Market Commentary

The S&P/ASX 200 Accumulation Index returned 8.8% during the month. Australian equities rallied along with global equity markets in April as fiscal and monetary support by governments and central banks buoyed market confidence. Global equity markets rallied hard, continuing to claw back the losses from February and March. In major global developed markets, the US S&P 500 was up 12.8%, Japan’s Nikkei 225 was up 6.7%, DJ Euro Stoxx 50 was up 5.4% and the UK’s FTSE 100 was up 3.9%.

The Reserve Bank of Australia (RBA) held the cash rate steady at 0.25% in April, after taking strong action in March. The quantitative easing measures introduced in the prior month have begun to be implemented, so far seeing the RBA buy over AUD 50 billion in bonds. This has helped stabilise bond markets. When the RBA implemented the policy they stated that they would purchase government and semi-government bonds to ensure that the 3-year bond yield remained at around 0.25%. Their activity so far has achieved this objective, with 3-year bonds ending the month exactly on the target.

Domestic economic data releases were mixed in April. Employment rose by 5,900 positions in March, above the 30,000 decline that the markets had expected. The unemployment rate was also ahead of expectations, ticking up to 5.2%. The NAB Survey of Business Conditions fell in March to -21.1points while business confidence fell to -65.6, which is the worst result on record. March retail sales were up 8.2%, led predominately by panic buying of food and other essential items. National CoreLogic dwelling prices continued to post gains, rising 0.3% in April. The annual inflation rate rose above market expectations to 2.2% in Q1 2020 from 1.8% in Q4. It was the highest inflation rate since Q3 2014 and the first time it reached the RBA target band since early 2018, reflecting the impact of drought and bushfires and early effects of COVID-19, with food prices notably jumping to a 5-1/2 year high of 3.2%.

During April the market was inundated with companies raising capital. There have been at least 35 deals announced since mid-March, raising over AUD 15 billion. The main reasons cited for raising capital was to increase liquidity or to strengthen the balance sheet. Some of the larger raisings by market value included National Australia Bank (AUD 3,500 million), Ramsay Healthcare (AUD 1,400 million), QBE Insurance (AUD 1,320 million) and Oil Search (AUD 1,160 million).

All sector returns were positive in April. The best performing sector was energy (24.9%), followed by information technology (22.5%) and consumer discretionary (15.9%). These were followed by materials (14.2%), real estate (14.2%) and industrials (12.7%) which also outperformed the broader market. Sectors that lagged included communication services (4.5%), healthcare (4.4%), financials (2.8%) and utilities (2.7%). Consumer staples (2.4%) was the worst performing sector.

The energy sector was the best performing sector during April, despite the turmoil in oil markets as continued travel bans and shutdowns suppress oil demand and oil prices turned negative during the month. Sector heavyweights Woodside Petroleum (23.3%), Santos (44.4%) and Origin Energy (26.9%) outperformed the market.

The information technology sector benefitted from positive returns. Afterpay Touch (66.0%) was the sector’s best performing stock, with the company providing an update that showed it is holding up well despite the COVID-19 crisis. Computershare (25.4%) and Xero (17.1%) also outperformed. The consumer discretionary sector rebounded from its underperformance in the previous month. Wesfarmers (10.0%), Aristocrat Leisure (19.4%) and Tabcorp (27.3%) were some of the key contributors to sector performance.

The financials sector lagged the broader market again in April, with the banks and insurers generally the worst performers while a number of diversified financials managed to outperform. Insurance Australia Group (-6.8%), Westpac (-1.3%) and ANZ Bank (-0.4%) were the key detractors.

A number of defensive sectors underperformed including the utilities sector. AGL (-1.3%) and Spark Infrastructure (-3.1%) were the key detractors.

Consumer staples were the biggest relative underperformers in April, after being the star performers in March. Metcash (-21.0%) was the worst performer following the markets disappointment at a surprise equity raising during the month. Coca-Cola Amatil (-1.8%) and United Malt Group (-3.2%) also dragged on sector performance.

Market Outlook

April saw some much needed relief as markets responded to the unparalleled stimulus measures from governments and central banks across the globe. Markets appear to be tentatively looking forward for a way out of the COVID-19 health and economic crisis, with many countries tentatively beginning to ease lockdown restrictions.

Nevertheless, recessionary conditions still loom. The earnings downgrades and/or removal of previous guidance due to COVID-19 has continued. Consumer cyclical stocks that are directly impacted by travel bans and social distancing, such as travel, gaming and leisure, were the first to withdraw guidance. Many non-essential businesses are being shuttered by order or by virtue that customers have dried up. Given cash flow concerns, company boards have reduced or cancelled dividends for the foreseeable future and capital raisings have been on the rise as another source of funds to allow companies to weather the storm. Thankfully, unlike during the Global Financial Crisis (GFC), most banks are well capitalised, have enough liquidity and are being supported by the government and regulatory bodies to allow them to be supportive to customers that are under stress.

While the rapidly developing situation and ensuing uncertainty makes forecasting more difficult, we continue to reassess our earnings estimates. This includes reviewing short-term earnings and implications for dividends and balance sheet risk, as well as long-term earnings, which have implications for valuations. As well as assessing the risks associated with stocks in the portfolio currently, we are also actively assessing opportunities thrown up by the aggressive and, in some instances, indiscriminate sell-offs. Ultimately the impact on long-term earnings estimates and valuations will be a function of the depth, duration and damage inflicted during this period of enforced subdued activity.

“How deep” and “how long” are the relevant questions being asked within Nikko AM, as the past few months have seen a dramatic turn in the global economy due to the spread of COVID-19.The unprecedented speed of this correction and changing economic landscape due to government intervention is making assessment of sustainable valuation difficult. However, this provides opportunities within different sectors and stocks as the sell-off has been often indiscriminate.

Like other large market corrections, it is always difficult to pick the bottom and thus rotating slowly into some of the beaten down value names funded by reducing and exiting the outperformers is an approach that we have found has worked well in these type of markets.

History suggests that the market will experience a significant and aggressive recovery when greater clarity regarding the outlook is achieved. It is likely that the trigger for such a recovery in this current crisis will be a reduction in new cases and thus countries reopening their economies. Value stocks tend to be pro-cyclical and have historically performed strongly coming off the bottom of an economic cycle. The bursting of the dot-com bubble led to a switch to value and the GFC also caused a reversal back to value.

The defensive bond-sensitive and quality names remain in “bubble” territory and would be expected to correct heavily when the market moves into more rational territory. Indeed, we saw a brief example of this at the end of April. The valuation divergence is illustrated by the gap between high and low PE names, which still remains extreme and as such there is significant upside potential in the portfolio as and when market valuations normalise to more appropriate levels.