Themes For July

The Australian share market edged marginally higher in July advancing by 0.5% despite Victoria moving into stage 4 COVID lockdown leading to a sharp negative revision to Australia’s economic outlook. The mining and gold sectors were the standouts, propelled higher by the gold price up 10.3% and iron ore 5% higher, offset by weakness in the energy sector. Gold is traditionally a hedge for uncertainty and also reflects the weakness the global reserve currency the USD.

In the US, the technology stocks continued to power ahead with the NASDAQ 6.8% higher outpacing the broader S&P 500, which improved 5.5%. Mainland China was the standout performer for the month, up 12.3% as its economy has kick-started post COVID ahead of the western world and was the principle driver of iron ore demand. The UK has experienced one of the heaviest COVID mortality rates with severe restrictions pushing its market down 4.4%. Bond markets were very subdued and comfortably absorbed new issuance used to finance burgeoning government deficits.

In currency markets the AUD advanced 4.4% against a weakening USD supported by firmer commodity prices to be now 30% higher than its March lows. A weak USD is likely to be a prominent feature of the financial landscape going forward as its high level of monetary expansion will inevitably erode the value of the greenback.

After the second lockdown what then?

Five months into the COVID crisis, economic growth and corporate profits are still captive to government policies designed with the sole focus of suppressing COVID infections. In most countries around the world the initial spike in infections in March was supressed by various lock down measures only to flare up again in second waves a few months later prompting the reimposition of restrictions such as the recent experience in Victoria. To backstop the negative economic consequences of these measures, governments have provided various employment support programs while central banks have flooded financial markets with liquidity. This approach was initially understandable to counter a relatively unknown, highly contagious disease and contain infections to within hospital capacity and preserve vulnerable lives. The harsh reality is that absent a vaccine anytime soon, this approach simply cannot be sustained indefinitely. While the preservation of human life is naturally of paramount importance, shutting down economies is a very crude and blunt instrument that carries a very heavy cost across a multiplicity of economic, social and other mental and physical health dimensions, the weight of which grows over time goes. While the public may tolerate a second lockdown, they are unlikely to accept a third and hence an alternate, more targeted strategy will soon be required.

As long as government policy is myopically focussed on supressing the virus at any cost, economic output will remain suboptimal, fiscal deficits will continue to blow out and governments will continue to print money to finance deficits without consideration of the long-term consequences. This strategy only makes sense if a vaccine or effective treatment medications are likely in the near future. By the end of this year a much more nuanced approach will be required from policy makers that places a higher priority on protecting the aged care sector, stricter and more uniform quarantine protocols together with more rapid testing and contact tracing. This will enable a more open economy and some alleviation of the brutal consequences that lockdown is imposing on small to medium sized business and the community in general.

Investment Outlook

As mentioned in recent commentaries, the arbitrary nature by which the global economy has been driven into recession makes short-term economic data and profit reporting virtually irrelevant, evidenced by the fact that many companies are refusing to provide any forward earnings guidance. The earliest period that we might consider earnings to be anywhere normalised is FY 2022. While low bond yields and easy liquidity has supported equity valuations, 2 year forward valuations are not cheap and hence a cautious approach is warranted and the maintenance of downside protection important. With the aggregate earnings pie shrinking, it has never been more important to pick the winners in the new COVID economy. To this end, our portfolios have benefited from exposure to companies that have flourished in the new digital enterprise, E commerce economy such as Amazon, Microsoft, PayPal, Visa and Alphabet (Google). These companies had already achieved dominant market positions prior to the pandemic outbreak, with their competitive advantage accelerated by changes in the new business operating environment. Similarly, in the local market, exposure to gold stocks such as OceanaGold and iron ore producers such as BHP, together with supermarket retailer Woolworths, has further assisted portfolio returns.