Economic update: What investors need to know

Secondly, investors should also be reassured that their financial planners and advisors are well equipped to deal with the challenges of a new operating model – like running their businesses from home – and that they are appropriately tech-enabled, staffed and contactable to meet their client’s financial needs. Further, one of the ways that advisors and their clients can tackle market volatility is through asset allocation and portfolio rebalancing. In particular, the investor – with the help of their planner or advisor - may want to consider rebalancing their portfolio, especially if their goals or financial circumstances have changed due to the pandemic. Also, a review of client portfolios is critical during heightened market volatility so that both client and advisor ‘stay the course’ - identifying sectoral and cash target allocations - and timing the market particularly if there has been a significant drawdown. Having sufficient liquidity, allocating strategically, being adequately diversified across asset classes and considering tax loss re-harvesting are all critical ingredients for an investor’s long-term financial plan in this environment. Ultimately an investment strategy and portfolio should reflect their combined financial goals, investment timeframe and individual risk appetite.      

Thirdly, while the strong rally in shares during April presents near term downside risks - especially given the release of dismal economic data and the potential for rolling lockdowns until a virus vaccine is found - we still  expect decent returns from shares over a 12-month horizon. Depending on your risk appetite and where you are in the income accumulation phase, I would recommend a large allocation to domestic and international shares counterbalanced by fixed income, commodities, infrastructure and property exposures in order to generate decent risk-adjusted returns for your portfolio.  

Current market volatility is likely inducing anxiety in many investors but strong company fundamentals are never more important than in a downturn. Why would you suggest that investors focus less on the “macro” environment and more on company earnings and dividends in the sectors that they are invested in?

Given that the pandemic has now morphed into an economic crisis with large swathes of the economy shutdown and jobless numbers rising, it is incredibly difficult for investors to completely ignore the macroeconomic backdrop. Australia’s economic miracle is over. We are likely to be in a deep recession for the first time in almost three decades. In fact, Commonwealth Bank Group economists are forecasting that economic (GDP) growth will contract by 5 per cent this year before lifting by 3.2 per cent in 2021. We also predict that economic (GDP) growth will plummet 8.5 per cent in the June quarter – the most since the Global Depression – after a smaller 0.4 per cent decline in the March quarter. Unemployment is forecast to reach 10 per cent in the June quarter and remain above 7 per cent next year.

That said, the virus crisis is unprecedented. The Morrison government and Reserve Bank of Australia are providing around $340 billion or near 17 per cent of GDP in combined fiscal and monetary stimulus to support Aussie workers, businesses and the broader economy. Interest rates have been cut to 0.25 per cent and the Reserve Bank is buying government bonds to keep borrowing costs ultra-low for households and businesses for the first time. Combined, these measures have eased funding, liquidity and credit stresses in financial markets that were apparent at the height of the crisis in March.  

Of course, central bank stimulus, fiscal policy measures - through targeted government spending - and more positive developments around the pandemic (i.e. economic re-openings, new infection rates have peaked and anti-viral medicines and vaccines are being tested with some success) remain key to financial market sentiment. And a re-surfacing of US-China tensions and the US Presidential election both also present downside risks as the year continues.

But portfolio managers, traders and investment strategists will also tell you that market dislocations and corrections present opportunities for stock pickers and sector allocators. While market moves have been outsized and the macro backdrop unfavourable so far in 2020, volatility has unearthed some value for investors. ‘Bottom-up’ sharemarket investors are also interested in individual companies for unique reasons, such as the quality of their assets and management teams, growth and earnings potential, product offering and channels, balance sheet strength and ability to deliver dividend income to shareholders.

So it is important that investors – where possible – get a good handle on some of the key metrics around company earnings and valuations – such as Price/Earnings (P/E) ratios and Earnings Per Share (EPS). Earnings and cash flows will undoubtedly fall in the months ahead due to the economic downturn with balance sheets increasingly stressed due to the virus shutdown. And of course, there will dividend cuts, but dividends can be harvested from a large variety of companies. And there is still plenty of income as well as value to be found in sharemarkets with the ‘search for yield’ ever-present - especially when comparing the value of shares with other investments. Overall, industry, sector and individual company research remains critical in determining the quality of a client’s portfolio. At the same time, determining where and when to take risk and portfolio position sizing matters a lot too. 

