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Another reporting season has come and gone and this has not been like any others we have experienced in the last decade. Companies reported lower than normal profits, dividends were either cut or suspended altogether and companies moved to cut costs aggressively as they shore up their balance sheets for the short-term.

Despite the current climate and a subdued reporting season outcome, the markets went up in August which continues to lead to the question we are mostly asked – “are stock markets out of touch with economic reality?”

This article seeks to summarise the activities we’ve seen in the real economy – as evidenced in the reporting season – and the enthusiasm on the markets and attempts to contextualise the events of these past months to help us predict what we may do in the coming months.

Reporting season overview

  • 103 out of the 137 companies (75%) reported a net profit after tax (NPAT).

  • We saw a dichotomy with some companies having done well and others seeing the toughest year in their cycle.

  • Overall, profits were down across board, leading to most companies either slashing their dividends or abandoning dividend payments to shore up their balance sheets.

Industry performance overview

  • Undeniably, several sectors have prospered in the period. Leading the charts locally, we’ve seen alternatives – particularly Gold – riding the flight to safety with high demand in the sector. Companies in the sector did well.

  • Some retailers – especially those with a good on-line presence – have reported higher sales and profits. We’ve seen good outcomes for JB Hi-Fi, Woolworths, Coles, Bunnings (through Wesfarmers) have all benefited from the effects of economic shutdown due to the global pandemic.

  • Health Care has also done well with focus on companies in the respiratory device manufacturing (ResMed) and protective equipment manufacturing (Ansell)

  • Other sectors of the economy have taken severe shocks. The service and travel industry – especially those firms dependent on domestic and global mobility (travel operators) – have experienced the toughest conditions over 2020, especially late in the first quarter and through the June quarter.

  • Australia’s uncertain energy policy as well as global demand and supply issues weighed on some energy companies such as Woodside Petroleum and Oil Search’s bottom line to mention a few.

  • Banks profitability has been weaker due to lower interest rates, the build-up of liquid assets and accelerating cost pressures.

Global view

  • Global shares continued increase in value in the last months since March 2020. However, it is clear earnings have been severely affected by the pandemic, although not as badly as anticipated. The US share market has been supported by the ‘big four’ tech giants (Amazon, Apple, Facebook, and Google), all of which beat estimates.

  • Amazon was arguably the biggest winner, reporting the largest quarterly net profit in its history, nearly double that of the corresponding quarter in 2019.

  • Apple reported revenue of US$59.7 billion, above estimates of US$52.2 billion, while every major product line saw year-on-year growth and beat analyst expectations. Apple also became a $2 trillion company.

  • Microsoft shares posted modest gains as the company tried to salvage a deal to buy TikTok’s US operations.

  • Across the Atlantic, EU leaders have been relatively successful in containing the Covid-19 virus and providing much-needed fiscal support. In July, the European Council approved a €750 billion package to fund fiscal transfers between member states.

So, what does this all mean?

  • Yes, the stock markets – both locally and internationally – appear to be out of touch with reality. However, let us remember that the markets are forward looking whilst the economy is backward looking. The markets see opportunities in the real economy in the future. It is betting on the fact that lives will return to normal and even if it is not business as usual again, it will be business in some form. Markets consider the value of a company based on business structures, confidence in management, cashflow, earnings and future direction of the business.

  • All economic indicators look at what has already happened. We are in a global pandemic mode, small businesses have lost the ability to do more business, unemployment is high – all these issues were predicted in early March when the stock market took almost a -30% dive.

  • We know that with companies holding up cash on their balance sheets and not paying out dividends, we cannot rely on dividends alone as a source of investment returns. It is important to look at the growth side of the equation to get a total return approach to investing.

  • Liquidity and policy settings remain favourable as central banks and governments continue to prop up economies via monetary easing and fiscal measures. Cyclical indicators remain weak, with most economic indicators such as unemployment figures showing weakness, although some data on unemployment has been better than expected.

  • We continue to see increased tensions between the US and China as well as Australia and China. These tensions will have an impact on local companies such as Treasury wines (TWE), A2Milk, Agribusiness, BHP, RIO, in some form. They could even have small impacts on Apple.

  • Also, we seem to forget that negotiations between the UK and EU are yet to be finalised with the UK set to finally exit the EU later this year. With no deal in sight, this could spark new levels of tensions.

  • Finally, risk indicators suggest that, although there seems to be some normality with tensions in the markets, there’s increased volatility, which could lead to higher risks in the markets. We continue to remain cautious.

In Conclusion

  • Interest rates remain at its lowest, globally. Meaning investors continue to seek other ways to generate returns on their cash. This is likely to drive activity on both property and share markets due to high demand for growth assets.

  • Much as it is widely accepted that the share market looks at future value, it is also important to note that there are a few headwinds on the way.

  • Geo-political tensions between China and Australia are bound to hurt some sectors of the economy in the short to medium term. However, as governments around the world, including China, look to generate economic activity through infrastructure projects, Australia stands to benefit from exporting Iron Ore, which could help the economy overall.

  • As the government stimulus tapers off – albeit gradually – it is important to see how this will impact some of the companies that have benefited from the stimulus package and what that will mean to the economy.

  • The US goes to the polls in November. At this stage, we have no indication of what markets will do based on the outcome. Either person winning the election will have some effect on the global economy.

  • Much as these issues show a gloomy picture, we also see some tailwinds in some parts of the economy.

  • If you can see past the short-term issues in some sectors of the property market, there are significant opportunities in some commercial real estates particularly in warehousing as more and more companies shift their goods and services online. With subdued valuations now, it could be a good addition to a diversified portfolio

  • We continue to see technology being a future driver of most parts of the economy. Be it, Edu-Tech, Bio-Tech, cybersecurity, renewable energy, technology will continue to play a major part in the new economies round the world. As always, it is never going to be easy to pick when to enter or exit the markets. Investing is a long-term strategy. A well-diversified portfolio will seek to balance out the short-term issues we face to drive long-term value regardless of markets.

This report may contain information sourced from research through our research house Lonsec. It may also contain our in-house assessment of the impacts of the COVID-19 pandemic on Australian and global economies. This information is general in nature and does not consider your personal circumstances. Before you implement any changes to your current situation, we recommend you speak to us.