Market Outlook

Although the global economy ended on a weak note in 2019, both manufacturing and services survey data were turning positive and suggesting a rebound was underway. This augured well for our overweight position in the undervalued, economically sensitive stocks.

It is now clear that not only has the recovery been put on hold by the COVID-19 outbreak, but we are entering recessionary conditions as a result. The tsunami of earnings downgrades and/or removal of previous guidance due to COVID-19 has accelerated. 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, there will be pressure on company boards to reduce or cancel dividends for the foreseeable future and capital raisings will be another source of funds to allow companies to weather the demand shock. Thankfully, unlike the Global Financial Crisis, 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 are reassessing our earnings estimates. This includes a review of short-term earnings and implications for dividends and balance sheet risk, as well as long-term earnings, which has 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 month has seen a dramatic turn in the global economy as COVID-19 has spread rapidly outside of China. Governments, central banks and other government agencies are working together to provide enormous levels of stimulus to stabilise and protect the economy, people and businesses while the shutdown is enacted, with the aim of slowing down and hopefully eradicating the transmission of COVID-19. The record level of Australian fiscal and monetary stimulus is warranted given unemployment may double from here. 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.

Brad Potter, Head of Australian Equities – Nikko Asset Management