June Market Update

Things don’t look better, just less bad

Less Bad No.1

At the start of this pandemic, governments around the world were relying on data out of China to determine the infection and fatality rates for Covid-19 and reacted accordingly. There was a high level of uncertainty and assumed high infection/fatality rates across a limited sample size, which did not allow for many different factors across nations such as smokers vs. non-smokers, health systems, living conditions demographics, etc.

As more data has been collated, the Infection Fatality Rate (IFR) has consistently dropped. Initially, it was thought the virus had an IFR of around 3.30% of those infected. This has most recently been reduced to 0.82%. Even this lower number is expected to be overstating the IFR given many of those infected may not have even been tested or shown symptoms.

Infection Fatality Rates Early China report vs. US recent data

Source: JP Morgan, R Verity et all, April 2020

Less Bad No.2

In early-March we saw the risk-free rates (government bond yields) and spreads (margin above the risk-free rate) increase to levels last seen in the 2008 Global Financial Crisis (GFC). This meant the cost of borrowing for corporates around the world was rising at the same time as their revenues were dropping. On the back of record levels of quantitative easing around the world, these spreads have now reduced back to levels just above pre-Covid benchmarks.

Short term corporate debt minus US Fed Benchmark

Source: Federal Reserve, WSJ Daily Shot

Less Bad No.3

All the “less bad” news above was triggered by the rise of Covid-19. As at the 1st June 2020, there are now 5.7 million confirmed cases of Covid-19 infections worldwide (and rising) with the US having the highest number of infections at 1.73 million.

Lockdowns appear to have led to the number of new daily infection cases in the developed world dropping. The curves have flattened hence “less bad” and most of the world is now moving out of lockdown. However, we now have the risk of countries having a second wave. With the US coming out of lockdown, this has led to the decline in daily cases of Covid-19 in the US stalling.

Covid-19 total number of infections per country

Source: Bloomberg, WHO, US Centre for Disease Control, National Health Commission of China, Harbour Asset Management

Less Bad No.4

There were many different approaches to the Covid-19 crisis, i.e. the UK initially opting for herd immunity before moving to a lockdown approach, or the US delaying going into lockdown. Once countries were in lockdown the focus was to “flatten the curve”. As shown below, the severity of the lockdowns is now reducing as more countries move to lower levels, but we are still not back to normal levels, hence “less bad” than when we were at the peak.

The chart below shows different approaches by country. Interestingly, this shows that New Zealand had the most stringent lockdown initially but has also now moved to the most relaxed level. This adds credence to the Prime Minister’s catch phrase of “Go Hard & Go Early”.

Oxford Covid-19 government response stringency index

Source: Oxford COVID-19 Government Response tracker, Blavatnik School of Government, Harbour Asset Management

Less Bad No.5

Unemployment rates in the developed and emerging markets have increased at speeds and to levels never seen before. There were 600,000 jobs lost in April in Australia and a staggering 40 million became unemployed in America (7 million people were misclassified in the US) in April & May. This is obviously going to be very bad for consumerism, but job losses are now slowing hence “less bad” than in April & May.

Australian monthly employed change

Source: Australian Bureau of Statistics, ANZ Research

US monthly change in non-farm Payroll

Source: US Labour Department, WSJ Daily Shot

The outlook

Below is a table showing the economic forecasts from multiple sources for different economies. This shows a wide variance in the expected depth of the recession as the world comes out of lockdown, but consensus is that 2020 is going to be a very tough year, with most economists expecting to see GDP recover in the 2nd Quarter of 2021.

Economic forecasts by country

Source: Bloomberg, ANZ CBA, ASB, NAB, Westpac, RBA, RBNZ, NZ Treasury, Harbour Asset Management

As discussed in previous market commentary, these forecasts have proven to be too optimistic in past months. This is not a negative reflection on the economists, but instead highlights the uncertainty around possible outcomes. As these forecasts are updated, the data is starting to get a bit better or as discussed above “less bad”.

How are the markets pricing in this poor data and uncertainty?

