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Written by George Lin Senior Investment Manager | Colonial First State |
After entering an unprecedented shutdown in March to curb the contagious Coronavirus, the world economy began to restart economic activity in the June quarter – aided by continued support from world governments and central banks. Growth investments like shares staged a strong recovery during this time. By quarter’s end, Australian shares delivered more than 16%, global shares (hedged to Australian Dollars) delivered more than 17%, while the Australian Dollar (AUD) recovered to 0.69 US cents. But that’s not to say it’s been a smooth run, with an escalation in geopolitical tensions, expensive valuations and fears of secondary waves of infection. While we believe a repeat of the June quarter rally is unlikely, we remain cautiously optimistic on the outlook for financial markets.
Over the quarter, we saw a shift in the distribution of confirmed cases from the developed to developing world – with Brazil, Russia and India now among the top four countries with the highest number of confirmed cases. On the other hand, Australia has been successful in flattening the curve. Despite the recent increase in new cases in Victoria, Coronavirus remains well contained compared to other countries. This allows Australia to ease social restrictions earlier than expected.
Source: FactSet
Source: FactSet
Unsurprisingly, extremely poor economic data has dominated the headlines in both Australia and overseas in early part of the June quarter. This is reflected in March quarter GDP data, which showed that many developed economies contracted over the quarter due to the lockdowns in March.
After economies began easing social restrictions, there have been tentative but encouraging signs of a robust economic recovery. This trend is most evident in the US, which surprisingly added 4.8 million jobs in June – reversing some of the massive job losses in previous months. This positive momentum is further reinforced by May retail trade data, which rose 17.4% after three consecutive monthly falls. Australia has also experienced progress – with a bottoming out of the level of economic activity. While the unemployment rate rose to 7.1% in May compared to 5.1% before Coronavirus, some leading economic indicators are pointing towards stronger economic growth. Retail trade in May grew by a surprising 16.3% in May, reversing part of the 17.7% fall in April (see graph below).
Source: FactSet
Central banks and governments have been providing vital support to economies since late March, and are now keen to reinforce it. The main central banks have sent strong signals to investors that they would maintain low policy rates in the foreseeable future.
The US Federal Reserve (the Fed) spent the June quarter implementing its asset purchase programs and assuring investors that policy rates would stay lower for longer. In June, Chairman Powell said the Fed was strongly committed to using its tools to do whatever it could “and for as long as it takes to provide some relief and stability”. Furthermore, the Fed was “not even thinking about raising rates”, with official forecasts for policy rates to remain on hold (0%–0.25%) through the end of 2022.
Likewise, the Reserve Bank of Australia (RBA) has reassured investors of the durability of its current policy setting. While the RBA acknowledged the improving economic outlook at its June meeting, it also reiterated that the “the Board will not increase the cash rate target until progress is being made towards full employment” and until it is “confident that inflation will be sustainably within the 2%–3% target band”. Given the RBA’s main issue before Coronavirus was that inflation undershot its target, conditions that call for a higher cash rate are unlikely to be met in the near future.
The relationship between the US and China deteriorated further. Senior US officials, including President Trump himself, questioned the origins of Coronavirus and the extent of China’s transparency during the early days of the crisis. China angrily denied those charges, leading to a further escalation in the dispute and speculation about a possible decoupling between the two countries. In the meantime, both the US and China have increased their military activities in the South China Sea and Taiwan straits.
Australia’s role in initiating an official probe into the origin of Coronavirus also angered Beijing. In early May, China announced that four large Australian abattoirs were suspended from accessing Chinese markets. China then imposed an 80% tariff on Australian barley imports for five years following an 18-month investigation into barley imports. While China vehemently denied any political motivations in those moves, there is a strong suspicion that Beijing is again weaponising trade as a means to achieve political objectives.
At the end of June, China also imposed a national security law on Hong Kong. Under the current “one country, two systems” arrangement, Hong Kong enjoys a high degree of autonomy, with its own legal system inherited from the United Kingdom, its former colonial master. President Trump responded by stating the US would revoke Hong Kong’s status as a separate economic entity, thereby endangering its status as a global financial centre.
The combination of aggressive policy responses, improving economic data and the reopening of many world economies drove financial asset prices higher over the June quarter (see table below, which shows returns up to five years). In particular, share markets posted strong increases – with some recovering most of their losses from last quarter. Europe’s Euro STOXX Index is 5.6% below its 2020 peak, the S&P 500 is 7.9% below its 2020 peak, while Australia’s All Ordinaries Index is still 16.5% below its 2020 peak. Nonetheless, the recovery is stunning given all major share indices have had a peak-to-trough fall of more than 35%.
The AUD is another beneficiary of the global economic recovery and improvement in investor sentiment. After falling to a low of 0.57 US cents in late March, the AUD rose past 0.70 US cents briefly before falling back to around 0.69 US cents towards quarter’s end.
Table 1: Main asset class returns as at 30 June 2020
| Quarter | 1 Year | 3 Years | 5 Years | |
| Cash | 0.06% | 0.6% | 1.2% | 1.4% |
| Australian Bonds | 0.5% | 4.2% | 5.6% | 4.8% |
| Global Aggregate Bonds | 2.3% | 5.7% | 4.9% | 4.8% |
| Australian Listed Property | 20.2% | -20.7% | 2.3% | 4.7% |
| Global Listed Property | 8.8% | -17.0% | 1.9% | 2.2% |
| Global Listed Infrastructure | 7.9% | -9.6% | 2.7% | 6.3% |
| Australian Shares | 16.5% | -7.7% | 5.2% | 6.0% |
| Global Shares (Hedged) |
17.5% | 0.8% | 5.8% | 6.9% |
Source: FirstChoice Performance July 2020, CFS Research & Performance
Notes:
Past performance is no indicator of future performance.
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Looking ahead, the most significant support for financial assets could be the extremely accommodative fiscal and monetary policies in Australia and overseas. Given recent communications from the main central banks, we can expect a low-interest rate environment to persist in the foreseeable future.
But we expect political tensions between the US and China to remain elevated until at least November. The deteriorating relationship between the US and China (and China and the rest of the world) is a long-term negative for financial markets, and will likely introduce episodes of risk aversion and market volatility between now and November.
Another reason for caution is the valuation of share markets. After the recent rally, some major share markets have priced in the good news of developments and have become expensive. In terms of trailing 12-month price-to-earnings ratio (P/E), the S&P 500 at 21.6 is now close to its pre-Coronavirus peak. Below, we see that the long-term median trailing 12-month P/E for the S&P 500 (from June 2000) is 17.2. While the Australian share market is better supported from a valuation perspective, it is no longer undervalued by valuation metrics. The All Ordinaries Index currently has a trailing 12-month P/E of 15.7, which is close to its long-term median of 15.9 but still some way below its recent peak of 18.4. Furthermore, the visibility on 2021 corporate earnings is low for a large number of companies.
Source: FactSet
We retain a cautiously optimistic outlook for financial markets. As we move into the next quarter we are more confident (in the absence of a significant external shock) that the global economy and financial markets are past their troughs and are on the path to recovery. However, this path is likely to have many twists and turns, and we anticipate that the extent of recovery in asset prices – especially share prices – could be more subdued over the next six months.
Colonial First State Investments Limited ABN 98 002 348 352, AFSL 232468 (Colonial First State) is the issuer of super, pension and investment products. This document may include general advice but does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) and Financial Services Guide (FSG) carefully, assess whether the information is appropriate for you, and consider talking to a financial adviser before making an investment decision. The PDS and FSG can be obtained from colonialfirststate.com.au or by calling us on 13 13 36. Past performance is not an indicator of future performance.