Quarterly Market Update – Q2 2021
June Quarter 2021
Market and Asset Class Views
The ASX200 recorded another positive performance in the March quarter lifting +3.0%, as the market was supported by a very strong reporting season, an impressive recovery in economic growth and commodity price strength. However, a sell-off in AU and global bond markets on increasing inflation concerns as GDP growth recovers more quickly than expected, eroded some performance by quarter end.
Economic data releases beat expectations, led by the latest December quarter GDP recording +3.3% growth QoQ, which was the first time on record we have had two consecutive quarters above 3% growth. A continuation of resilient household consumption (+4.3%) was the catalyst, with the reopening in Victoria providing the largest impetus. January’s Trade Balance recorded the largest surplus ever courtesy of increased export volumes and prices, additionally the February unemployment rate fell to 5.8% the lowest level since Mar 2020. Economists (including the OECD) continue to lift their CY21 growth forecasts, with the range now being mid-4% to 5%, an increase of over 1% from last quarter’s estimates. The RBA’s accommodative policy setting remains, suggesting that interest rates will continue to remain low until 2024 and increasing their QE program by a further $100mil along with extending the duration by six months.
The December half reporting season was the best for some years, with better than expected EPS growth aided by positive margin improvement. Earnings expectations for the full year have seen strong upgrades particularly in the banking sector, as that sector recorded lower impairment charges (including some impairment write-backs). Combined with robust earnings in the resources sector on improved commodity volumes and prices, this has led to either actual or expected dividend increases. The latest February business confidence survey which printed the best outcome in a decade, supports this optimism with clear evidence of an uptrend in hiring and investment. FY21 earnings growth estimates are now circa 15% up from sub 10%, with banks providing the strongest EPS growth at around 25%. Valuations have eased with the ASX200 FY21 PE multiple at 20.0x, down from 21.5x last quarter.
Equity markets have continued to witness the rotation trade into economically sensitive stocks as several jurisdictions continue to provide large fiscal stimulus support. This economic reflation, which we have previously flagged, has heightened concerns of increased inflation and led to a major bond market sell-off and increased volatility in risk-assets. In this environment long-duration or growth stocks are likely to more susceptible compared to value names. The AUD flirted with 0.80 during the quarter as commodity prices rallied, with both iron ore and copper hitting decade highs. Despite some retracement from the peak, we expect continued strength on the back of the global growth recovery.
We maintain our Overweight, courtesy of the improved earnings outlook, strong economic recovery and a domestic COVID-19 vaccine rollout.
US equity markets continued to hit new all-time highs during the March quarter, although we experienced increased bouts of volatility as bond yields were aggressively sold off on inflation fears. Those concerns were fuelled by the speed of the US economic recovery, courtesy of the incredibly expansionary fiscal (and monetary) policy. This reflation enthusiasm saw continued rotation to value versus growth stocks, with the Dow Jones index outperforming both the broader S&P500 and tech focussed NASDAQ indices.
With the Democrats winning control of both houses of Congress, they have moved quickly to approve a new substantial $US1.9tril COVID-19 relief stimulus package (American Rescue Plan), which President Biden signed into law mid-March. This spending program will deliver direct cash payments to individuals of up to $1,400 and includes $20bil for specific focus on COVID-19 vaccine provision and distribution. This follows directly on from December’s $US900bil stimulus plan, which positively impacted January consumer spending. Monetary policy remains accommodative with the Federal Reserve (FED) maintaining interest rates at a historical low range of 0-0.25%, with Chairman Powell indicating no change is likely through to 2023.
Economic data releases continue to point to a rapid recovery, as the country continues to accelerate their inoculation program. The FDA has approved usage of three COVID-19 vaccines (including the one-shot variety), with over 145mil doses administered. The latest Manufacturing PMI leading indicator recorded one of the best improvements in conditions since 2010, with GDP growth for 4Q20 of 4.3% following on from the record rebound of +33.4% in Q3. Economists continue to revise up their CY21 estimates with a number now expecting 6.5% YoY growth from 5.5% previously and lowering their unemployment rate forecasts to circa 5% by year end (with one estimate at 4.1%), versus the latest February release of 6.2%. The FED also lifted its growth forecast to 6.5%, combined with an uplift in their inflation estimate to 2.2% from 1.8% previously.
Enthusiasm for this V-shaped recovery was evidenced in the latest 4Q20 reporting season, with actual earnings growth of 4% for the S&P500, compared to a forecast of minus 10% in early December. Estimates for 1Q21 are for 22% growth and +24% for CY21. Equity strategists are generally forecasting further upside for the S&P500, with a number expecting the index at 4,500 at year end.
Whilst valuations are elevated and bond yields pose a threat, we think the risk-reward still favours equity exposure as the catalysts of increasing vaccinations, lowering of new COVID-19 cases and stimulus measures will drive economic growth.
