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Monthly Wrap: August 2020

The world economy continued its upward, if uneven, recovery in August – much to the relief of world governments and financial markets, explains Senior Investment Manager George Lin.

       Written by George Lin
Senior Investment Manager | Colonial First State
 

 

 

August saw the global economy continue its recovery from the initial shocks and economic shutdowns caused by the Coronavirus pandemic – much to the relief of world governments and financial markets. As confidence returned, higher-risk assets – including the FAANG (that is, Facebook, Apple, Amazon, Netflix and Google) stocks – performed particularly well. By month’s end, the All Ordinaries was up 3.1%, while the Australian Dollar (AUD) traded higher at 74 US cents.

Key developments in Australia

As expected, the Reserve Bank of Australia kept the official cash rate on hold at 0.25% in August – citing a highly uncertain outlook following severe global economic contractions, coupled with a substantial rise in asset prices and large raisings of debt and equity as reasons for the decision. Over the month, relations with China also continued to fray, following the announcement of a probe into Australian wine exports. This comes after China enforced a hefty tariff on Australian barley exports and increased tariffs on Australian beef earlier this year.

 

 

Australia’s economic recovery continued

 

Some of the more recent economic data in Australia has been generally consistent with the global theme of an economic recovery. For example, retail trade rose by 3.3% in July – the third consecutive rise since the 17.7% fall in April. The level of business confidence, as measured in the NAB Business Survey (figure 1), rebounded in June after sharp falls over previous months. And although the unemployment rate rose to 7.5% in June, with more than a million Australians unemployed, 210,000 jobs were also created over the month (figure 2). The rise in employment and the number of job advertisements, which are leading indicators of employment, suggest that the tide for employment may have turned after the significant falls we saw in April and May.

 

Source: Factset
Figure 1
Source: Factset
Figure 2
Australian share market looked through negativity

 

Australia kicked off its half-yearly corporate reporting season in August. By month’s end, 60% of stocks listed on the ASX 300 (or 80% by market capitalisation) had reported earnings, with around 38% missing consensus earnings expectations (which is above the 30% average). A large number of companies also declined to provide earnings guidance for the second half of the financial year – demonstrating the still uncertain economic outlook. But despite the generally disappointing season for profits and dividends, the Australian share market closed the month 3.1% higher at 6,245 points, as investors adopted a “look-through” perspective on the negative impacts of Coronavirus and focused more on when they believe earnings will recover. The AUD also continued to rise and finished the month at 0.74 US cents – driven higher, in part, by weakness in the US Dollar and US central bank monetary policy. Since its low in mid-March, the AUD has appreciated 28.5% versus the US Dollar.

Key developments globally

Over the month, New Zealand delayed its general election, the UK and European Union failed to find common ground on a Brexit deal, while tensions continued brewing between the US and China despite both nations reaffirming their commitment to the 2019 phase-one trade deal – with tit-for-tat sanctions and technological tensions making headlines. The month can be summarised by Chinese social media app TikTok, which entered into discussions with potential new owners, appointed an Australian as its interim chief executive officer, and also announced plans to sue the US Government after it was threatened with being banned in the US.

 

 
The economic recovery continued

 

Data released in August pointed to a continued – but uneven – recovery for the global economy. For example, JP Morgan’s Global Purchasing Managers’ Index showed a recovery for both the manufacturing and service sectors. After falling to historical lows in April, both indices have risen and are now slightly above 50 – a threshold suggesting activities in the global manufacturing and service sectors are now expanding, not contracting. In particular, the strong fiscal supports provided by various governments (for example, JobKeeper in Australia) have allowed households to maintain consumption at levels higher than suggested by the level of unemployment. This is evidenced by the recovery in retail spending in some of the main developed economies (figure 3).
 

Source: Factset
Figure 3
 
August was a strong month for share markets

 

Over the month, higher-risk assets continued to recover from March lows, albeit at an uneven pace. In the US, second quarter earnings reports were better than expected – particularly as the worst-hit quarter due to the pandemic. Towards the end of August, about 86% of companies on the S&P 500 had reported, with 77% beating earnings forecasts and 66% beating revenue forecasts. Net income was down by 32% for the companies that had reported (at the time of writing), compared with the 43% that markets expected. Not surprisingly, the Healthcare, Technology and Utilities sectors were able to maintain positive earnings growth, while Consumer Discretionary, Energy, and Industrials were the worst affected sectors. Given the better-than-expected earnings reports, analysts’ consensus for 2020 earnings per share (EPS) growth has been revised higher, from -23.5% to -20.4%.


US large-cap technology stocks performed particularly well, with the likes of Apple, Facebook and Amazon all reporting better-than-expected earnings in second quarter – benefitting from the structural shift to a digital economy that was only accelerated by Coronavirus. Apple’s share price is now trading at USD $129 after a 4-for-1 stock split, making it the first company with a market capitalisation greater than USD $2 trillion. Over the month, the S&P 500 rose 7% and briefly reached the record highs seen in February, while the technology-dominated NASDAQ performed even better (figure 4) – rising 9.6% in August, or 31.2% since the start of 2020. Other major share indices (including Australia’s All Ordinaries) are still about 13.9% below their pre-Coronavirus peak (figure 5).

Source: Factset
Figure 4
Source: Factset
Figure 5

Forward-looking views

Over the short term, it’s likely that episodic spikes in Coronavirus cases will continue until a vaccine is made widely available. But for now, markets seem willing to tolerate this so long as governments remain equipped to manage the Coronavirus. This suggests the global economic recovery will likely remain patchy, uneven and subject to short-term reversals. While there will be periods of weakness (for example, Australian economic data has yet to reflect Melbourne’s stage-four Coronavirus restrictions), government policies and low interest rates could maintain the positive momentum. While these policies are likely unsustainable and may have long-term implications, it is too early for markets to focus on the timing of exits from those policies.


On the geopolitical front, tensions between the US and China remain a long-term concern. Trump will harden his rhetoric against China as part of his presidential campaign, and the hawks in the current administration will likely push for measures to accelerate the de-coupling between the two countries which cannot be easily reversed by a potential Joe Biden administration.


Indeed, as the US ends its summer vacation, markets will increasingly focus on November’s US presidential election. While Biden has maintained a comfortable lead of 6–8% in national polls, this lead is not insurmountable. Most state-based polls suggest Biden’s lead in the swing states is smaller than his national lead, which means a repeat of 2016, with Trump overtaking from behind to win the election, is not impossible. But how will financial markets react to the election? Trump’s re-election will be a continuation of the status quo – one that may be seen as generally pro-business and share market-friendly, but impacted by the volatility generated by midnight announcements on Twitter and extreme partisanship. A Biden win, if combined with the Democrats winning control of the Senate, may represent a significant shift to a less market-friendly regime which focuses more on redistributing income from capital to labour and tighter regulations.

 

One positive surprise that could change market dynamics is progress in the development of a vaccine. Currently, there are five candidates under phase-three clinical trials, and there is a possibility that one or more will be approved by regulators for emergency use by the end of 2020.

 

 

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