In Asia, the resumption of domestic activity in China saw its market up 7.7% while Hong Kong advanced 6.4% despite ongoing civil unrest as China clamps down on pro-democracy protesters. Elsewhere, Europe improved 3.5%, Japan 1.9% and the UK edged 1.5% higher for the month. The common denominator pushing all equity markets higher is the powerful impact of monetary and fiscal stimulus driving asset prices higher while reducing the attraction of more defensive asset classes now referred to as the “TINA” (There Is No Alternative) effect. Whereas after the GFC there were some constraints on central bank balance sheets and budget deficits, in the current environment policy makers are prepared to “do whatever it takes” to cushion the global economy through the COVID crisis.
Safe haven buying saw gold reach an 8-year high while the “risk-on” mood strengthened the AUD 3.5% against the USD, which weakened against most other major currencies. Despite record issuance of government debt to finance fiscal spending, bond markets absorbed this supply in their stride with US 10-year treasuries finishing at 0.67% while Australian 10-year bonds closed at 0.93%.
“Second Wave” fears for markets
Ever since the beginning of this pandemic there have been concerns about a “second wave” of infections once the isolation restrictions began to ease. From an economic perspective, the concern is that this may impact the pace of reopening the economy or worse still, result in the re-imposition of lock down measures. In the US in recent weeks there have been increasing infection numbers in states such as Texas, Florida, California, Arizona and Georgia that were previously less affected than hot spots like New York. While this development is of concern, the reality is that once the economy began to reopen, a spike in new infections was to be expected given the absence of vaccine and herd immunity. To some degree, the increase in new infections is also a consequence of vastly increased levels of testing which is also reflected in falling mortality rates, which is now estimated by the US Centre for Disease Control to be just 0.26%. From a health care perspective, the imperative has always been to protect the vulnerable and make sure there is sufficient capacity in hospitals for critical care patients. To this end, there is now much better protection protocols in nursing and age care facilities, and hospitals at the moment are coping with demand.
The situation in the US is complicated by political issues, growing social unrest and the economic imperative to get people back to work. While President Trump is a lightning rod for criticism, the reality is that most of the COVID policy management policy issues are in the hands of State Governors and City Mayors. In this respect there is a growing divide between Republican controlled “Red States” and Democrat controlled “Blue States”. With President Trump’s re-election chances largely hinging on the performance of the US economy in the lead up to the November election, Republican Governors in Texas, Florida and Georgia are much less likely to re-impose restrictions compared to Democratic Governors in New York, California and Michigan. An overriding concern in all States is the growing level of civil unrest, which in part is a consequence of the high level of community anxiety associated with previous lockdowns.
Closer to home, a spike in new infections has resulted in level 3 lockdown rules being re-imposed in Melbourne and a closing of the Victoria/NSW border for the first time in 100 years. With Victoria accounting for some 20% of Australia’s GDP, the 6-week lockdown period could wipe up to 1% off Australia’s GDP. It is very likely that the Federal government’s financial support programs, JobKeeper and JobSeeker, will now be extended past their original expiry date in September which will alleviate concerns of a “fiscal cliff” impact on consumer activity.
These developments underline our view that the next 12 months will be a very difficult period to forecast economic growth rates and corporate profits. Our best forecast is that aggregate measures for these variables will only return to pre-COVID levels in 2022.
For many investors there appears to be a growing disconnect between the economy and financial markets. Despite increasing uncertainty on the growth outlook, equity markets continue to power ahead from their March lows. This underlines the powerful effect of quantitative stimulus on asset prices, which has been well evidenced since the GFC in 2008. See below the massive ramp up in US money supply as a consequence of Federal Reserve balance sheet expansion in response to the COVID crisis. With seemingly no political or economic constraints on short-term monetary and fiscal policy, these measures will continue to provide support for long-term assets such as shares.
The market’s performance also reflects the fact that investors are now looking past the valley of 2020 and 2021 and ahead to 2022 earnings forecasts when economic conditions should begin to normalise. Based on reasonable earnings expectations, the 2022 price to earnings ratio for most equity markets is roughly the same as pre-COVID valuations. This reinforces the fact that the market is not cheap, but it remains more attractive than most other asset classes. While low bond yields appear unattractive, they remain in strong demand for their defensive characteristics and liquidity so continue to play an important role for downside protection and risk mitigation. For the financial year our multi asset portfolios held up remarkably well, delivering a positive return over a tumultuous period in financial markets, well ahead of most industry peers.