Market Outlook

While the ongoing global COVID-19 situation and ensuing uncertainty makes forecasting 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 any aggressive and, in some instances, indiscriminate sell-offs.

Economic shocks such as the one we are currently experiencing typically result in social and economic adjustments. 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. Some of the more obvious potential transformations include: 1) employees working from home for all or part of the week; 2) potential drop in required office space amid the work from home theme; 3) reduction in the use of public transport and increase in car travel; 4) potential decline in business travel as virtual meetings increase on the back of improving technology; 5) an accelerated shift in market share of e-commerce and omni-channel retail; and 6) surprisingly positive impact of low interest rates and government stimulus on housing, with early signs of increased interest in moving away from the inner CBD suburbs. It is still too early to be confident that these adjustments will be longstanding or perhaps just a one-off. As such, the Nikko AM team continues to invest significant time to identify, and thus appropriately value, any of the structural winners and losers.

The 2020/21 Federal budget delivered out of season in October was, as expected, one of the most stimulatory budgets we’ve ever seen. Echoing the RBA’s explicit statement that reducing unemployment is a “national priority”, the budget outlined a commitment to provide continuing extraordinary fiscal support until Australia’s unemployment rate is below 6%. The initiative involves a broad strategy of spending to drive economic growth and job creation across many sectors via tax cuts, wage subsidies, infrastructure spending and investment incentives together with a boost to housing and a reboot to manufacturing. The spending was widespread across defence, health, technology, university research, the energy sector and regional areas.

The US election became even stranger, if that was possible, with President Donald Trump contracting COVID-19 along with a number of his key advisors. He was, however, only hospitalised for a short period and is already back in the White House and thus arguably minimising the impact to his campaign. The key risk remains a drawn-out election result, exacerbated by the political parties disputing the outcome through the courts. A clear victory by either party is likely to be viewed positively.

The combination of extreme positioning and valuation differentials that are still evident in the market always provides strong forces when the market reverses. Recessions are typically the catalyst for changes in leadership styles and our expectation is for history to repeat with value outperforming—particularly when the world becomes less sensitive to the COVID-19 situation via a vaccination or a therapeutic solution. Like other large market corrections, it is always difficult to pick the bottom. Therefore, 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.

Source: Brad Potter – Head of Australian Equities – Nikko AM