Russell quarterly update
Here’s a summary of investment markets for the three months ending 31 March 2020
Global share markets tumble
Global share markets were sharply lower in the first quarter; though they did start the period well thanks in part to improving US-China trade relations and the subsequent signing of their ‘phase one’ trade agreement. The deal, signed by US President Donald Trump and China’s Vice Premier Liu He midway through January, marked a welcomed truce in a dispute that had plagued financial markets for over a year and a half. Stocks also benefited early on from news the US economy expanded in line with expectations in the final quarter of last year and some encouraging earnings updates from the likes of JPMorgan, IBM and Microsoft. In saying that, there were some notable misses on the earnings front, including Goldman Sachs, Exxon Mobil and Chevron. Sentiment was further buoyed by evidence global manufacturing activity was improving and news US consumer confidence hit a two-year high in February. The latter reading was particularly notable given consumers account for around 70% of all US economic activity.
However, share markets reversed direction drastically toward the end of February and continued their slide through March as it became increasingly likely that the rapid spread of coronavirus outside of Mainland China, where the virus originated, would push the global economy into recession. Investors had been hopeful that a coronavirus-related slowdown in China would prove transitory in nature and that the virus’s reach could be contained. But a significant jump in new infections worldwide, first in South Korea and later in Italy, Spain and the US, forced governments to start imposing strict containment measures aimed at preventing the virus’s spread. For the most part, this included the shutdown of all non-essential services and activities, which had the effect of bringing parts of the global economy to a near standstill. In response, companies scrambled to shore up their balance sheets, with many shelving investment plans and either cutting dividends or pulling them altogether. Others withdrew forward-looking guidance due to the futility of trying to determine the future path of the virus and its potential impact on their business. Major developed share markets, including Europe (-25.6%1), the UK (-24.8%2), Japan (-20.0%3) and the US (-20.0%4), all suffered heavy losses over the period. In fact, at times the daily declines in the US were so sharp that they triggered automatic 15-minute trading halts; a mechanism originally introduced to restore calm and prevent a repeat of the 1987 market crash that became known as ‘Black Monday’. Compounding all of this was a steep decline in the price of oil, which sank on concerns a new price war between major producers Saudi Arabia and Russia would see supply spike at a time when demand was falling. West Texas Intermediate crude oil fell almost 67% to just USD20.48 a barrel over the period, marking the commodity’s worst-ever quarterly performance.
Importantly, stocks did get something of a reprieve late in the period as governments and central banks the world over moved to implement various measures aimed at supporting growth and restoring confidence in financial markets. In the US, the Trump Administration revealed an unprecedented USD2.2 trillion relief package - equivalent to 10% of the country’s gross domestic product (GDP) - that included one-off payments to households, business support and an increase in unemployment benefits. At the same time, the US Federal Reserve cut interest rates to almost zero and committed to unlimited quantitative easing (QE). We also saw similar responses from the Bank of England, the European Central Bank and the Bank of Canada. Together, these actions helped to lift global share markets off their lows for the period and contributed to a strong rally into quarter end.
Australian shares were also weaker over the period, with the S&P/ASX 300 Accumulation Index closing the quarter 23.4% lower. Like its global counterparts, the local market’s early gains were wiped out by the economic uncertainty caused by the rapid spread of coronavirus globally. From its peak on 20 February to its low on 23 March, the index fell more than 36% as the Federal Government moved to shut down all non-essential services and activities. Amongst the hardest hit stocks were our major miners, with the likes of BHP Billiton and Rio Tinto falling on expectations commodities demand will taper off as global growth slows. Also hit hard were the ‘Big Four’ banks and travel and tourism names like Qantas and Flight Centre, which fell 53.4% and 77.5% respectively as officials here and overseas acted to limit people’s movements.
Helping to limit the decline was the introduction of various measures by both the Federal Government and the Reserve Bank of Australia (RBA) aimed at propping up the economy. Prime Minister Scott Morrison announced a series of relief and stimulus packages totalling around $213 billion that included increased funding for the local healthcare system, additional payments for welfare recipients and wage subsidies for employers. Meanwhile, the RBA cut the official cash rate twice and introduced QE for the first time in its history. Similar to what we saw in global share markets, these measures contributed to an 11.8% rise in the index from its low on 23 March through the end of the period.
RBA cuts interest rates, introduces quantitative easing
The RBA cut interest rates twice in the first quarter; taking the official cash rate from 0.75% to a new low of just 0.25%. The first of these moves - a 0.25% reduction - came at the Bank’s planned board meeting in early March and was driven by a combination of rising market volatility and evidence the rapid spread of coronavirus would cause major disruption to economic activity globally. The Bank later confessed to having given thought to cutting rates more aggressively at the time before it ultimately settled on the 0.25% reduction. The second move came at an emergency meeting on 19 March, when the Bank lowered interest rates a further 0.25% and noted that the cash rate was likely to remain at its current level for another three years due to the ‘extraordinary’ circumstances at play. This meeting also saw the Bank introduce QE for the first time. Officials had earlier flagged that if interest rates ever fell to 0.25% it would consider implementing unconventional monetary policy. As part of its QE program, the Bank committed to purchasing government bonds and semi-government securities in an effort to keep borrowing costs down. The Bank also announced a $90 billion, three-year credit facility for banks with incentives to lend to small- and medium-sized businesses. [Note: the RBA left interest rates on hold at 0.25% following its early April board meeting.]