We maintain our Overweight.
European equity markets embraced the recovery trade in the March quarter with a rally of +7.7% for the Stoxx600 pushing the index to year highs, this was despite an uneven economic recovery courtesy of ongoing COVID-19 restrictions, coupled with concerns on inflation and a sell-off in bond yields.
UK and European countries endured further hard-lockdowns during the quarter which has impacted industrial production (IP) and GDP growth numbers. The latest January IP data in the major economies of Germany and the UK both recorded negative outcomes of -2.5% and -1.5% respectively. Current GDP expectations for the combined EU region are for a negative result in 1Q21, following the -0.7% contraction in the December quarter. With lockdown restrictions targeted to be relaxed by mid-year, estimates for CY2021 now sit around 4% with strong uplift expected in the second half. In the UK, the Treasury now expects CY21 growth to be 4%, whereas the OECD is more bullish with its recent upgrade of 0.9% to 5.1% growth.
However, the recovery and pathway out of COVID-19 curbs is still uneven across the region. The UK has announced a timetable to progressively ease all restrictions by mid-June subject to acceptable virus control. Germany has agreed to a phased easing of restrictions, including reopening of shops as they come out of the partial lockdown currently in place until mid-April. Conversely, Italy has reintroduced tougher nationwide controls to reduce a new surge in cases and in France a number of regions have moved back into lockdown. Similarly across the EU the vaccination rollout has faced challenges and differing success. The UK has now inoculated over 30mil people (~45% of population), whereas Germany, France and Italy have all struggled to get to through 10mil doses each, despite having approved four vaccines including the new one-injection type.
Governments and Central Banks have continued to provide fiscal and monetary stimulus to aid the regions recovery. The UK Budget released in early March announced an additional £65bil of fiscal measures for FY21/22 (total now £407bil), which included extending the job furlough scheme by 6 months to the end of September plus grants to hard-hit industries like retail and hospitality. Interestingly, to assist funding this enormous fiscal program they will raise corporate tax rates from 19% to 25% in 2023. The ECB have maintained their existing QE programme of €1.85tril, but said they expect purchases in the next quarter to be conducted at a significantly higher pace after a jump in global government bond yields, which has boosted inflation expectations.
Consensus earnings estimates for CY21 are for an increase of circa 32%, significantly above the mid-20% in the US and a PE multiple of 17x, which is a 25% discount to the US.
We move to Overweight given this continued attractive valuation differential.
Emerging Market Equities:
Emerging market equities had a good start in 2021, delivered 3.9% in AUD terms as measured by the MSCI EM Index over the last three months. North Asia has demonstrated the best containment of the COVID-19 so far and is expected to continue the normalisation of activities supporting economic growth.
We believe that emerging market economies will benefit further as the vaccine is distributed in developed markets in first half of 2021 and in emerging markets later this year.
China, in particular, has enjoyed a much faster recovery with GDP growth achieving 6.5% YoY. The Chinese government also plans to create more than 11 million new urban jobs. Going forward, China will focus on domestic self-sufficiency, technological innovation and environmental protection. However, signs of intervention by the government cloud the investment environment as the Shanghai Stock Exchange halted the much-anticipated $37 billion IPO for online payments giant Ant Group. It would have been the largest public equity offering in the world. Trade tensions with the US will continue, but we expect it to be more predictable under the Biden administration.
Notwithstanding the health and economic impact, the COVID-19 crisis accelerated the move to a digital economy. As major semiconductor producers, Korea and Taiwan region will benefit from this evolution. The Manufacturing PMI’s of both are at multi-year highs amid strong foreign demand and improving operating conditions.
Meanwhile, supply chain delays remain a concern amid stock shortages and shipping-related delays. This in turn drove up the input costs for EM countries.
Turning to Q2 2021, we expect EM countries to be the key beneficiaries of a vaccine-led global economic recovery. Improved global demand, a more stable trade policy and a weak US dollar are all positive for EM equities. However, we need to remain cautious as a weaker than expected economic recovery would reduce external demand from key markets and put pressure on EM exports. Overall, despite the downside risks, we do believe the tailwinds outweigh the headline factors for EM equities and remain Overweight in this asset class.
A-REITs trended lower in March quarter -0.5%, after delivering 13.3% in the quarter prior, as COVID-19 related headwinds exacerbated by the rising bond yields outweigh the improvement of fundamentals. The recent reporting season saw several positive updates from retail portfolios due to a combination of provision write-backs, lower rental relief and lower cost of debt with relatively muted earnings on the other hand. However, share-price moves were constrained as investors were wary given the bond yield thematic at play and awareness the rent relief programme aided balance sheet and profitably, as a once off.
