20 May Market Commentary – May 2020
April was positive for financial markets, with early signs of a momentum based recovery from the bottom of the market in late March.
Given the level of market volatility, the extent and speed of the recovery surprised many – it was one of the sharpest and quickest market turnarounds in history. However, the second half of the month was a different story as markets slowed and the recovery seemed to weaken slightly.
We have the Central Banks’ policy stimulus to thank for the ‘relief rally’ so far, with governments continuing to respond with ongoing confidence boosting announcements throughout April. The significant policy support will likely remain in place until governments and Central Banks see robust evidence of a lasting recovery.
But despite the momentum, uncertainty remains high amongst investors. There’s no doubt COVID-19 brought an abrupt end to one of the longest growth cycles markets have ever experienced. But the extreme shock to economic and market fundamentals has thankfully been largely offset by enormous amounts of policy-driven stimulus supporting the market. Without this, the repercussions could have been far more devastating. It will probably stay like this until we see significant progress towards lifting social and economic lockdowns across the world’s major economies, and the rate/number of infections reduces across the global population.
Key global trends – equities rebound
Following heavy losses in March, global equities rebounded in April on hopes that coronavirus-driven economic shutdowns would quickly ‘flatten the curve’ of new infections and allow economies to re-open. Extreme monetary and fiscal policy responses also supported investor optimism. The MSCI All-Country World Equity Return Index rose by 10.4% in local currency terms, after a decline of 12.8% in March. After some credit market disruptions in March, the yield on the Bloomberg Global Aggregate Bond Index edged back down in April, from 1.17% to 1.0% p.a., allowing global bonds to post a modest gain in the month. The $US stabilised after recent solid gains while gold prices pushed higher.
As seen in the chart set below, global bond yields remain in a strong downtrend, and gold prices in a strong uptrend. The $US has levelled off into a choppy range over recent months though still with an upward bias, while global equities still appear to have a downward bias.
Global equity fundamentals – watch earnings
As seen in the chart pack below, the rebound in global equities – at the same time as earnings expectations have fallen sharply – has pushed the price-to-forward earnings ratio to a relatively high 17.7 – higher than at the market peak earlier this year. CY’20 earnings are now expected to fall 19% below CY’19 levels before rebounding by 25% in CY’21. Earnings expectations are likely to drop further in the weeks and months ahead.
Given the drop in bond yields, and rise in PE ratio, the equity-to-bond yield gap (EBYG) (a measure of relative valuations) narrowed to 4.7%, which arguably is still reasonable relative to the average of 4.9% since 2005. As noted last month, however, of concern is the likely continued downtrend in earnings expectations, which will tend to push up PE valuations unless equity prices also adjust downward to some degree.
Global equity trends – health care, gold, technology and quality
Across global equity sectors, global gold miners and health care were again strong relative performers in the month and retain high relative momentum. Major energy producers also bounced back strongly last month in expectation that oil prices might eventually rebound. Otherwise food, financial and European stocks continued to generally underperform, while Japanese relative performance remains patchy.
Technology and quality themes are holding up best, though emerging markets also rebounded last month after recent relative weakness.
Australian equity trends – technology and resources
Among Australian equity sectors, technology, resources and small/mid-cap exposures performed best last month, while financials continued to underperform. Technology, resources and small caps have the strongest relative performance compared to the market, but remain in outright price downtrends. Along with financials, listed property has also lagged of late, which has contributed to the relative underperformance of high-yield market exposures. Infrastructure has so far held up better than listed property.
Cash and bonds – government yields drop, credit spreads widen
Local bond yields held at low levels last month, while credit spreads contracted marginally. The stabilisation in yields saw a levelling out in fixed-rate bonds returns relative to cash, with relative performance of credit exposures improved.
If you would like to know more, talk to Michael Sik at FinPeak Advisers on 0404 446 766 or [email protected]
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