through this health crisis was mixed outside of the traditional sectors of Office, Industrial, Retail, and Residential. Hotel assets largely remained shut down or operated at extremely low occupancy levels during the early months of the pandemic despite the improving travel volumes over the past six months. In the Healthcare sector, both skilled nursing and senior housing have suffered significant drops in occupancy, as well as higher costs for PPE and staffing. A full recovery in these sectors will be extremely difficult until the pandemic is brought under control and infection rates subside. In contrast, property sectors that support the digital economy such as Data Centres, have enjoyed a burst in demand building on growth from the past decade, and likely to continue through the pandemic and beyond.
The disparity in performance across asset types remains, heightened by the wide variation in valuations in the public real estate markets, with some market segments trading at premiums and others at significant discounts to adjusted NAVs, particularly in Office and Retail sectors.
Notwithstanding that we continue to believe in the longer term I-REITs offer better diversification and greater access to sectors that are benefiting from the structural changes, A-REITs are better positioned for a ‘return to normal’ in the coming year, as the overall economy is the most important factor and performance driver for REITs which is highly depended on the progress against the pandemic and introduction of a vaccine.
Overall, we move from Negative to Neutral on A-REIT and remain Neutral on I-REIT in the coming March quarter.
Strategic allocation to alternatives assets such as infrastructure, private equity, and precious metals remains critical to minimize the impact of highly-correlated mainstream assets dropping in a market downturn. Alternatives not only provide effective portfolio diversification but with access and liquidity improving, can offer a further source of alpha and income over the long term.
Spot gold price tumbled 6.3% to 1,762 USD/oz during the month of November 2020, on the back of a strong rally in risk assets due to a vaccine induced euphoria. This was largely driven by selling in gold ETFs which were a key propellent in the first half of the year, an increased investment in crypto currency assets eating into gold’s share, and a muted demand for the physical metal especially from countries such as China and India.
Since then, gold has recovered back to 1,887 USD/oz implying an increase of 7.1% from the November lows and in line with its’ price at the end of September. In the short-term we expect gold’s desirability as a risk hedge to diminish as vaccine rollouts gather momentum. Longer term, the key factors impacting gold outlook in 2021 are the direction of interest rates, inflation, and USD dollar movements. Lower interest rates and increased inflation expectations will support gold as an inflation hedge. This combined with expectations of a weaker US dollar in 2021 should support gold prices and reinvigorate demand from key emerging market economies.
Infrastructure has been underpinned as one the key asset categories benefiting from the unprecedented amounts of fiscal stimulus extended by most advanced and some emerging economies in 2020. Looking ahead, we expect to see several local infrastructure projects being accelerated and new opportunities to be created in the utilities, transport and telecommunication sectors. We expect user pays/contract assets to regain strength against a backdrop of a recovering economy and recommend a balanced exposure to regulated and contract assets to be able to benefit from this return to normal.
Q3 saw a burgeoning recovery in the private equity sector with total buyout activity in the quarter reaching US$148bn, exceeding levels in 2019 by 10% although volume over this period dropped 24% to 750 deals. The industry’s resilience and ability to bounce back offers investors a cause for optimism alongside the record sums of dry powder (currently at US$ 1.7 trillion) available for deployment. In the long term, PE stands to benefit from the sustained low rates, low-yields environment that follows an economic downturn. In the shorter term, the industry must navigate through the myriad of opportunities by employing a disciplined and focused approach to identify opportunities where innovation and growth coincide with conventional wisdom.
The investing landscape has changed meaningfully due to the tumultuous events of 2020. Investors are now attuned to the fact that government yields nearing 0% won’t be able to meet their needs for the foreseeable future. We recommend broadening alternative strategies to include a greater use of private equity and infrastructure investments to improve the trade-off between risk and return and partake in the global recovery while retaining gold as a long-term inflation hedge.
Overall, we remain positive on the sector for the next 3 months.
The only role that Bonds are currently playing is a ballast to negative economic news. There is no real return currently, actually negative, and rates will only fall from here if we have another economic crisis (not our prevailing view). In the face of (even moderate) rising rates in this normalisation process, will see any duration components of bonds cause hurt. Notwithstanding RBA Yield Curve control, we move to underweight. Our preference is to retain overweight exposure to yield components of the FI universe. We remain attracted to Investment Grade Corporate for quality yield. Private Credit is recommended where the transparency level is high through to underlying assets. Bank Hybrids will remain well bid after a flurry of issuance and margins over BBSW are expected to narrow as supply is readily absorbed.
We expect Long Rates to rise in a moderate fashion as a response to some normalisation of curves as the COVID-19 vaccine sees abatement of the need for further Emergency stimulus as vaccine rollout occurs. Hence, we are negative on International Government and associated Duration based exposure. Similar to our Australian call, we remain attracted to the yield and “at risk” components of the FI spectrum. Again, appropriate risk assessment is mandatory as we move out the risk spectrum.
Overall, we move to underweight on the view that growth classes provide a better risk/return dynamic this quarter and the FI asset class by moving to underweight becomes the predominant funding source.
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