Financial markets have continued their upward trajectory through the course of July. This follows a very strong June quarter, with the months of April, May, and June all posting solid performances when it comes to equity markets.
As we sit at the back end of July, domestically, our market is up roughly around about 2%. Global equity markets have also been up around that – in some instances, even a little higher.
In the US, we’ve seen the second-quarter reporting season take centre stage – and the results have been mixed.
From our perspective, this is entirely acceptable. When we look at the global macro backdrop, it’s clear that the lockdown of the global economy has impacted so many businesses and their earnings outlook. However, from our point of view, it provides a good thematic as we head into to the reporting season here domestically.
The following charts relate to the upcoming reporting season here domestically – and what have been some of the key drivers of financial markets, particularly equity markets, over the last couple of months.
The chart below shows the earnings outlook, across not only the broad markets – shown by the red dotted line – but a number of the major sectors in the domestic market: materials, broad based industrials, and financials. There are several points to note.
First and foremost, from March onwards, we saw a significant decline in the earnings outlook, one that we feel was completely acceptable. With the economy going into lockdown, we saw so many businesses close – not only domestically, but globally. And that was going to have a significant, negative impact. Businesses had to cut dividends, or raise capital to shore up their balance sheets to get through COVID.
We believe that the earnings outlook heading into this reporting season is going to be significantly weaker. Companies have cut guidance, both in absolute and relative terms, to prior periods. But despite that, one of the positives that we’ve witnessed over the last little while, as we’ve been engaging with individual companies, has been that the decline in the earnings outlook seems to have stabilized.
As you can see on the chart, we haven’t seen a further decline in the earnings outlook through the months of May, June and July. Heading into reporting season, we feel that the market may have seen a bottom in terms of the decline in the earnings outlook. Clearly, not all corporates are going to be in the same boat as others – the material sector has fared much better than other parts of the market. But we do believe that this is a positive that we can take into the second half of this year and beyond into FY21, as corporates start to reopen, the economy starts to reopen and corporates start to regrow their earnings outlook.
So we believe that stability in the decline of the earnings has provided some positive aspects to the outlook for equities in the medium term.
The second chart below highlights one of the challenges that we have seen with the performance of equity markets. As you can see, it demonstrates the market capitalisation of the four big tech companies: Amazon, Microsoft, Google – so effectively, Alphabet – and Apple. The market capitalisation of those four companies is now the equivalent of the entire market cap of the Japanese stock market.
While this is quite incredible, it does pose a challenge, but not so much around the uptick itself. Looking back at the overall performance of equity markets, we have seen quite a narrow dispersion in terms of that performance in the context of the uptick. This is something we are considering when it comes to both asset allocation and portfolio construction.
The lack of breadth and depth in terms of the market rally is something we’ve been particularly aware of. We are even seeing it domestically, with parts of the market like the tech sector that have performed exceptionally well compared to the rest of the market. We’re very mindful about that as a relates to portfolio positioning. We believe it provides important context as we head into that reporting season outlook as to what are going to be the key drivers heading into the second half of this year into FY 21.
We do ultimately believe that the outlook could start to improve – despite some of the challenges here domestically. With the fiscal backdrop support from the RBA seeing the reopening of the global economy – albeit at a mixed pace – we believe that we are potentially seeing the worst of the market downgrade in terms of earnings.
So there’s no doubt that there are some challenges ahead. It’s going to be a difficult reporting season in terms of profitability. But our focus is on positioning for the future – how are we going to take advantage of those opportunities that present themselves, while avoiding getting caught up in the hype of just a few sectors delivering that outcome? Similarly, our focus is also on ensuring we maintain that diversity across our portfolios, and manage the risks accordingly.
As always, we’d love to hear from you. And if you have any concerns about your portfolio, please feel free to reach out to your advisor.
Piers Bolger is Chief Investment Officer at Viridian Advisory
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