Market & Economic Update
by Financial Keys
The Australian equity market (as measured by the S&P/ASX 200) continued to press forward, posting a healthy (+4.3%) in the March quarter. The 12-months to 31 March 2021 finished with an extraordinary return (+37.5%), once the carnage of March 2020 dropped out of the yearly numbers.
The March quarter was dominated by an upbeat February reporting season described by some as the “best in the past decade”. Over 50% of companies reported stronger half year Earnings Per Share (EPS) growth estimates whilst only 27% missed their forecasts. A number of companies however did bring future earnings forward so this will need to be carefully watched and taken into account.
Major themes to come out included the disparity between pandemic losers (Banks, Energy, Materials and Travel) and the winners (Technology, Retail). This was part of a broader quarterly theme as investors rotated into Covid losers i.e. “value” orientated stocks at the expense of previous winners “growth” stocks, which sold-off relatively. Another notable theme was dividends. Dividends per share were revised up approximately 5% over the month. Some 57% of companies declared a dividend, up from 53% in August. Aggregate dividends are actually up by 5% on a year ago.
Quarterly returns were led by cyclicals as the economy continued to recover. Financials (+12.2%), Communication Services (+8.8%) and Energy (+3.8%) led the way with growth orientated sectors Information Tech (-11.3%) and Healthcare (-2.3%) lagging. Large caps, as measured by the ASX 50 (+5.3%) started the year off well outperforming the mid cap, as measured by the ASX Mid 50 (+0.2%) and small-cap (+2.1%) sectors.
Whilst the US and Europe continue to be enveloped in multiple pandemic breakouts, public discourse (aka riots) and general economic weakness, all major developed and emerging market bourses still managed to perform well. Central banks reaffirmed their accommodative positions and governments outlined multi-billion dollar fiscal policy packages led by US congress approving newly inaugurated president Biden’s combined $3T Covid relief/Jobs Plan package. Unhedged indices outperformed their hedged counterparts as the USD and EUR appreciated relative to the Australian dollar during the quarter bringing a temporary halt to recent strong gains. This was mainly due to, as noted earlier, increased optimism following the US fiscal boost and better economic data out of the Eurozone.
The S&P 500 returned a strong (+7.5%) whilst the broader global share index (MSCI World NR) provided investors with a healthy (+6.3%) gain. Emerging Markets (as measured by the MSCI EM index) returned (+3.6%), underperforming developed markets as lagging vaccine programs, rising US Treasury bond yields and accompanying USD strength provided headwinds. Europe (as measured by the STOXX Europe 600 index) returned a solid (+5.3%) whilst Asia excluding Japan (MSCI AC Asia Ex Japan) also recorded a positive return of (+4.1%). Increased optimism towards economic re-opening was tempered late in the quarter by slower vaccination rollouts leading to the reintroduction of lockdown restrictions in some countries.
Property & Infrastructure
The Australian listed property sector (S&P/ASX 200 A-REIT) also benefitted from the rotational trade into cyclical sectors during the quarter however a strong March (+6.6%) unfortunately did not reverse poor returns in January and February. The sector returned (-0.5%) for the quarter.
The divergence in performance across sub-sectors continues with Office still struggling; whilst Retail is witnessing shoppers returning and low interest rates continues to provide a tailwind for Residential.
Overall, reporting season did highlight to a degree that the sector could remain competitive and provide investors with solid returns as rent collections are improving and asset values generally are increasing or holding up. Global listed property returned +8.81% for the quarter (far outperforming the domestic sector due to opportunities within deeper and broader sectors) and global listed infrastructure (+5.63%) provided healthy returns for the quarter.
Bonds and Cash
Whilst the RBA and central banks globally remained accommodative in support of bond markets via stimulus programs, yields on 10-year treasuries, both domestically and globally rose markedly during the quarter as confidence grew off the back of vaccine rollouts and economic stimulus. The 10-year Australian Treasury yield increased from 0.972% to 1.772% whilst the 10-year US Treasury yield experienced a similar movement, rising from 0.91% to 1.74% - overall indicating rising growth expectations and potential inflationary pressures. Bond returns therefore suffered heavily as a result with Australian bonds (Bloomberg AusBond Govn 0+Yr) reaching further negative territory on a real basis (-3.6%) whilst global bonds (BBgBarc Global Aggregate TR Hedged) were not immune, falling (-2.5%). Corporate bonds (Bloomberg AusBond Composite 0+Y TR AUD) continued to outperform sovereign, although did not escape, returning (-3.2%). Higher yielding bond assets (BB, BBB and some CCC) remained broadly buoyant with cooperative monetary policy in place. Cash yields remained untouched as the RBA left the official rate at 0.10% throughout the quarter.