One of the more interesting outcomes so far in this economic slowdown is the bifurcation that has occurred between the wider indices and tech stocks. As shown in the table below, The FAANG stocks have all produced attractive positive returns year to date (YTD) versus the negative performance across the board from the passive indices.

This bifurcation in performance is one of the main reasons that we have not reduced the allocations to growth within the PWA portfolios thus far. In the Global Financial Crisis (GFC) of 2008 no stock was safe as everything sold off due to the global uncertainty around capital markets.

In the Covid-19 crisis of 2020, share markets were all initially selling off as global bond markets froze, with some specific healthcare stocks and streaming services rallying. The central banks around the world have now supported the wider markets with extreme levels of quantitative easing and fiscal stimulus. This has greatly reduced the risk of a GFC style sell off, and we are now instead seeing a recessionary sell off which allows specific sectors such as technology & well capitalised firms to do well.

Share market update by indices (local currency)

Source: Bloomberg, Harbour Asset Management, as at 24th May 2020

As share markets continue to rally, we are seeing the negative market sentiment reduce in the US with investors that were sitting in cash returning to the markets to participate in the current rally. We have also seen this with many fund managers who moved to defensive positions in April cautiously returning to the markets in May. The managers’ ability to move in and out of markets gives us comfort to stay positioned with growth exposure during these uncertain times.

Consensus earnings downgrades (12 mth Fwd)

Source: Morgan Stanley, WSJ Daily Shot

As was widely forecast, we continue to see earnings downgrades from most global listed companies, with best estimates pointing to a c.20% – 30% reduction in global earnings in the next 12-month period. At present investors appear to be largely ignoring this, looking past the next twelve months of negative data and investing with an eye to the expected recovery.

Consensus earnings downgrades (12 mth Fwd)

Source: Bloomberg, Harbour Asset Management

It is quite possible this current market rally is overdone, and that the level of possible variance in outcomes over the coming twelve months support a cautious approach to investing. However, as mentioned specific sectors are benefiting during the pandemic driven slowdown and central banks are injecting unprecedented levels of stimulus into the global markets in an effort to support their economies through the short-term recession.

NZ market update

In late-May we received an excellent market update from Dominick Stephens (Westpac Chief Economist) on New Zealand’s economic situation. Below are some charts from this presentation.

Property market

We will start with the most favoured investment of all New Zealanders. Westpac is forecasting that NZ property prices will decline by around 7% by the end of 2020, before recovering back to post-Covid levels by mid-2022. If this occurs, then this will be one of the quickest recoveries in modern times.

With the RBNZ pushing local interest rates lower and releasing the brakes on the number of high loan-to-value ratio (LVR) loans the NZ banks can write, the property sector will get strong support through this economic slowdown.

NZ House prices during economic downturns

Source: Westpac Economics

NZ Government Debt to GDP

The NZ Government Debt to Gross Domestic Product (GDP) is forecast to rise from a globally low level of 20% to a still globally low level of 50% over the next four-years as the government attempts to provide the stimulus to support New Zealand through the coming recession.

The RBNZ has recently increased its forecasted level of Large-Scale Asset Purchase (LSAP) programme to NZ$60 billion. These funds are being used to purchase government bonds, funding the fiscal stimulus plans. The RBNZ purchases may see them owning more than 50% of all NZ government debt in the coming year.

NZ Government Debt to GDP forecast

Source: Westpac Economics   

RBNZ purchasing most of government debt

Source: Westpac Economics  

Summary

We are currently living through a period that will make the history books. The disruption caused by the Covid-19 virus and global lockdown is at unprecedented levels, as are the government and central banks stimulatory responses to this crisis.

Looking at the markets on a forward price to earnings measure, share prices now appear to be trading at expensive levels. Is this still the right measure for share valuations in a world where interest rates are now at historically low levels?

The markets appear to be trading on short-term good news such as government and central bank stimulus, or stories about a vaccine for Covid-19 and ignoring the impact of the coming global recession.

We continue to monitor financial markets and remain cautious in general. The amount of negative economic data expected in the coming months could potentially see renewed volatility; however, central banks have shown a willingness not to just sit on the sidelines if such volatility becomes extreme.