Weekly Market Update - 12/08/2021

The week that was

For some time, we have not only taken more notice of shorter-term market news but have been fairly obsessive about monitoring developments in the US (recent ructions amongst large Chinese tech stocks notwithstanding). This approach still makes sense given the unprecedented nature of the COVID recovery and the equally unprecedented stimulus being pumped into the largest economy, and by far the largest share market in the world. Last week though, robust economic growth and consumer sentiment in Germany broke into the market consciousness. In a week defined by a delta variant driven growth scare giving way to an earnings driven rebound, Europe was ultimately the best performing market (up by around 2%). Despite a stronger than expected US Non-Farm Jobs report on Friday, there is a creeping sense that COVID could yet throw a curve ball at the less vaccinated industrial mid-Western states in the US as well as in Asia. Meanwhile, the breadth and depth of the reopening rebound in Europe has started to surprise on the upside.

Australia was the next best performing equity market thanks to just two stocks. Commonwealth Bank added 0.35% by a 4% rise in its share price and its size in the index (it is now just under 9% of the ASX 200 index and twice the market cap of its nearest peer, Westpac). AfterPay is only 1.5% of the market but it got there pretty quickly and rose by almost 40% last week after Square, the disruptive payment platform, made a bid for the company in Australia’s largest ever takeover. Otherwise, most sectors were in positive territory here and abroad with banks and IT stocks leading the way, along with energy and materials stocks ending the week in slightly negative territory. Overall it seemed that strong economies and corporate earnings surprises were difficult to ignore but offset to some degree by concerns about future growth.

Commodity markets were mostly in the red, reflecting a weaker growth outlook with iron ore bearing the brunt of falls. Iron ore prices are now down almost 25% over the last 3 weeks although the local miners have fared much better. BHP and Rio are actually still up for the last few weeks as they remain awash with cash, and investors have found it difficult to pass up dividends that amount to more than 10% of the current market capitalisation in Rio’s case.

Government bond yields also reflected the uncertain outlook, with yields falling sharply early in the week only to bounce back as the economic data improved and ended the week slightly higher in most jurisdictions. That seemed to be the proximate cause for a sharply stronger US Dollar, rather than signs of financial stress or any flight to quality. Similarly, while credit spreads also continued to ease slightly, it would also be a stretch to say there are many signs of stress in corporate bond markets just yet.

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What we'll be watching this week

While markets fret about economic growth, interest rates and the inflation outlook, in our view, the range of outcomes barring a precipitous crisis is steadily narrowing. The more pessimistic scenarios look like a return to the trend of secular stagnation seen pre-COVID, but with more debt and more downwards pressure on interest rates. More optimistic scenarios acknowledge a potential pump-priming of the economy, but the aforementioned restraints mitigate against runaway inflation, or at least that seem to be the market’s take on things with implied inflation rates ebbing in the last few weeks. We will be working this into our current scenario analysis and long-term assumptions.

In the shorter term, we are also keeping a keen eye out for signs of anything that could lead to a short-term volatility. Two common refrains we hear are that ‘there is nothing on the horizon that could derail the bull market’ and ‘stock and bond implied volatility is muted, and probably suppressed, meaning that if volatility does increase it is likely to do so quicker’. These apparently contradictory statements are both quite coherent with an economic and financial system which is effectively still on life-support.

COVID is probably no longer the kind of unknown that will cause the next market crisis but, as the focus shifts to vaccination rates, there is perhaps a slower moving economic story unrolling. We are keeping an eye on how different regions are progressing, with a particular emphasis on the large continental European countries that seemed to have caught a tailwind just as the US plateaued. While this is very much in the public domain (and probably in ‘the price’), it is worth noting and is plausible reason why European stocks might have their moment in the sun after Asia had it’s turn last year followed by the US in the last few months.

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Integro Holdings (WA) Pty Ltd ABN 61 612 297 739 AFS Licence No. 489444

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