Quarter in review
March was one of the oddest quarters we’ve seen in some time. Given all the things happening (or not happening) in the periphery, you’d be forgiven for thinking that it wasn’t a strong quarter for markets but in reality it was.
It wasn’t all plain sailing with one of the biggest government bond sell-offs since the 1994 bond market crash. In other asset classes, Australian listed property fell, global listed infrastructure and property rocketed higher, Australian large company stocks outperformed small company stocks, global equities saw the strongest returns (almost a years’ worth of return) surprisingly boosted by European equities in contrast to the continuation of lockdowns; all whilst the Aussie dollar retreated a little, largely on unexpected US dollar strength. The other significant change was the large rotation into Value stocks, including those stocks left behind or beaten down by Covid-related government-imposed restrictions in 2020.
To begin the quarter, in the US we saw the Republicans lose both senate seats in the Georgia run-off which resulted in a split 50-50 senate. The result means a likely logjam for legislation requiring a super-majority which would need a number of senators from either party to cross the floor; but also means that other legislation that can pass with a simple majority can do so relatively easily, with VP Kamala Harris having the casting vote. The overall outcome allows a non-Republican controlled senate to push through greater spending to support Covid recovery efforts.
At the same time, we saw the beginnings of an impressive vaccine rollout by certain countries, particularly Israel, the UK, and the USA; whilst the Europeans struggled with bureaucratic red tape. This resulted in a lessening of restrictions for those countries with either strong vaccine rollout or strong previous efforts to curb the spread of the virus; but an increase in and lengthening of restrictions for those countries and regions that did neither well. That trajectory progressed in the same fashion as the quarter went on.
In the background, we first had the “GameStop” controversy which saw retail punters (investors) battle it out against hedge fund managers (the so-called professionals), with retail punters using a toxic but somewhat effective combination of social media, derivatives / leverage, free brokerage on trades, government stimulus cheques, and boredom (given government-imposed restrictions) to pile into stocks and commodities for that matter, to counter short positions (i.e. betting that a price will fall) from the professional investors. Whilst the latter was right to be positioned short given some of the poor quality of these investments, they largely got caught out at their own game. The result was a significant increase in volatility in markets, particularly on an intra-day basis, which led to broad investor concerns regarding the stability of the market.
We witnessed one of the largest and fastest increases in government bond yields seen in decades. It’s worth pausing to note (and impress) that whilst rising bond yields mean higher income returns in the future, it can also mean large capital losses given a bond has a fixed maturity which means that the price of a bond and its yield move in different directions. It’s also worth noting that the bond’s coupon (what the bond issuer promises to pay) is not the same as the bond’s yield, with the yield calculated as the coupon divided by the prevailing market price for the bond.
Whilst bond yields were likely to rise over the course of this year due to a combination of rising inflation expectations (founded or unfounded), improving economic outlook and large government fiscal support programs; such as US President Biden’s US$2 trillion package along with the mention of more to come, and some better than expected economic data, a significant and fast rise in government bond yields was triggered, to the levels seen prior to Covid beginning.
However, developed economy central banks like the US, Europe, Japan, and Australia all strongly reiterated and re-confirmed that their loose policy stance (i.e. rates at or near zero plus money printing) would be in place for some time to come (i.e. at least for the next 2 years, but likely 3 years). The result was a more than 4% fall in Australian government bond returns in the quarter.
In contrast, equity markets looked straight through the bond market carnage, in effect turning a blind eye to their all-important nearest relative and powering through any obstacle that could be perceived. This is not totally surprising given the quantum of both central bank and government stimulus that is finding its way into the market, in addition to vaccine optimism. However, it is important to note that the bond market is largely used as a valuation and pricing mechanism for the equity market. That is, if bond yields are higher, either equity earnings must rise to account for the price, or the price must fall to account for the higher bond yields. Given the strong returns from equities, with global listed property and infrastructure joining the party, it’s fair to say investors are of the view that earnings will rise to justify the rising equity prices. Time will tell.
We are at a juncture of sorts, in terms of inflation expectations versus inflation reality; with the US doing its best to stoke (or poke) the inflation monster with significant government spending and infrastructure spending. Inflation is critical as it then dictates how central banks will act in the future i.e. either as a handbrake or as fuel for asset price growth. We’ll know more on this front in the months to come and will be watching critically because a very different inflation outlook can dictate or require very different portfolio settings.
We’ll also be closely watching vaccine efficacy (including safety), vaccine distribution and vaccine take-up, as this then dictates the pace of country re-opening and hence the pace of the economic recovery effort. The faster the pace, the quicker the improvement in corporate earnings and balance sheets. Whereas a slower pace than currently expected could result in earnings disappointment and stressed balance sheets which can then precipitate a market correction. A watchful eye on both data and corporate earnings updates will be key.
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