BE NIMBLE TO CATCH THE RECOVERY

Ayear on from Australia’s first lockdown, our economy has been put through the wringer. While there’s a long road to recovery ahead, it’s better positioned than many of its global peers. Partly thanks to the federal government’s massive economic support, mainly JobSeeker and JobKeeper, the labour market is looking strong.

Unemployment has pared back from 7.5% in July 2020 to 6.6% in December, while underemployment sits at 8.5% as of December. To top it off, the labour force participation rate has recovered not just to pre-Covid levels, but to an all-time high of 66.2%.

Real estate

The property sector has once again reaffirmed its sacred place in the national economy. As of January, CoreLogic’s home value index hit a record high, surpassing the previous high-water mark from September 2017.

Meanwhile, people continue to escape from the capital cities to the coast and country. Regional dwelling prices rose 1.6% in January and 7.9% compared with those from a year ago.

“Internal migration data shows more people are leaving Sydney and Melbourne for regional areas, resulting in a transition of activity from the metro regions to the outer fringe and regional markets,” says Tim Lawless, CoreLogic’s research director.

“Better housing affordability, an opportunity for a lifestyle upgrade and lower-density housing options are other factors that might be contributing to this trend, along with the newfound popularity of remote working arrangements.”

Shane Oliver, chief economist at AMP Capital, adds that regional dwellings have “less vulnerability to the financial stresses caused by the pandemic-driven economic downturn, less exposure to the slump in immigration and increased buyer interest as people seek to relocate from cities as part of a secular trend towards working from home and a greater focus on lifestyle”.

The regional shift has also seen houses outperform units. “Demand for units has diminished through Covid-19 amid record low levels of investor participation and changing living preferences. At the same time supply levels are heightened in some precincts. While demand and supply remain imbalanced we are likely to see units continue to underperform relative to detached housing markets,” says Lawless.

Sharemarket

Not all sectors were squeezed by the pandemic; some even excelled. An oddity of this recession is that traditional growth sectors became defensive, while defensive sectors became susceptible to volatility.

“Funnily enough, tech was viewed as a defensive sector because people were working from home,” says David Bassanese, chief economist at BetaShares. The shift to work-from-home arrangements, and massive gains out of Silicon Valley, have led to a booming technology sector.

“It is the most volatile sector, but those who took the risks have done well,” says Michael McCarthy, chief market strategist at CMC Markets. “The two phenomena largely driving that are a preference for those IT stocks in the US, and the performance shown by the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google) as well as Tesla).”

“And, of course, we had the emergence of the buy now, pay later services over 2020, which benefitted from the lockdown environment and became investor favourites.”

Despite their performance throughout the pandemic, these sectors may have run their race.

“The winners started to lose ground against the losers at the back end of last year, and the shoe is beginning to look like it’s on the other foot as it relates to the areas of the market that should perform well in 2021,” says Kyle Rodda, market analyst at IG. “Investors are rotating to areas of the market that were beaten last year and would benefit from the reopening trade.”

McCarthy agrees that performance in 2020 should not be the basis for forecasting into 2021. “The challenge for investors looking at that sector is that it’s seen strong performance already, and there are real arguments going on about valuations in the sector, especially when it comes to stocks such as Afterpay, which are at eye-watering price-earnings multiples,” he says.

Afterpay’s performance has been stratospheric. At the time of writing, its value has increased 1500% from March last year

McCarthy is wary of materials and consumer discretionary stocks for the same reasons.

“Given the big economic pickup forecast this year, materials was viewed as one of the sectors that would be in the spotlight. The materials sector has already run hard. The sharemarket prices the future, and because the whole thematic of a bounce back in 2021 is well explored the support for materials stocks means they’re at a less compelling price level.

“It’s a similar thing with the consumer discretionary sector, which is actually above pre-Covid levels. It’s more than recovered all the lost ground. People are expecting that the pent-up consumer demand means it would be a great year for consumer discretionary stocks.”

On the flipside, the energy sector remains depressed, suggesting it could be better positioned than most to piggyback the recovery.

“The energy sector is complicated by the global warming discussion, but if the economy recovers in 2021, it seems likely the oil price will continue to lift, and if that’s the case the energy sector will be a way for investors to gain exposure to the recovery thematic.”

The reflation effect

Many financial commentators point to 2020 as the year of reflation, broadly defined as inflation that pulls up prices from below the long-term trend.

Some, such as Vanguard, hold tempered expectations of the outlook for inflation.

“In 2021, we anticipate a cyclical bounce in consumer inflation from pandemic lows near 1% to rates closer to 2% as spare capacity is used up and the recovery continues,” it says. “A risk is that markets could confuse this modest reflationary bounce with a more severe but unlikely episode.”

“[The] reflation genie is out of the bottle and central banks have lost control,” says Mathan Somasundaram, from Deep Data Analytics. “This year will be all about risk management and trading as reflation takes a stranglehold over asset prices.”

Reflation bodes well for sectors such as resources and consumer staples.

“The market is focused on that reflation trade and so-called value stocks that benefit from that kind of trade – so, you’re looking at the commodity players, miners, energy sector and the banks,” says Rodda. Other sectors may not fare so well.

“In a reflationary environment, interest rates are no longer predicted to go down,” says McCarthy. “That means that interest rate sensitive sectors like property and utilities could be underperformers over the course of the year.”

Reflation is a reversion to a norm, so don’t expect runaway prices anytime soon.

“Just because growth recovers, I don’t think inflation will be a problem,” says Bassanese. “For structural reasons inflation will stay low. From a market point of view that will be good news because bond yields will stay low.”

Fixed income

For fixed-income investors, there is light at the end of the tunnel despite record low interest rates. 2020 saw deep cuts to dividends, especially in the banking, transport and leisure sectors. Three banks alone – CBA, NAB and ANZ – accounted for 60% of the $12.3 billion fall in dividends in the third quarter.

“Expect dividends to edge higher, but a difficult operating environment in 2020 will naturally result in management taking a more cautious approach with dividend payouts,” says McCarthy. “We’ve already seen dividend payout ratios slashed in the finance sector pre-Covid, due to remediation costs, but if the regulator moves post-Covid to force banks to defer or abandon dividends we’ll see a rebasing. We’ll see dividends improve over the year, but it will take a while before management brings ratios back to pre-Covid levels.”