What are some of the key metrics you would advise investors to keep an eye on over the next few months? Which sectors do you think have a good chance of returning to normality versus those that will be forever changed?

In terms of the overall market, we retain our forecast of the S&P/ASX200 index reaching 6,250 points by year end, but we also expect some near term downside risks.

• The market has rallied hard since March 23 – the most recent low – with the index up around 18 per cent as of May 6.
  
  
• Economic data to be released in the next couple of months is likely to show the biggest economic contraction in decades with unemployment at recessionary levels.
  
  
• In our view, lower interest rates support equity valuations by lowering yields of other asset classes and supporting corporate earnings through various monetary policy transmission channels.
  
  
• But corporate profits are deteriorating. The NAB business survey has trading conditions and profits at record lows in March. Surveys from the Bureau of Statistics and ACA Research shows that business revenues and turnover are down 70-75 per cent since the virus crisis began. Earnings will be weak due to the COVID-19 economic shutdown. Bloomberg consensus is for ASX 12-month forward Earnings per share (EPS) to fall by 10 per cent in FY20. We’ve already seen a huge number of ASX listed companies (70-75 per cent for the consumer discretionary, industrials and real estate sectors) abandon earnings guidance and trim targets for the 2020 fiscal year due to the impact of the virus.
  
  
• Capital raisings: Amid a severe and sudden collapse in earnings, 28 ASX companies have already asked investors for more than $17 billion in cash with capital raisings across almost 40 deals since March 18 – consumer discretionary companies have been responsible for 8 deals. The $11 billion in cash raised in April is the most since 1994 headlined by the NAB’s $3 billion raising.
  
  
• Valuations: While less demanding than earlier in the year – valuations are becoming stretched again, limiting potential market upside. The 12-month forward P/E ratio is now close to 17 times earnings after falling as low as 13 times earnings in the March quarter sell off. And if you exclude the banks, resources and property trusts, P/E ratios are closer to 25 times earnings for FY20. 
   
• Dividend disruption: We think that the ASX200 will retain an attractive yield of around 4 per cent, but business dislocation from the COVID-19 crisis will likely see dividends cut. Already almost 30 listed Australian companies have officially cut or deferred dividends and more are likely to follow as they assess COVID-19's impact on their cash flows and capital positions. Dividend forecasts for the S&P/ASX200 have been cut 25 per cent - the most since 2009 - which is much more than any other major developed market due to the fact that we have the world's highest payout ratio on the back of our franking system. And of course the banks – traditionally higher yielding – are already (ANZ & NAB) cutting dividends and are likely to defer dividends - if necessary - given margin pressures from lower interest rates, potential payout restrictions from regulators and due to a desire to preserve capital buffers.
  
  
• Volatility may also be heightened amid thin liquidity and volumes as pension funds prepare for $30-$50 billion of COVID-19 superannuation payments to be withdrawn. Already $7 billion in early super access requests have been received. UBS estimates around $8 billion in Aussie equities may be sold. And of course lower dividends presents another risk to equity demand from superannuation.  But most super funds will have sufficient cash buffers to cope with the withdrawals, in our view.

In terms of sectors, I think that the government will take a staggered approach to the reopening of the economy and normalisation of industries. While most states – except Tasmania and Victoria – have already begun easing some COVID-19 restrictions, we think the Morrison government will remain cautious with the onset of winter, given the virus may flourish in colder weather. That said, we expect that the construction, mining, agriculture, education, retail trade, finance, health care and manufacturing industries will be at least partially re-opened from mid-May. Property, wholesale trade, and transport and warehousing could follow in June-July should a second wave of infections be prevented. And Arts and Recreational services will likely re-open in spring should we get through winter unscathed. Of course, the international tourism industry will open last should international borders re-open at the end of 2020, but a “bubble” with New Zealand could be established earlier.

