It would be hard to dream up a more stunning account of what markets did during the March-June period than what ultimately unfolded, especially given the carnage of the prior quarter.

A technically precise climax sell-off on March 23 kickstarted a rally that became known as the ‘re-opening trade’. Equities were drawn into a strong updraft as evidence built that the real world had began to revive and governments and central banks across the globe reaffirmed their commitment to policies that would underwrite a path to recovery.

By close of trading on June 30, the S&P500 would have rallied 42% from the March low, the S&P/ASX200 34% and the S&P/ASX Small Ordinaries 46%. Australian small caps handily outpaced ASX100 names, with resource names (chiefly gold) making short work of small cap industrials during the period in review.

Some notable events during the quarter:

1. Crude (WTI) oil traded to negative US$38/barrel. At futures contract expiry, traders actually had to pay buyers to take oil from them due to the non-availability of oil storage, hence the negative oil price (Your author has never seen this occurrence before). The negative oil price resulted in well shut-ins which brought on a spike in natural gas prices (as gas is commonly produced with oil) and a slump in the sugar price as traders perceived reduced demand for ethanol, a major user of sugar production.
2. Day traders returned to the market with a bang. The FT reported that 800k people opened sharetrading accounts with the three largest US on-line brokers through March-April. The world was introduced to Robinhood.com too.
3. Stockmarket demigod, Stanley F. Druckenmiller, declared in mid-May ‘the risk-reward for equity is maybe as bad as I’ve seen in my career’.
4. GS expect US equity issuance to top US$300bn in 2020 with US$170bn raised to date. This will be the highest level since the dotcom mania of 2000.

Locally, consumer discretionary stocks were +36% over the quarter, with materials +34% and small cap financials/financiers +28%. By the end of May the ANZ/Roy Morgan Consumer Confidence Survey had reported on 8 consecutive weeks of improved readings, doubtless aided and abetted by JobKeeper, JobSeeker and the early superannuation redemption initiative. Retail therapy, especially of the on-line variety, was on display with buoyant updates from Temple & Webster (TPW), Kogan (KGN), The Reject Shop (TRS) and Beacon Lighting (BLX). Motor Cycle Holdings (MTO) advised a ‘best ever’ May trading month for new and used bikes as well as accessories. This resilience coincided with a number of ASX companies reporting reduced requests for financial assistance from customers.

J P Morgan advised that fewer ASX listed companies made changes to consensus earnings estimates from March and those that did, increasingly upgraded estimates (% of companies upgrading: April 16%, May 28% and June 60%).

Corporate confession season is under way as I write this note and I expect the market to remain alert to any major shift to trading environments.

A look at the technicals

Several closely followed US equity benchmarks have seen momentum dissipate in recent weeks. It is possible to draw valid downtrend lines across the tops of February 20, June 8 and the early days of July for the S&P 500 and S&P 500 (equal weight), NYSE Composite and the Wilshire 5000. It therefore follows that nascent support lines projecting out from the March lows need to be monitored for durability rather closely.

The Nasdaq and Nasdaq 100 have been running their own race with record highs a daily occurrence through July trading notwithstanding deteriorating breadth. The overheating in this market moved to a crescendo on July 13 with both indices posting daily key reversals. This set up is synonymous with trend turning points, so the grounds for a retracement from these levels are compelling. Look out below.

Sentiment indicators are strangely mixed. Citigroup’s Panic/Euphoria Model is camped firmly in the euphoric bracket while the AAII Bull Index is sitting snuggly in the BUY zone, a contrarian read on cooling investor sentiment. The NYSE Put/call ratio has moved lower indicating complacency on the part of investors, not ascribing much value to downside protection. It is also worth pointing out that speculative positioning in VIX futures is very short with bears outweighing bulls by 2:1. 

This implies professionals are betting on lower volatility moving forward. Another indicator of investor lassitude.

The ASX/S&P 200 Index appeared to be approaching stall speed into the early days of July. With narrowing range days and declining daily turnovers-never a great indication of market health. Despite moving off trend from the March 23 rally, the benchmark has shaken off its torpor and resumed upside momentum. Early days but encouraging all the same. We draw succour from the local markets secular uptrend from December 1992 and how spectacularly it held in March to extraordinary results as evidenced.

The Small Ordinaries Index had been troubled by resistance from the February highs. Price action on July 20 was decisive and appears to have set the scene for a renewed upside thrust. Resource names are leading the campaign with passage to the old (2018) high the first stage in an unfolding bull drive. It is also reassuring to see that breadth through the Small Ords has been improving from the March lows with ~72% of stocks trading above their 100-day moving average versus 51% in May and 7.6% in March.

