Market update with Shaw and Partners, August 2020


by Clive Tompkins

Shaw and Partners Chief Investment Officer Martin Crabb discusses the global macro backdrop, and the Australian reporting season and market.

Martin Crabb:
I've just been asked to talk for about five or ten minutes, which is nowhere near enough time to talk about what's going on in markets and how we're seeing things, but just a few sort of high-level thoughts from the CIO's office here about how things are panning out.

So, there's a few things I wanted to touch on. One is, obviously, just the global macro backdrop. So, what's happening with the central banks, interest rates, monetary policy, etc. Which is, obviously, the key determinant of markets, financial markets. And secondly, just to touch on reporting season so far in Australia, which is taking up a lot of time at the moment. As you can imagine, there's lots going on. Lots of companies reporting results again today, and no doubt today's speaker can sort of shine a little bit of light as what's going on in their businesses as well.

So, it's a difficult time for investors because of the lack of guidance that's being provided by companies -- and that's not their fault, they just don't know. So few companies have visibility about the second half of the year, let alone next year, that very few of them are providing guidance at the current time. So that's why there's so much volatility in the market, is that it's pretty uninformed. So if you’ve got an uninformed market and a number of surprises, then a lot of people have to shift quickly.

So just sort of starting out, if I may, on the global macro backdrop. We do have the Jackson Hole meeting, which is normally where all the central bankers get together and play golf, and have a few drinks and talk about things, but it's all virtual this year. We're awaiting Jay Powell's speech about monetary policy settings and whether or not they'll adopt a more flexible approach to inflation targeting.

And why is that important? Well, if the Federal Reserve decides to use an average inflation rather than a 2 per cent target, they'll let the economy run hot, and that'll mean a more accommodative monetary policy for longer, which the markets are really going to like. So, we're all sort of watching that pretty closely. But I think it's just important to understand that what central banks are saying to us both here and overseas is that they do see an extended period of very low interest rates. And we're seeing that with the three-year yield curve targeting by the Reserve Bank here, setting cash rates at 0.25 out for three years, which makes the opportunity to refinance your debt, whether you're a mortgage owner or a business, very attractive. So we're seeing a lot of companies and individuals take advantage of these low interest rates. But it also means as an investor, you can be relatively confident that your cost of financing is going to stay low for at least the next three years, if not longer. And the Federal Reserve in the US is kind of saying the same thing without specifically targeting interest rates.

So, one of the key determinants of the price you pay for any sort of cashflow is the risk-free rate, and the governments have set these risk-free rates both at the short and the long end of the curve at very low levels. So that means you can pay more for equities, and that's exactly what's been taking place with PA expansion going on around the world.

To add to that, the risk profile. So obviously we've been knocked for six by the time coronavirus. It's a huge deflationary shock. It's also something that no one alive has ever dealt with before. So it has created a lot of uncertainty and it’s pushed the risk profile of a lot asset classes up very, very high. That's been coming down pretty much since the 23rd of March, which is the low point in the market. So, measures of volatility, whether it's the VIX index or corporate spreads, any sort of thing that measures risk, has continued to trend down.

So, that's another reason that you pay more of equities, is there's less risk and there's more certainty around the future. So we've had low interest rates and low risk rates. And the third component really is growth. So obviously a lot of industries have been struggling, the coronavirus has hit them for six. A lot of industries probably won't be able to recover to where they were, whether that's hospitality or real estate, etc. But for those companies that do have growth, and just think of Apple here, for example, people are just willing to pay more and more for that because A, they've got a lot of costs of funds, B, there's more certainty around the outcome. And thirdly, we know that that company is going to continue to grow.

So we've seen the growth stocks, if you like, be continually upwardly re-rated, and that's caused the S&P, as probably the most growthy index in the world, and the NASDAQ, to continue to power ahead. And the NASDAQ's well above its sort of pre-COVID levels, and the S&P’s sort of reached back on the back of mostly companies that have got pretty strong growth profiles.

The Aussie market as a whole, we do have a lot of growth companies, some of whom are talking to you today, but as a whole, the Aussie market's not seen as a growth market. It's very heavy on resources and bank stocks and real estate, which don't tend to have a strong sort of secular growth trend to them. So, we as a market have probably suffered a little bit because of that lack of growthiness. The sectors of the market that do display growth and think here of the technology and health care sectors, they have performed exceptionally well, but I suppose the the oldie worldie industrial businesses, real estate, etc, have sort of suffered a bit.

So that's sort of what's going on in the world, and we do see that continuing, we do see low interest rates continuing to pervade, and investors seeking yield will move into riskier assets. So that's going to continue. The risk profile of the market will probably start to be challenged a bit by two political events. One being the November elections in the US, which does look like we will see a change of presidency and maybe even a clean sweep by the Democrats, and that will obviously be nervous for markets because Trump is actually a known commodity. He's volatile, but he's known, whereas the Democrats, a little bit of an unknown picture at the moment. We also have the Brexit, so that looks like it's steering towards a hard Brexit in October.

So around October, November, we will see risk being back on, if you like, so investors need to be aware of that.

And just finally quickly on the domestic profit reporting season, we're probably about two-thirds of the way through. We've got about nine or ten of the large ASX 100 companies reporting again today, very mixed results, but net-net it's a beat. So the markets, the companies are producing better than reported profit results, and interestingly keeping their costs under control. So we saw, for example, Suncorp Bank (ASX:SUN) the other day had a significant reduction in their cost-to-income ratio. So even though they're challenged at the top line, a lot of companies have been very flexible with their cost structure and sort of kept their margins up quite strongly.

So, so far, both in the US and in Australia, corporate profits are holding up a little bit better than expected. So, I suppose if we put all that together, we've got a relatively positive albeit cautious outlook towards the equity market at the moment. We're suggesting clients remain fully invested as per their long-term investment policy, but obviously any sort of pullbacks in the market you use as an opportunity to add to position.