The June blog coincided with the completion of the first phase of the market recovery from a low of 4546 in March to 6148 on the 10th of June 2020, followed by a retracement to around 6000. In the six weeks since, the market has traded in a band of +/- 200 points around the 6000 level. This was consistent with the two Burrell Broadcasts in April and May where the base case was for the market to return to a 6000-6200 range to complete the first phase of the recovery. The market was trading a long way from that level at the time and the prediction may have seemed bold. It was partly based on a complementary view of the banks that they would recover from $15-16 to around $20 and then track sideways.
The S+P/ASX 200 Index finished the financial year in 2020 with a return of -11.3% (-8.9% with dividends). The top 20 stocks were 2% worse than this and the financial sector in particular finished the year down 24.7% for the year. Three of the major banks fell from around $25 to $15 i.e. by 40% and have only partly recovered. Depending on asset allocation, the majority of portfolios have finished the year down 5-15%, a reasonable recovery off the 30% lows on the 23rd of March 2020. In a number of cases portfolios were pivoted to the more defensive stocks in the Burrell focus list, based on the view that the COVID correction saw most stocks fall together, but the cream should rise to the surface during the recovery.
In cricket analogy, the first innings score from March to June was pleasing. Looking forward, the second innings starts with the reporting season both domestically and internationally, there is the COVID 19 second wave in the USA and now in Victoria, together with international issues around the US presidential election including some probability that the US corporate tax cuts are reversed so as to be increased from 21% back to 27-28%. The reporting season is the first over to be faced. There is considerable doubt as to how the markets will respond. On the one hand expectations have been lowered dramatically, particularly in the US and it may be that markets see June as a lost quarter of production due to COVID 19, the September quarter being also materially affected and the markets will look forward to more normal times.
The alternative is for stocks to overreact to the June quarter as being a systemic issue rather than an issue related to COVID 19. A number of companies have made announcements during the traditional “confession” season, some positive and some negative. The negative announcements resulted in adverse share price movements. A number of material write downs in asset values have also been announced. Company executives are just as prone to reacting to sentiment as others and the question is whether some of these write downs are kneejerk reactions to short-term movements in underlying COVID affected measures e.g. retail shopping traffic, oil prices, etc. This leads to the old chestnut which is the debate is to whether share market prices react to statutory profits or to the numbers which analysts and advisors spend most time on, the underlying profit numbers. Statutory numbers are widely reported and many self-directed investors appear not to have access to adjusted underlying earnings numbers. To compound problems, the range of analyst expectations is as wide as we’ve seen over several decades. The reporting season may not resolve these wide range of expectations, as the companies themselves do not know how their companies will trade looking forward and how large an impact COVID may have on the economy and on their company.
James Bishop is the author of a Bulletin entitled “Economic effects of the Spanish Flu published by the Reserve Bank of Australia. He concludes; “the Spanish flu period highlights how disruptive a pandemic can be to economic activity. In saying that, and being mindful on how different the economic economy is now, the Spanish flu period and the strong economic growth that followed shows that rapid recoveries from pandemics are possible if the public health aspects are not too prolonged. A surprising feature of the Spanish flu episode was how quickly the labour market appears to have recovered”. Your diarist is not necessarily endorsing this view, because the reality is that we simply do not know. The second wave in Victoria is sending down some bouncers that are difficult to handle. One might query whether a good deal less economic damage could have been caused by other solutions, including a government quarantine facility for those who refused to quarantine at home or were unable to do so for various reasons. It is interesting that Victoria has again let the side down, as it did during the Spanish flu. Refer to the paper by Humphry McQueen “the Spanish Influenza Pandemic in Australia, 1912-1919”.
The difficulty in predicting the economic impact of COVID upon the economy was highlighted by a 4% fall in major bank prices on 3rd of August 2020, the day that the Victorian Premier announced the level 4 business shutdown.
Companies with defensive earnings including those with business models that benefit from COVID should hold up well, with early reporting by companies including Woolworths and Supercheap (including Rebel Sports) showing good increases in revenue, profits comparable to the previous year. In contrast we expect most companies to be interrupted by COVID 19 and our base line is for earnings to be down 20%.
With respect to the high risk sectors that have suffered severe COVID effects including airlines, other travel and entertainment businesses, the June blog noted the advice not to get too far ahead of the curve by Paul Taylor from Fidelity Australia. Burrell have also avoided these sectors and to date such caution has been rewarded. Some of those businesses will not return to previous levels until the 2021/2022 year, depending on the golden bullet i.e. if and when a vaccine is available. There are currently at least four different scientific methods being utilised around the world in the race to produce a vaccine. The consensus is around some optimism for a vaccine by December 2020, although there is no consensus as to whether the vaccine will have a short-term protection such as existing flu vaccines that require annual inoculation or whether it will be permanent such as polio and MMR vaccines. The vaccine under development by the University of Queensland utilising the “CAP” technology appears promising. There is also a recent article from the head of the University of Oxford team stating an 80% confidence that a vaccine will be available before Christmas 2020. Success with a vaccine would support a more rapid recovery in economic activity.
Low interest rates are supportive of stock prices. Cash rates in Australia are 0.25% for 1-3 years and 1% for 10 year funds. This leads to the capital TINA effect i.e. ‘There Is No Alternative’ to investing in stocks and property as other sectors simply are providing almost no return. So if the markets can get some clear air, the low interest rates will provide material impetus to further share price recoveries. On the other hand, the longer economies are impacted by COVID, the more likely they will trade sideways with stocks adjusting negatively should they report adverse information.
The value v. growth valuation debate has been front and centre during the COVID period. The view both in Australia and the US is that the divergence between valuation multiples on value stocks as compared to growth stocks is not justified by the differences in earnings. There is some tech bubble in the growth valuations, so that care is required. While momentum has carried the growth stocks to higher levels, we saw in 2000 what happens to growth stocks where growth estimates are unrealistic. A deal of the recovery in high risk companies including those close to insolvency such as HERTZ is attributed to new retail investors, whereas professional and experienced investors have been more cautious and discerning. This highlights the need for caution with growth stocks. An old adage was that when the taxi driver starts opining which stocks to buy, it is probably time to exit the market. In this instance, caution towards stocks driven by sentiment and momentum rather than realistic earnings expectations is advisable.
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