Sovereign Wealth Partners and InvestSense Pty Ltd

Markets

For the first three weeks of May markets were range bound before ‘animal spirits’ returned in the last week of the month. Most markets, including Australian equities, finished the month up by 5-6% in local currency terms.

The cyclical Australian Dollar also rebounded later in the month leaving international investments around 2% lower after accounting for currency movements.

All of this can be seen as a continued, but partial, reversal off the falls seen in February and March. To put this in context, world markets are now just 10% of their February 21st, pre-Western World COVID high’s. The other significant thing that happened in equity markets late in the month was a rotation from growth and defensive stocks (technology and healthcare) into value and cyclical stocks. In essence this meant that it was previously shunned sectors such as banks, energy companies and industrials that led  the market higher in a shift in sentiment that only occurred in the last week. For many this was a somewhat surprising development against the backdrop of a discordant US where polarised politics has fuelled the debate over the pace of economic reopening and stubbornly high levels of COVID related deaths.

It also appears that the Federal Reserve appeared to be withdrawing some of the liquidity that has led to the huge market bounce seen in April. Then in the last few days of the month the market brushed aside the mounting trade tensions with China and domestic race related riots.

This all adds up to a market that wants to go up and bears many of the hallmarks of the beginning of a cyclical recovery. Except that at this point we don’t have much to recover from, certainly in terms of price falls, and it would be hard to argue that investors, consumers or corporations have reached the nadir of despair that usually presages a recovery of sentiment and economic activity. Or perhaps we should be asking if some 10% of global wealth is in fact a fair haircut for the disruption and lost economic activity that COVID has wrought upon the global economy. One might even surmise that markets are sniffing out potential productivity gains that could arise from the creative destruction that is actually happening and which central banks have spent the last 10 years trying to avoid. Or it could just be that the biggest ever monetary stimulus by the Federal Reserve in the shortest ever period has lit a fire under markets.

In fact, in the first week of June, Australian share market rose by 4%, with much of that coming on Thursday when the treasurer announced the Australian economy had shrunk by 0.3% in the quarter to 31 March and the economy was indeed in a recession, since the second quarter will inevitably be negative too (technically, a recession is defined as a period of two consecutive periods of shrinking GDP).

So, have the investment markets gone crazy?  Here are two typical fund manager responses from Livewire interviews published 6 June:

“It’s definitely a liquidity led recovery, but the difference this time round is that with the impact on the real economy the government has come in with a massive stimulus, its happened globally, not just Australia, its an unprecedented response not just to the health crisis but governments realising that unless they’re willing to have mass unemployment they’ve got to provide stimulus that puts the economy on life support and hope that once the payments come off we can recover and move on.” Catherine Allfrey, Wavestone Capital

“It’s certainly factoring in a very bullish scenario, a V shaped recovery if you like.  It may be right but there’s plenty of unknowns, for example about how unemployment will come back in the second half of the year and what happens consumer spending.  So many Australian companies are “B to C” – business to consumer – and rely on consumer spending.  The market has taken a very strong view, I’m not sure if that’s correct, but we’ll find out.”  Matt Williams, Airlie Funds Management

There are clearly as many reasons to be bearish as there are to be optimistic and, as ever, our focus shifts to the longer term, from which point we work back until shorter-term portfolio implications become easier to discern. In this way, we attempt not to be overly reliant on devilishly difficult short-term predictions of sentiment and central bank decision making.

In practice this has turned our focus towards areas of the market that remain fairly valued and therefore may prove resilient in a downturn but, more importantly, where we have greater confidence in achieving reasonable long-term outcomes. Hopefully, the characteristics of the latest rally in Western markets is a good sign (this was the most pronounced one-week value/growth rotation since the start of the relative decline of ‘value’ in 2009).