After a stellar 2019, the first quarter of 2020 was a very difficult one for investors as share markets saw a very quick sell-off as the coronavirus (COVID-19) pandemic started to spread out of China to Asia, Europe, and the USA. After the S&P/ASX 200 peaked on 20th February at 7,162 points, the index rapidly reversed previous year gains as panicked investors sold-off equities on the back of growing COVID-19 fears. World economies have now largely been brought to an abrupt halt by the pandemic, which is affecting over 180 countries with no end in sight, as the coronavirus has shut down entire states and sports leagues, restricted travel, closed national borders, halted airline operations and severely curtailed business activities.
Most share markets saw the worst quarterly performance since the Global Financial Crisis: The S&P/ASX 200 finished the quarter down 24.0% to 5,076.8 points with the Energy and Real Estate sectors the weakest — falling 48.9% and 35.3% respectively. The Healthcare sector held up well, edging up 1.5%. In comparison, the MSCI All Country World Index fell 21.7% to 442.4 points, the S&P 500 dropped 20.0% to 2,584.6 points and China’s Shanghai Composite was relatively less hurt, down 9.8% to 2,750.3 points.
Domestically, investors witnessed a cautious reporting season in February and the subsequent depth of the fallout from COVID-19 to the real economy has led to most companies withdrawing or revising guidance, and some have also reduced or suspended dividends, along with a subdued outlook commentary.
Most commodity prices (with the exception of gold) fell sharply over the quarter as countries around the world nearly halted activity to contain the virus, which affected demand for most commodities. Oil was caught in a perfect storm due to the COVID-19 induced slowdown and an increase in production by OPEC nations. This led the oil price to fall 59% from US$64/barrel at the end of December 2019 to US$26/barrel at the end of March 2020. Gold, the traditional ‘safe haven’ commodity rallied ~5% to US$1601/oz on the back of fears of a global recession, aggressive easing measures by the major central banks in response to COVID-19, and the prevailing low interest rate globally — an environment supportive of gold.
Domestically, the Reserve Bank of Australia (RBA) cut the official cash rate by 25 basis points twice in March including an emergency out of cycle meeting to end the quarter at a historic low of 0.25% as the coronavirus pandemic continues to stoke economic fears.
The Australian dollar also hit a low of ~US57 cents during the quarter — its lowest level since 2002, before recovering slightly to finish at ~US61 cents as low interest rates, trade tensions and the recent bushfires all played off against each other along with volatile commodity prices exacerbated by COVID-19.
Unlike sectors such as travel, tourism, retail and hospitality which are bearing the full brunt in the current environment, some sectors are likely to be resilient including resource companies and the defensive consumer staples (i.e. supermarkets, food & beverage manufacturers). In this regard, a weaker Aussie dollar is likely to provide a cushioning impact. Although the quoted iron ore price fell 9% to US$84/tonne, it’s up ~5% in Australian dollar terms to A$138/tonne — benefitting from a sharp decline in the A$ from US70 cents at the end of calendar 2019 to the current US61 cents. In fact, iron ore is projected to be Australia’s first commodity to top $100 billion of exports in a single year due to direct exposure to rising Chinese demand despite virus fears. Similarly, drought breaking rain together with encouraging rainfall projections and a lower A$ is likely to boost earnings for the agricultural sector.
We are now forecasting a global recession in CY20 but the depth and duration of this recession is dependent on fiscal responses of major governments together with support from central banks. In this regard, one most encouraging action has been the policy response from countries like USA, UK, Germany, and Australia where governments have committed to pay a significant proportion of workers’ wages, defer business loan repayments, and provide other support packages during the shutdown to minimise redundancies. In the USA, a very substantial fiscal stimulus package has been agreed, worth about 10% of GDP.
In Australia, both Federal and State Governments have been announcing large stimulus measures to support households, businesses liquidity, and minimise job losses. The Australian government has so far announced a total fiscal stimulus of $223 billion which represents around 11.5% of our country’s GDP, including a very recent $130 billion wage subsidy in its third round of stimulus which is estimated to support ~6 million eligible workers.
Against the global backdrop of elevated risk, we now expect the global economy to contract in CY20 by 1.6% versus our previous forecast of a 1.3% expansion. In comparison, the Australian economy is forecast to fall by 4.8% in CY20 on the back of negative household consumption, weaker dwelling and private business investment, and lower exports which are only partly offset by much higher government spending.
The Australian share market is currently valued on a forward consensus price earnings ratio of 13.2x, which is ~10% below the long term average of 14.6x. The forward consensus dividend yield for the Australian share market is 5.0% (80% franked). However, we expect earnings and dividend downgrades of ~20% in the coming months and therefore this attractive investment arithmetic will diminish. All up, we believe that the Australian share market, as measured by the S&P/ASX 200, is likely to finish calendar 2020 at 5,200 which is ~2.5% above the 31 March 2020 close of 5,077 (excluding dividends), albeit investors need to brace for periods of heightened volatility throughout the year.