Australia’s first recession in 29 years was confirmed on 2 September 2020, as the nation recorded its second quarter of economic decline.
While the headlines sound scary, for the equity market outlook, the recession actually means relatively little. The Macquarie Investment Analysis Team have released an incisive analysis, which we have summarised for you below.
The Macquarie Investment Team have concluded that while investors should not completely ignore the negative growth, “extraordinary levels of monetary and fiscal support have fuelled a bull market in risk assets (equities) that…for the most part has differentiated between structural (and cyclical) winners and losers”.
This is due to the following factors:
- The equity market is forward looking and leads growth declines and recoveries, by somewhere between 2-3 quarters
- While the hit to economic growth is concerning, the path forward is now more relevant.
- If 2Q20 marks the low point, then the equity market may already be well on its way to recovery.
- Additionally, COVID-19 has accelerated distinction meaning that some sectors, noticeably technology and healthcare, have risen substantially as other have been declining. This has provided for a significant tailwind for the market.
- The recession has not been driven by a build-up and purging of excesses
- There has not been build-up and purging either within the economy (i.e. excess inventory) or the financial sector (i.e. excess leverage or speculative activity).
- This is positive, because there will not be the traditional need for time to unwind excesses and normalise for imbalances – instead, as mobility picks up, so too will economic activity.
- Household income has actually increased through the downturn
- This increase has been supported by unprecedented levels of monetary and fiscal policy support, loan and rent deferrals as well as early superannuation withdrawals.
- While the removal of these income supports will put increased downward pressure on the consumption outlook, they have worked well, providing a base to support spending as conditions begin to normalise and through the transition from government assistance to employee compensation.
- Capital markets have been open and functioning
- This has meant that unlike some downturns where dislocations in credit markets are the accelerator of weakness, this has not been the case during the COVID-19 scare.
- Australian corporates have tapped capital markets at an unprecedented pace, not only reflecting the scale of the hit to earnings, but also, the scale of liquidity on offer as well as the cost of raising capital which had fallen dramatically for both debt and equity.
- This means many corporates are now well placed to leverage a rise in demand without having to restructure.
- The economy is not the equity market
- Some of the hardest hit sectors, such as tourism and education, are barely represented within the equity market.
- Others that have remained exceptionally strong.
- Obviously, Financials are dragging the performance of the market down, but banks are are in much better shape to absorb a potential rise in bad and doubtful depts (providing a floor for valuations) compared to the GFC where banks faced liquidity and solvency concerns.
As always, be carefully sceptical with scary news headlines and think deeper into the actual implications and what it means for you and your long term plan, and as always, if you’re not sure, ask our team!
Stay safe and well,
The Income Solutions Team