The Australian housing markets remain strong with house price increased 2.1% in February, the highest monthly rate since 2003 combined with CYTD auction clearance rates being >85% in Sydney and >77% in Melbourne. Residential developers saw a continued improvement in sales in 1H21 with settlements largely maintained, benefitting largely by the stimulus measures announced at both the federal and state level in response to COVID-19. The residential environment is likely to remain strong in the near-term, albeit the risks of stimulus programs rolling-off, decreasing affordability and macro-prudential regulations remain in the medium-term.
The Office sector continues to face cyclical and structural headwinds in the short to medium term with the full impacts on demand unclear. Whilst CBD office will remain a necessity for businesses, tenant’s footprint is likely to decline. Though a strong cyclical recovery could result in an improvement in underlying conditions through the back end of CY21. The Retail leasing metrics were significantly impacted by store closures throughout CY20, and are likely to experience a period of rental rebasing in the near term, despite the largely maintained occupancies. The Industrial sector remained resilient, continued to be supported by largely unchanged occupancy, consistent rental growth and positive revaluations. It is worth noting that as COVID-19 related tailwinds taper, particularly the large shift to e-commerce, Industrial markets may somewhat weaken.
We note the sector is trading at a discount to the ASX200 and tends to perform well during times of volatility. We believe A-REITs exposures that provide secure, long-term, and predictable profits can attract some investors, in spite of their modest underlying earnings growth. We retain our Neutral view on the asset class.
We continue to monitor movements in the I-REITs space accessing exposure to this asset class via our International Equities allocations.
The performance of our Alternatives universe was mixed, with Private Equity being the best performing sub-asset class.
Private Equity assets delivered strong returns over the quarter, underpinned by the risk-on
sentiment and excess liquidity in light of elevated public market valuations as well as the central banks’ commitment to anchor short-term interest rates at historic low levels. Private Equity performance has also been supported by a high level of exposure to sectors with strong
momentum such as technology, coupled with record levels of IPO activity. Overall, US IPOs raised $155 billion in 2020, almost double the next best level since the credit crisis, where $88 billion was raised in 2014 across 309 listings. The shift to over-weight Private Equity on 1st January 2021, relative to Gold, Infrastructure and Hedge Funds has proven to be correct.
The Spot gold price has fallen through-out the quarter, down 9.9% from 1898 to a low of 1676 and ended the quarter at 1710, interestingly, we observe and suspect some traditional gold market participants are increasing allocations to crypto currency assets as an alternate store of
value. With Gold’s long-running defensive role in the portfolio as a hedge against inflation spikes and weakness in US$, we continue to hold our neutral view.
Performance has varied across Infrastructure assets. Transport and energy sectors continue to outperform with their leverage to the recovery. We also anticipate the increasing infrastructure spending globally, including the proposing US$3 Trillion Joe Biden infrastructure package and Australia’s A$110 Billion Infrastructure Investment Program, to have a positive impact on this asset class, albeit in selected pockets. We expect the rising real rates and accompanying inflation to have limited impact on infrastructure assets in the medium to long-term due to underlying
cash flows’ CPI-linked nature. Overall Infrastructure assets continue to provide an attractive yield and serves as inflation protection in investors’ portfolio.
We maintain our preference to Global Macro strategies within the Hedge Funds universe, with the belief that these strategies are well positioned to exploit policy events as well as any significant central bank intervention. Overall, we remain overweight the Alternatives asset class, with a Positive 2 view on Private Equity and neutral across other asset classes.
We entered 2021 underweight the Fixed Income asset class and went further underweight in a mid-cycle review on 24th February 2021. So far our moves have been strongly vindicated. The 10-year bond started the quarter in US at 0.91% and Australia at 0.97% and finished the quarter at 1.71% and 1.75% respectively.
The big question facing the FI market is the long term 40-year bull market trend broken or simply a correction with the long-term trend still intact? Technically, we are still in retracement, but the question of a fundamental reversal will be answered by how the massive stimulus of $’s being injected globally is used by recipients – i.e. will the $’s be spent or saved?
If spent and injected into the real economy, then the reflation argument spills over into a reset of inflation expectations being higher. If saved, then the short-term monetary supply increase and velocity will quickly dissipate, rates will stop rising and the curve will flatten and then rates will rally.
We watch for the data to point the way.
One of the dramatic trends we have seen is the move by Asset Allocators to recommend a significant and fundamental underweighting and in some cases total exit of Traditional Fixed Interest assets (i.e. Government Bonds & Semis) for retail portfolios. In the absence of yield the role of bonds for the retail portfolio is left to being a ballast item which cash can also perform with no market losses caused by rising rates. Clients are increasingly being directed into credit risk assets to generate returns and are therefore taking on more risk.
In the active domain we retain a preference for unconstrained asset managers who have the ability to rotate quickly on duration, real returns, credit and yield curve factors. We retain our current underweight exposure to the class, notwithstanding there will be price rallies as the mathematics of carry and roll-down trades become evident. We see better risk adjusted returns in other parts of the investment menu.
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