News, Views, and Commentary July 2020

The global economy continues to experience a severe contraction as second waves of Covid-19 infections are being battled in numerous countries.  Cases per week in a number of countries, including Australia, the US, and Japan, have exceeded previous peaks.  The Reserve Bank notes in its most recent Statement that “even though the worst of this contraction has now passed, the outlook remains highly uncertain”.    On a more positive note the RBA also notes a strong recovery in industrial activity in China and a local Australian downturn that will possibly be not as severe as expected.

That said, it is a widely held view that the worst of the economic news is yet to unfold with the economy being largely supported by substantial and unprecedented Government packages.  The Federal government announced extensions to the JobKeeper and JobSeeker programs, along with estimates of a $184 billion budget deficit in 2020/21 and an unemployment rate of 10.75% at the end of 2020. However, these estimates were made before the second wave in Victoria.

Things are still in a holding pattern of sorts with real unemployment numbers hard to gauge, company outlooks still quite uncertain, and no real clarity over the future course of the Virus and further waves.   Magellan’s Hamish Douglass noted in an interview with CommSec this week:

The most important risk at the moment is the pandemic. Usually, you can assess an economic crisis and a policy response and make a decision off the back of that, but this is intersecting with a scientific issue and a medical crisis. The science is very hard to handicap at this stage and the economic crisis will depend upon the depth of the health crisis and we don’t know when we’ll have a vaccine. The science will guide how long this goes on for and it will guide the economic outcome. That’s the number one issue.”

This is all a little difficult to rationalise when we hold it up against the significant rally in share markets over the past few months.    If we sat down in February 2020 and thought to ourselves, well, imagine that in 6 months from now we have a worldwide pandemic with over 22,500,000 people infected and almost 800,000 deaths, no vaccine, a halt to international travel for a few years, and Australian government debt heading to around $184 billion, I reckon we’d be surprised that the Australian and US share markets had dropped by only 13% and 6% respectively. 

Add to this worsening tensions between China and the rest of the world and the impending US elections, it isn’t hard to feel that maybe the financial markets are priced for another correction.  But here’s where some of the competing factors we’ve mentioned in recent Newsletters come into play again.  For example:

  • Central banks around the world have gone to extraordinary levels to stabilise economies and pump money into the system
  • Investors are receiving little or no returns from other assets – maybe this motivation along with an optimistic confidence allows the share markets to ride on through for longer
  • Is the US market really as broadly overpriced as it first appears?  In the first chart below, see how the 5 Big Tech stocks (Apple, Microsoft, Google, Amazon, and Facebook) are responsible for almost all the growth in the US S&P 500 index in recent times. That leaves the remaining 495 companies pretty flat. 

We all know that if something is too good to be true then it normally isn’t true but, to quote Hamish Douglass again, “it can go on a long time before the party ends”. So the conundrum is evident, and where the share markets head in the near term is genuinely a 50/50 call.

As far as our clients are concerned, we’ll remain focused on working with our research partners to stay on top of changes as they happen and across new data as it emerges.  It is important to maintain the same disciplines: have a strategy and regularly review it with us so you’re well prepared to ride through the rough patches with whatever share allocation you have, large or small.       

Chart 1: the big 5 tech stocks

 

Sources: RBA, Quilla Consulting, MLC Asset,  Magellan Global, CommSec.

Chart 2:  Netflix has a higher market value than all four Big Aussie Banks combined, but a fraction of the earnings