Weekly Market Update - 28/06/2021

The week that was

Most equity markets were up last week by 1-2%, although the Australian market was an exception, weighed down by banks and CSL. In the recent past stock markets have been highly sensitive to moves in expected interest rates with tech stocks being especially volatile. However, last week interest rates edged upwards and markets, especially value stocks, also moved higher. The common cause was strong consumer, housing and employment data in the US along with the move closer to the approval of?a 1 trillion dollar infrastructure budget with a bipartisan group of 10 centrist US senators agreeing terms. This was just one small step towards an actual deal, and arguably the easiest part (focused on the physical infrastructure that both sides already support) but equity markets have taken it at face value and were prepared to overlook the negative impact of higher interest rates. This was partly because Fed Chair Jay Powell has been at pains to reassure markets that inflation is transitory and rates are going nowhere soon. That meant that the tech heavy Nasdaq was up 2% while the more industrially focused Dow Jones was up some 4%, leaving the broader S&P up 3% and the best performing global market. It also meant that global financials and materials stocks were up almost 4% and energy stocks were up almost 6%, while defensive utilities and consumer staples languished.

Closer to home, it was not altogether clear why the local market lagged global markets. The spectre of a lock-down in Sydney and elsewhere was perhaps not helpful but the worst detractors, the banks and CSL, were not obviously COVID affected. In the case of CSL, this could be just down to the fact that they have seen a 50% rise since the beginning of the year and the fact that they have suffered a couple of modest broker down grades. Regarding the big local banks, once more, they were looking a bit expensive, especially compared to overseas peers. Overall, though, despite positive contributions from IT and materials stocks the local market was down just under 1%.

Commodities were mostly up, led by industrial metals and energy while currency markets were also calm after some bigger moves in the week before. The most significant price action was therefore in bond markets with US 10 Year Treasuries moving up 0.2% from their lowest point on Monday to finish the week just under 1.55%. Other government bond markets followed suit but to a lesser extent while credit spreads reduced slightly.

Barring a market crash in the next few days that means most Australian diversified portfolios are likely to be up another 2-6% for the quarter and up from their pre-COVID levels by a similar amount (they had just broken even at the end of the last quarter). In that sense investors have now been ‘made whole’ by monetary and fiscal stimulus and, for financial asset prices at least, it is as if COVID never happened.

What we’ll be watching this week

As Sydney and other metropolitan areas go into lock down, Australians have been reminded of the fragility of a largely unvaccinated population. However, it also looks like economies with even the most successful vaccine programs are not yet immune from the effects of COVID even if most of the individuals are. The last few weeks have seen Israel, the US and the UK, all with relatively high vaccination rates, having to take steps to mitigate the effects of the even more highly transmissible delta variant. As we got to the end of 2020 there was a sense that lock-downs and then vaccines offered a linear way through COVID and beyond. This view has been challenged firstly by the spike in cases in Asia and now possibly by the delta variant.

We are starting to get a clearer picture about the interrelationship between real rates (after inflation) and to some extent how equity markets might react to the kinds of shifts we are likely to see. Where rates head from here, remains anybody’s guess, but the scenarios, given a directional view of rates, can be worked on and planned for. The fly in the analytical ointment may be the prospect of central banks next salvo if markets put more pressure on them to maintain super rates as inflation expectations rise.

The different ways in which COVID and now the stimulus are aimed at reflating economies has created an unusual dispersion in valuations and quite singular investment theme. There are a significant rump of companies that seem fairly valued given historical pre-COVID growth dynamics but potentially very cheap if analysts estimates of growth in a reflationary environment are to be believed. Even with the healthy pinch of salt that analysts’ expectations of earnings growth generally deserve this has become striking and is something we are seeking to understand more, especially as most other assets seem quite expensive and vulnerable to disappointment.

In the past few weeks the Fed has sought to reassure markets about the transitory nature of inflation while ‘talking about talking about’ tapering and normalising interest rates (and then walking it back when markets get upset). Far be it from us to ‘fight the Fed’, but for our part we are 'talking about talking about’ coming off the fence about inflation and we see considerable evidence of more persistent than expected and structural changes to potential inflation along with impaired production capacity. It is therefore incumbent on us to spend, if anything, more time understanding the more deflationary forces but for now we remain moderately underweight.

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Integro Holdings (WA) Pty Ltd

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