Here, co-portfolio manager in the Australian equities team, Tom Young, reflects on some lessons 2020 has given us about the domestic market.
What lessons have we learned from the way that markets responded to the events of 2020?
It’s been a very eventful year! First and most importantly, in most cases volatility means opportunity. I remember thinking in April that we would look back on this as a once-in-a-generation buying opportunity. That said, we tend to overlook the fact that the market goes through cycles of volatility once every few years – more recently the rate hikes from the US Federal Reserve in 2018, before that the Chinese hard landing, before that the Euro debt crisis and before that the GFC.
Do you think we’ll look back on this year’s market activity as part of that series or a landmark event in its own right?
History is likely to see this as the end of a bull market that began with the global financial crisis, followed closely by the beginning of another. The question is whether it is actually a step change in terms of the dynamics that have driven markets over the past decade and the strategies that have worked in that environment. Will they hold into the future? It really does feel a lot like the bull market over the last decade, fuelled by central bank liquidity pushing asset values higher. The same kind of stocks have been the beneficiaries so far, namely growth stocks and especially the tech sector. We’ll have to wait and see how that plays out now that vaccines are rolling out and the global economy is beginning to recover with no sign of any appetite from governments or central banks to reach for the brake lever.
How does the recent performance of tech stocks seem in that context?
For many of these companies, positive cash flows are a long, long way out into the future and very uncertain, particularly in an unsettled climate and particularly if the discount rate increases. The reality is that most of those invested in them today won’t hold stock when those cash flows occur. So you’re relying on the market having a more bullish outlook on the company at the time you exit your position as when you bought. Businesses that are generating cash flows now are far less hostage to future market sentiment and future interest rate rises.
It has been a difficult year for cash flow and dividends in Australian equities. Did that match with your expectations at the start of the pandemic?
We were very conscious at the start of the year that dividends in Australia were overly concentrated in the banking and iron ore sectors, where seven stocks generated half of the dividends in the ASX 200. The miners held up well on the back of strong ore prices but the banks were hit hard by the crisis and put under guidance from APRA to restrict dividends.
Back in the early months of the pandemic we estimated the eventual peak-to-trough decline in dividends would be about 40%, of which half would come from banks, and it looks as if we were fairly accurate.
The strength of the recovery has been somewhat surprising, however, especially in consumer discretionary spending where people diverted expenditure from holidays, restaurants and entertainment to goods, and you can see it in the retail sales numbers. Companies which are benefitting from this tailwind have had a remarkable year and a number have produced healthy dividends. The outlook for the banks has improved as well, with APRA reassessing their guidance for next year and the housing market heating up again.
How will we look back on this in 10 years’ time?
The sell-off in March was brutal – the global financial crisis condensed into one month. Given what we know now it’s fair to ask whether that volatility was justified. I think a large part of that was fear around a global event where most people had little or no experience to inform their decision-making, and I also question whether that was exacerbated by the increased penetration of passive investing compared to previous crises.
This year might also be a turning point in how we value systemic risk. If you’d told me twelve months ago that we’d go through our first recession in thirty years with some of the lowest insolvency rates on record I’d have said you were crazy. But the government has pulled out all stops to keep businesses in business, which has benefited the economy but ultimately calls into question a lot of the assumptions that were made about economy-wide risk.
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