Investment insights on the path ahead to a market recovery
While it seems financial markets have survived the first waves of volatility, what could happen next – and what might that look like?
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. Investments like shares made 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 recovered to 0.69 US cents. But that’s not to say it’s been a smooth run, with an escalation in tensions between the US and China and fears of secondary waves of infection. While we believe a repeat of the June quarter rally is unlikely, looking ahead, we still 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 the developing world – with Brazil, Russia and India now among the top four countries with the highest number of cases. On the other hand, Australia has been successful in flattening the curve (see graph below). Despite the increase in new cases in Victoria towards quarter’s end, Coronavirus remains well contained compared to other countries, which allows Australia to continue easing restrictions and restart activity earlier than expected.
Unsurprisingly, extremely poor economic data dominated headlines internationally in the early part of the June quarter. This is reflected in March quarter Gross Domestic Product (GDP) data, which measures the total value of goods and services produced in an economy, and is a key indicator that financial markets often refer to. Many developed economies contracted over the March quarter due to the lockdowns.
But after economies began easing social restrictions, there were 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 reflects business activity associated with the sale of goods to consumers. This rose 17.4% in May after three consecutive monthly falls. Australia has also experienced progress with economic activity. While the unemployment rate rose to 7.1% in May compared to 5.1% before Coronavirus, some leading economic indicators have pointed towards stronger economic growth. For example, retail trade in May grew by a surprising 16.3%, reversing part of the 17.7% fall in April.
World central banks and governments have continued providing vital support to economies and are keen to reinforce it. For example, both the US Federal Reserve and the Reserve Bank of Australia (RBA) have assured markets that policy rates would stay lower for longer to provide some relief and stability in their economies. In Australia, the RBA noted that the economic outlook for Australia may not be as poor as initially thought, and has so far had some success in supporting the economy.
Despite this progress, geopolitical tensions flared – causing additional volatility in markets. For example, the relationship between the US and China deteriorated further. Senior US officials, including President Trump himself, questioned the origins of Coronavirus and the level of Chinese transparency during the early days of the crisis. This led to a further escalation of 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 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 denied any political motivations in those moves, there is a strong suspicion that Beijing is again using trade as a means to achieve political objectives.
At the end of June, China 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 saying 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 central bank policy responses, improving economic data and the reopening of many world economies drove investment prices higher over the June quarter (see table below).
Table 1: Main asset class returns
|Asset classes||Quarter||1 year||3 year||5 year|
|Global Aggregate Bonds||2.3%||5.7%||4.9%||4.8%|
|Global Equity (Hedged)||17.5%||0.8%||5.8%||6.9%|
Source: Australian Shares: S&P / ASX 200 Accumulation Index; Global Equity (Hedged): MSCI All Country World Net Index AUD Hedged; Cash: RBA Cash Rate; Australian Bonds: Bloomberg AusBond Composite 0+ Yr Index; Global Aggregate: FTSE World Broad Investment Grade Index AUD Hedged
Past performance is no indicator of future performance.
In particular, share markets posted strong increases over the June quarter – with some recovering most of their losses from last quarter. Europe’s Euro STOXX Index is 5.6% below its 2020 peak, America’s S&P 500 is 7.9% below its 2020 peak, while Australia’s All Ordinaries Index is still 16.5% below its 2020 peak (see graph below). Nonetheless, the recovery is stunning.
Looking ahead, the extent of recovery in financial markets, especially share prices, could be somewhat subdued over the next six months and have a high level of short-term volatility. But overall, we are more confident that – in the absence of another significant external shock – the global economy and financial markets are on the path to recovery, but a path that will still have some twists and turns along the way. In the meantime, our Investments team continues to communicate closely with our skilled investment managers to learn more about the risks and opportunities for investing on behalf of members.
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 no indicator of future performance.
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