4 new additions to our portfolio

After a lengthy spell, we returned to The Reject Shop (TRS) register. An executive overhaul, equity raising and plan to rework the business model attracted us to this one-time retail darling. Key areas of focus in this redux involve a) striking the appropriate rent and wages per sales ratio’s, b) SKU rationalization and supply chain review, c) renegotiation of store leases (average 2 year tenor), d) IT investment and e) where practicable, ‘borrowing’ from the highly successful US-based Dollar General Corp model. A thoughtful store rollout should logically follow.

We also established a position in PushPay Holdings (PPH) during the quarter. The company is the market leader in digital giving solutions to the faith sector in the US. The faith based giving market is estimated to be ~US$100bn in the US with PPH’s addressable market ~US$50bn. PPH processed around $5bn USD in FY20 giving the company around 10% market share. Over the last 12 months it has become clear PPH is at an inflection point for both cashflow and earnings. Under the stewardship of CEO Bruce Gordon, PPH has transitioned from a founder-led investment phase into an optimize/monetization phase. What is more surprising is the very conservative nature of the accounts (a rarity in small cap tech, outside Iress). We believe the next few years for PPH will be rewarding and that COVID-19 will accelerate the already entrenched trend to digital giving/engagement from cash.

We spent significant time monitoring the progress of economies opening globally. After a strict level 4 lockdown, NZ emerged as one of the few countries with the virus under control and an economy that proved relatively resilient. SkyCity Entertainment (SKC) NZ properties had been closed since March were allowed to progressively reopen during Alert Level 2 in early May. With a significant debt load, ongoing capex for the Auckland Convention Centre & Adelaide Casino refurbishment, the stock had seen a significant de-rate as analysts expected earnings to be depressed for more than 18mnths. SKC is a monopoly asset in NZ, that largely targets the domestic market, with International VIP earnings in a normalized year ~10%. Despite borders remaining closed as the alerts were scaled back, patrons flocked back to the casino ensuing record weekends and 90% occupancy in the Auckland Hotel on a number of Saturday nights. We initiated a position in May as we began to get clarity on re-opening, post a labour restructure and gained further conviction as the balance sheet was improved with a NZ$230mil equity raising in June.

During NZ stage 4 lockdown, Synlait Milk (SM1) was granted essential service status allowing it to continue production of its key dairy products. After a downgrade in early February on lower infant base volumes, and ongoing margin pressure from the A2 Contract, we grew concerned that new contracts for infant formula manufacturing remained elusive, and covenant uncertainty on the Pokéno site would continue to weigh on the stock. We took advantage of the infant formula pull-forward trade which benefited Synlait’s share price during lockdown to exit the position during the quarter.

Outlook

In writing this outlook, I find myself in that perplexing position (with Druckenmiller’s retort fresh) of marrying the market’s resilience with the abundance of disconcerting data/anecdotes around.

Dallas Fed chief, Robert Kaplan, was recently quoted “The US economy is slowing due to the chilling effects from rising infections, muting the rebound and muting growth”. Public health outcomes will continue to have a short-term effect on investor sentiment for some time none more so than vaccine/therapeutic announcements.

There is no missing that US valuations, certainly PE ratios, have returned to levels last seen in the late stages of the dot.com rally in 2000. Equity risk premiums have been dented when the debilitating 2020 growth shock is imputed but if incorporating a 2021 recovery then equities continue to be highly appealing over bonds.

The amount of liquidity afforded the market by central banks as well as fiscal accommodation by governments will continue to support risk appetite and therefore stocks.

Professor Jeremy Siegel (Wharton School, Penn and author of vade mecum ‘Stocks for the Long Run’) recently offered an interesting insight into US financial conditions today versus the GFC. Events during the crisis in 2008-2009 necessitated banks hold excess reserves. Banks complied, holding these balances to shore up balance sheets. Today these reserves have been lent out and now sit in current accounts-transaction accounts held by individuals, small and large businesses and ready to be spent. The result is M1 (money supply) is +25% in eight weeks. During the GFC M1 grew 15-20% but it took well over a year to materialize. Siegel quoted famed economist Milton Friedman who offered that excess reserves in the banking system were potent but far more so when they found their way into M1/M2. The conclusion here is that the US will see a substantial consumption boom in 2021 that will propel the economy upward, backfilling the strong move in equities in 2020.

At the time of writing, Chinese stocks were cooling down post a 17% rally in the CSI 300 from June 30, fuelled by credit growth and policy stimulus and fanned by state-owned media reporting a bull market to be underway. We have previously seen how their bubbles can end if left to inflate freely. But there are important benefits to be had from advancing stockmarkets, namely bolstered consumer sentiment, capital inflows (therefore currency stability) and access to FAI funding.

On closing, the arrival in force of the household/retail investor across global markets needs to be watched. For me it is an unmistakable marker that the eleven-year-old bull market is maturing with their participation a requisite closing chapter in the cycle of markets.

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