The Wrap: Oz Equities, Investors, Covid-Strategy, Housing

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Weekly Broker Wrap: Oz equities momentum, investor confidence, strategies for living with covid, global housing ripe for price reversal

-Wilsons suspects peak earnings momentum may be reached this quarter
-Investor expectation of economy recovering well post-covid, drives ‘mum & dad’ confidence in ASX-listed companies above pre-pandemic levels
-Major Asian economies are expected to shift from ‘zero covid’ to ‘low covid’ strategies

By Mark Story

Oz equities: Is earnings momentum about to peak?

With both the ASX200 index and forward earnings estimates now sitting higher than pre-covid level highs, the question Wilsons suggests investors are now pondering is whether growth is peaking.

Wilsons looked to the 2010 post-GFC period for insights into how markets typically behave after earnings momentum peaks. The broker discovered that during 2010, the market generated gains in both the three- and six-month periods before earnings momentum peaked.

The market then contracted by around -11% in the first three months after the peak.

The broker’s research also suggests that while cyclicals are historically the most sensitive to this shift – as earnings momentum peaks and rolls over – the growth or defensive sectors should start to outperform once the market turns a corner on momentum.

While the reflation trade – reflected in an economic cycle upswing – has carried value stocks to above pre-covid levels, Wilsons suspects a rotation back towards growth stocks if earning growth rates start to peak.

Given earnings momentum is currently at exceedingly high levels, Wilsons believes there is now a growing risk that growth has peaked, and the market will struggle to sustain this momentum over the next 6-12 months.

While some of this rotation has been evident since March, Wilsons notes it has become more pronounced over the last month as growth concerns have returned to the market's thinking.

Wilsons believes we may reach peak earnings momentum this quarter. However, due to stronger global stimulus than post-GFC, and a commodities cycle that’s still in the first half of expansion, the broker suspects this expansion phase could be longer than in other periods.

Also fueling this outcome is an economic recovery that’s likely to take another 6-12 months as the world reopens.

Assuming earnings keep growing at a slower rate than over the last six months, the broker believes the market will not get sufficiently spooked to reverse the reflation trade.

Having concluded that the risk-return trade-off is not as favourable for cyclicals as it was at the beginning of the cycle, Wilsons believes the stronger overriding theme of the next 12 months will be the reopening of the global and domestic economies.

Despite current lockdown hiccups, Wilsons suspects this theme should provide significant impetus to the earnings growth cycle. The broker suspects both the financials sector – due to further earnings upgrades – plus the materials sector – due to elevated levels of copper and iron ore prices – could push the index earnings per share (EPS) higher and support the reflation trade.

Wilsons expects to see further consensus upgrades going into the FY21 earnings season, and believes FY23 earnings could be upgraded, offering another tailwind for cyclicals. While Wilsons still believes this cycle will stay the course, the broker has trimmed weighting to cyclicals to 60% from 70% in light of the risk and probability of history repeating itself.

Over the last quarter, the broker has increased its holding in quality growth stock CSL ((CSL)), added Telstra ((TLS)) as a low beta, defensive stock; and removed Super Retail ((SUL)) and Reliance Worldwide ((RWC)), two cyclical, covid winners.

Investor confidence: Exceeds pre-pandemic levels

According to the Chartered Accountants Australia and New Zealand’s (CA ANZ) latest annual survey, the confidence mum and dad Australians have in Australian capital markets (87%) and ASX-listed companies (90%) is now greater than pre-pandemic levels.

Despite the uncertainty of covid, investors with particularly rosy levels of confidence in the Australian markets (49%) have rebounded even more with a 13% rise over 2020.

Survey data attributes heightened confidence in investor expectation that the Australian economy will recover well post-covid, noting the ASX historically bounces back, and overall confidence in Australia's productivity.

Three-quarters of the 1000 investors surveyed by CA ANZ also registered confidence in capital markets outside of Australia. This marked an 11% rise from the same time last year compared to confidence in Australian capital markets making an 8% jump.

CA ANZ’s Amir Ghandar suspects this domestic confidence could be spilling over into foreign investment opportunities, especially with Australian investors preferred international markets that are gaining control over the covid crisis and vaccine rollout.

“Whether this rebound is short-lived or here for the long haul will be proven by how well we manage this crucial next year of the crisis, particularly as other global economies start to re-open,” explained Ghandar.

‘Zero-covid’ strategies waning

While the “zero covid” strategy practised in parts of Asia has delivered health and economic benefits, The Economist Intelligence Unit (EIU) suspects it will become unsustainable as the global economy reopens.

To preserve their status as business hubs, the economic think tank suspects a cluster of major Asian economies will shift from policies aimed at eliminating covid – including successful stringent lockdown measures – to one based on living with it.

Conditional on achieving widespread vaccination, the EIU expects transitioning away from zero-covid strategies – to low-covid models like those adopted by Japan and South Korea – to occur gradually in each of the zero-covid economies (excluding Vietnam) by mid-2022.

However, there is also the risk, adds the EIU that the emergence of covid variants resistant to current vaccines could quickly persuade zero-covid countries to retain their current approach. The EIU suspects any liberalisation of border controls would also see Australia and New Zealand directly benefit from a revival in international tourism and student flows.

While China will be the most cautious about reopening, the EIU expects zero-covid regions to retain tight border controls throughout 2021, only relaxing them from early 2022 when mass vaccination has been achieved.

Based on the EIU analysis, the pressure to rethink covid strategies will be most acutely felt in Asia’s city-states of Hong Kong, Macau, and Singapore, where there’s a heavy reliance on international business and tourism.

For example, Hong Kong and Singapore have sizable foreign worker numbers, with 30% of the latter’s population having neither citizenship nor permanent residency status. If neither Hong Kong nor Singapore can operate effectively as a hub, EIU suspects businesses may prefer to move more of their operations elsewhere.

Global housing: 10% overvalued

Based on data from the Jorda-Schularick-Taylor macroeconomic history database, Oxford Economics concludes that real house prices within advanced economies maybe around 10% overvalued versus long-term trends.

While the prices or price-to-rent ratios look 10% or more above trend in several economies, within certain countries that is not the case.

Looking across four indicators, Oxford identified the Netherlands, Canada, Sweden, Germany, and France as the riskiest markets, and notes the German price-to-rent ratio has not increased much from 1990 relative to other markets.

Interestingly, Oxford also notes some previous hot spots such as Australia – which registered the highest price-to-rent ratio across 14 advanced economies – does not feature here, thanks in part to price corrections in 2018-2019.

Oxford assesses the macroeconomic risks from the current house price boom as twofold: Firstly, it might exacerbate overheating risks, and secondly, it might push prices far from fundamentals, risking a later price crash that threatens activity and financial stability.

The economic forecaster’s long-run assessment of the current boom suggests the risks are skewed to the second kind, which would result in a big price reversal. With valuations already looking high in many economies, Oxford suspects the length of the boom also adds to the risk.

What’s clear from the evidence, adds Oxford is that the longer a housing boom continues, the more likely it is to end, especially as prices become more detached from fundamentals. But that said, Oxford believes the risks look lower this time compared to the lead-up to the global fiscal crisis, with the slower rise in mortgage credit making a notable difference.

Overall, in light of opposing influences such as demographics, the savings glut, and the possibility of higher inflation, the economic forecaster sees the behaviour of real rates as the key issues for coming years.

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