Given the risks around the economic outlook right now, coupled with the RBA signalling that interest rates won’t rise until there’s been significant progress toward its employment objective, our view is that the cash rate will likely remain around its current low level for an extended period.
Domestic growth surprises in the final quarter of 2019
Australia’s economy expanded by more than expected in the final quarter of 2019, with GDP for the three months ended 31 December coming in at 0.5%. Analysts had anticipated growth of 0.4%. However, it’s worth noting that the period covered did not include the recent bushfire crisis or the coronavirus outbreak. Further, an upward revision to third-quarter growth from 0.4% to 0.6% would imply that the economy actually slowed over the period. Government spending and stronger production volumes within the mining sector contributed positively to the outcome. There was also a modest uptick in household spending, though domestic demand overall remained soft. Both housing construction and business investment were weaker.
On an annual basis, the economy grew 2.2%; up on the revised 1.8% growth recorded in the 12 months ended 30 September. Moving forward, growth is expected to slow considerably in the first quarter of 2020 as the adverse effects of bushfires and the coronavirus pandemic weigh on the economy.
Australian dollar falls sharply
The Australian dollar (AUD) fell sharply over the period. Not surprisingly, much of the currency’s decline was driven by increasing concerns surrounding the rapid spread of coronavirus and its potential impact on domestic (and global) growth. This forced the RBA to lower interest rates to near zero and introduce unconventional monetary policy like QE; neither of which is particularly good for the AUD. It also led to steep declines across the commodities spectrum, including iron ore - our biggest export - and saw demand for the US dollar (USD) soar as investors favoured the currency’s perceived ‘safe haven’ qualities.
The AUD fell 12.2% against the Japanese yen, 11.9% against the USD, 10.4% against the euro and 6.3% against the British pound. The broader Australian Trade-Weighted Index5 closed the quarter 9.3% lower.
The coronavirus pandemic has stalled the mini-cycle rebound and made a global recession likely. Although the duration of the pandemic remains unpredictable, monetary and fiscal stimulus, pent-up demand and a lack of major imbalances argue for a solid upswing when the virus threat eventually clears. Provided the virus is transitory, the global economy should be poised to rebound in the second half of this year. However, whilst equity markets are likely to rebound once the virus is contained, the growth disruption from the virus is likely to trigger a 2020 recession, with global GDP growth likely to be negative in the first quarter and at high risk of contracting further in the second. Progress in containing the virus will have a direct impact on the depth of such a recession.
Our view on global equities remains optimistic. Valuations have clearly improved after recent, large market falls. The outlook is more positive once factoring in the substantial stimulus measures being implemented, even though our near-term outlook is for a recession. Equity markets which have been hardest hit by the virus may be those that benefit the most from the eventual rebound. We believe UK and euro zone equities are attractively priced. Europe’s high weighting to cyclical stocks should help it outperform in the recovery. Emerging markets equities should also benefit from the eventual recovery as they too are attractively valued and have the additional benefit of easing US-China trade tensions. We maintain an underweight to US equities, driven primarily by their expensive valuations relative to these other regions.
For fixed income assets, we continue to see government bonds as universally expensive. Whilst they may rally if the coronavirus pandemic escalates further, they nonetheless remain at risk of underperforming once the post-virus recovery commences. We believe high-yield debt is now very attractively priced. Although there is considerable uncertainty regarding liquidity risks in credit markets, the current spread to US Treasuries has historically been a rewarding point to add exposure.
In terms of currencies, we expect the ‘safe haven’ rally in the USD will unwind once we reach the post-virus recovery phase. This should favour currencies like the British pound, the Australian dollar and the Canadian dollar, which are now significantly undervalued relative to long-term purchasing power parity comparisons.
Moving forward, the major risks to our 2020 outlook include more aggressive and longer containment measures should the coronavirus pandemic re-escalate when current measures are relaxed. The economic impact of the virus may turn out to be larger than expected, with a sharp plunge in cashflows causing highly-indebted companies to default, triggering a credit crunch in the broader economy. Further, it is possible that global supply chain disruptions could have a larger and more sustained negative impact on global growth. Nonetheless, we remain alert to risks and volatility as we enter a likely global recession. Importantly, we believe this is an environment that will favour our active management approach.
1 European stocks measured by the EuroStoxx 50 Price Index
2 UK stocks measured by the FTSE 100 Index
3 Japanese stocks measured by the Nikkei 225 Index
4 US stocks measured by the S&P 500 Index
5 The trade-weighted index is an indicator of movements in the average value of the AUD against the currencies of our trading partners.