But three industries stand out for me as the most disrupted from the COVID-19 crisis. Commercial property and Real Estate Investment Trusts (REITs) will likely be impacted by retailers increasingly moving online and to suburban and industrial warehouses. And vacancy rates for commercial offices could lift as companies opt to reduce their footprint in favour of staff working-from-home arrangements. The other is travel companies and airlines. Aussies may prefer to drive and buy caravans rather than fly, take cruises and stay in hotels due to health safety concerns. Of course, a retreat from globalisation could see manufacturers, the health care sector and agricultural-facing companies do well due to a desire to have more control over food security and medical equipment and supplies in the future.  

How do you think about the effect that a vaccine or effective treatment for COVID19 will have on global markets?

Global equity investors are forward-looking. Despite the increased likelihood of a global recession with mass unemployment and business shutdowns, investors in shares have been buoyed by improving prospects for Gilead Sciences’ remdesivir coronavirus treatment after positive anti-viral testing to treat the disease. However, medical experts have cautioned that that the results were only based on a sample of 125 patients and not a full clinical trial. Other big pharma companies in the race to find a treatment and vaccine, include Johnson & Johnson, GlaxoSmithKline, Sanofi, Pfizer, Roche and Novartis. And of course, epidemiologists at a host of global universities have also been engaged to fight COVID-19. While a vaccine is still expected to be at around 12 months away from being used to treat virus patients, investors with exposure to healthcare companies have been rewarded with strong share price performance given the defensive posture of the sector in the downturn and positive sentiment associated with potential COVID-19 cures. And US investors have been favouring Aussie exposure due to our success in combating the virus outbreak. In fact, US net flows into Aussie-focused Exchange Traded Funds (ETFs) totalled US$159 million as at April 30. While the development of a vaccine and anti-viral treatments are supportive of markets, the potential for secondary virus transmissions and rolling economic shutdowns in the interim, could pose downside risks to sharemarket performance. 

What should investors look at in a volatile market?

One of the ways that investors can tackle market volatility is through asset allocation and portfolio rebalancing.

For example, if you are risk-averse or approaching retirement, you may consider a conservative asset allocation designed to produce income (traditionally, this would mean a portfolio heavily weighted towards bonds and cash, rather than shares).

Alternatively, if your goals are geared toward longer-term growth, and you’re comfortable taking on more risk, you may consider a portfolio that is more heavily weighted towards shares. Selecting shares from different sectors is important, as smaller companies are considered more cyclical than blue chip companies.

Discovering growth opportunities

In the current environment, investors may favour quality companies that can demonstrate true earnings growth in a persistently slow-growth and low yield environment. Some investors may prefer companies that represent "good" value as valuations for growth-dependent shares may be considered to be ‘rich’, despite the correction last year.

If you’re looking for growth-orientated stocks, current volatility means that some companies are considered cheap or undervalued by the sharemarket. “Undervalued” means that the price per share is lower than what the estimated price should be based on the company’s earnings or total worth.

On the CommSec website, you can search for companies that the experts believe are undervalued. Log in to your account and go to Quotes & Research > Tools > Recommendations.

You can also use the CommSec Stock Screener to search for undervalued growth stocks. This is an ideal place to start your research if you’re looking for growth opportunities.

Keeping an eye on your portfolio

It’s generally a good idea to check your portfolio at least once a year to ensure that your asset allocation still aligns with your financial circumstances, investment goals and risk tolerance. You may want to consider rebalancing if your goals or financial circumstances have changed.

Understanding the current economic climate is another way to keep tabs on your portfolio. There might be specific triggers – like changes in government policy or geo-political uncertainty – that prompt you to reassess. Knowing how you will respond in these situations, whether you adjust your portfolio allocation or sit tight, could help you reduce your risk over the long term.

Understanding the implications of withdrawing

Before you withdraw from an investment you should understand all the implications, risks and costs involved, including:

Crystallising losses: If the value of your investment is falling, you are technically only making a loss on paper. A rise in prices could soon return your investment to profit without you doing anything. Selling your investment makes any losses real and irreversible.

Incurring capital gains tax (CGT): Make sure you know what your CGT position will be before selling any asset.

Losing the benefits of compounding: If you’re thinking about making a partial withdrawal from an investment, remember that it’s not just the withdrawal you lose, but all future earnings and interest on that amount.