As we commence the new financial year, we also reflect on the past year: how markets reacted to significant events and the changing economic conditions and how we have navigated these unprecedented times. More importantly, we challenge what should be front of mind for investors going forward.
Australian equity markets returned -7.7% for the year to 30 June while abroad they delivered +4.1% (in Australian dollar terms). However behind these numbers is a tale of two halves that couldn't be more different.
During the last six months of 2019 equity markets were in their eleventh year of a bull market. However, we were questioning the sustainability as corporate earnings growth waned. While not foreseeing a recession on the immediate horizon nor a global pandemic, we were progressively reducing equity allocations. Yet markets lacked a catalyst to see them return to more normalised levels.
By early 2020 we were delivered a catalyst in COVID-19. To manage the health crisis most major economies were put into recession 'by government decree'. As investors struggled to factor in the pandemic and resulting economic shutdown, markets experienced a short but sharp pullback: the ASX was down 37% in less than 5 weeks while the S&P 500 in the US fell 34% in similar rapid fashion. Thankfully, our tactically overweight allocations to cash and defensive investments built up over the course of 2019 positioned our portfolios relatively well for this unexpected shock.
Following coordinated policy responses from governments and central bankers, markets promptly bottomed in late March 2020 and embarked on a sharp recovery. In fact the US equity markets' June quarter return was the strongest in 21 years. While not attempting to pick the bottom in markets, instead preferring to wait for clarity in the outlook, we started re-entering equity markets in select quality investments at opportune prices as it became clear the health crisis was able to be managed and restrictions on economies started to be relaxed. We suspect we'll look back on some of the investments made in this period as a once in a generation opportunity to acquire quality investments at extremely attractive prices.
Today, the ASX 200 is 17% below its February peak while the S&P 500 remains only 6% below its peak. The technology-heavy NASDAQ index is already 7% above its February level reflecting that indices exposure to businesses benefitting from the immediate changes brought about by COVID-19 and expectations of longer-term structural changes to business and consumer behaviour.
Domestically our performance in containing the virus has been better than most (notwithstanding some troublesome Victorians!). We have also enjoyed economic support from the Reserve Bank and Federal Government and a resilient iron ore price, a key export. In fact we would expect Australia to be viewed as a potential safe haven for investors in the near-term so wouldn't discount both the Australian equity market being supported and currency firming in the coming months.
However, while we may be through the worst of the health crisis, we feel there are already some issues we need to be considering for the 2021 financial year.
- A globally-accessible vaccine remains to be discovered. Consequently, economies will continue operating in 'second gear' as they carefully manage the risks associated with re-opening economies too early to avoid a deeper recession.
- The June quarter should incorporate the greatest economic impact from the lockdowns. We expect to see market volatility around macroeconomic data releases as well as around the company reporting season in August.
- The United States' Presidential election in November is fast approaching. While we are wary of predictions, a Biden victory coupled with the Democrats winning control of the Senate could be a material earnings headwind: a risk we feel markets are yet to fully price in. The outcome of the election is also likely to impact US/China trade relations which have recently returned to the headlines and cause further market volatility.
- Unless extended, many government support packages have a fixed end date. As we approach this 'fiscal cliff' there is uncertainty around how economies may be able to support themselves. This is another potential issue that could see further market volatility.
- We expect a period of low interest rates. While acting as an economic support mechanism through the current recessionary period, it is also supportive of asset values. Given the likelihood of low rates for some time, at some point investors will rotate out of traditional fixed income investments and into riskier investments in search of better 'income' returns.
- Finally, we need to balance all of these issues when assessing value. We are wary that in some scenarios current valuations could appear stretched.
In a post-COVID 'new normal', we expect to see a number of companies emerge as winners and losers. The feedback to date from company management has been resounding that many of the structural trends evident pre-COVID have only been accelerated. For example, it took 12 years for the penetration of eCommerce in the US to rise from 6% of total retail sales to 16%. In the initial 10 weeks of the COVID health crisis, penetration leapt to 26% and there are signs it will maintain these new elevated highs.
As we regularly suggest, investors need to act carefully in this environment. Given the level of disruption underway, now is not the time to be taking an index (or passive) approach to investing. With our active, global, long-term and quality perspective, we will ensure we continue investing in those companies best positioned to grow and flourish.