April 2022 | Monthly View

What we liked

• Australian retail sales in February reached their second highest level on record regaining momentum after the Omicron outbreak, a positive sign for the economy. Retail turnover increased 1.8% on the month, compared to expectations of a 1% increase.
• Australia’s unemployment rate has fallen to its lowest level in over 13 years, hitting 4%. The result largely beat market expectations, which expected a drop to 4.1%.
• Australia trade balance showed a strong surplus of $12.89 million. With exports up 8% and imports down 2% in January. This highlights the strong demand for Australia’s goods, particularly in mining and agriculture. The trade balance released by the Australian Bureau of Statistics is the difference in the value of its imports and exports of Australian goods.
• The U.S. added 431,000 jobs in March as the coronavirus pandemic receded and employers went on a hiring spree. The gain was lower than expected but was also the 11th consecutive month of gains above 400,000, the longest such stretch of growth on record. This resulted in the unemployment rate falling from 3.8% to 3.6%, its lowest level since the pandemic struck.
• U.S. job opening remain high, indicating continued strength in the employment market. The JOLTS report indicated 11.3 million job openings. This compares to around 7 million prior to the COVID pandemic.
• China’s factory-gate inflation eased to its slowest pace in eight months in February as consumer price growth also softened. The producer price index (PPI), which measures the cost of goods at the factory gate, rose 8.8 per cent on-year, the slowest rate since June last year. This is positive as it provides scope for Chinese policy makers to stimulate their economy.

What we didn’t

• Australian business confidence fell 5 points to +14 index points in the first quarter from the fourth quarter of 2021, while business conditions were down 5 points to +9 index points over the same period, according to a survey by National Australia Bank.
• Australian confidence index dropped 4.2 per cent to 96.6 points in March, according to Westpac, the lowest it has been since September 2020. This was attributed to ongoing flooding, supply chain woes, inflation, and Russia’s invasion of Ukraine.
• The University of Michigan consumer confidence index of consumer sentiment dropped to 59.7 points, the lowest level since 2011. This read remains low by historical standards and casts a shadow on the health of the U.S. consumer despite a strong jobs market and strong retail sales.
• U.S. advance retail sales grew 0.3% for the month, slightly below the 0.4% Dow Jones estimate. Stripping out autos, sales were up 0.2%, well below expectations for a 0.9% increase and indicative that after a rapid pace to start the year, consumers were slowing down. Some good news was provided with January figures being upwardly revised to an increase of 4.9% from the initial read of 3.8%.
• The German ZEW headline numbers for March showed that the Economic Sentiment Index deteriorated sharply amid the Russia-Ukraine war, coming in at -39.3 from 54.3 previous while missing estimates of 10.0 by a wide margin. Germany is most affected in Europe from the Russia/Ukraine conflict as they are the largest trade partner with Russia within Europe.
• China’s manufacturing and services sectors simultaneously contracted in March for the first time in two years. The manufacturing reading came at 49.5. Forecasts were for a read of 49.9. A read below 50 indicates contraction.

Base Case

Our view of the most likely scenario for markets over the coming months, for which our portfolios are currently positioned.
72% Probability

The speed of the economic improvement is expected to continue moderating from 2021’s stellar growth rate. Despite this global economic activity is expected to remain above average, although lumpy. This is mainly due to Geo-political tensions, COVID outbreaks along with continued supply chain disruptions.

Central banks in developed economies are expected to diminish their ultra-accommodative policy stance as economies improve and inflationary pressures build. This is likely to manifest itself with a continuations of market volatility over the coming months. The exception to this appears to be China, who is expected to begin a more accommodative monetary policy stance to promote growth within their economy. On the fiscal front governments have indicated they are willing and able to step up with spending to support their economies. Governments are expected to maintain stimulatory policies with an eye to sustain employment and wage growth, as well as supporting long-term social objectives such as carbon reduction through energy transitions and social inequality.

Risks remain. Those we view as most prominent include increased Geopolitical tensions (U.S./China, Aust/China, Russia/Ukraine, China/Taiwan, Iran/Saudi Arabia), greater slowdown in the global economy than is currently expected, faster than expected increases in government bond yields (due to inflationary pressures building), a further increase of COVID-cases across different regions pressuring health systems, continued high levels of supply chain disruptions and stimulus packages that underwhelm expectations.

This scenario is likely to see us maintain a constructive medium-term view on growth assets. Capital preservation will be targeted through appropriate company and sector allocations that benefit from the maturing of this business cycle. Overall asset allocation will retain a bias to growth assets.

Bear Case

Our worst-case scenario for the coming months, which we are prepared to position for should conditions deteriorate.
14% Probability

Global consumer demand for goods and services falls further than expected as the expected pick up from pent up demand underwhelms. Rather, the consumer remains apprehensive once the direct-to-consumer fiscal support from governments and central banks begins to wane. Additionally, supply chain issues remain as do inflationary pressures. Geopolitical tensions could act to further increase commodity prices, further exacerbating inflationary pressures. This could leave central banks with conflicting signals and potential for higher prices to create demand destruction from consumers. Essentially this means financial conditions are tightening while inflationary pressures remain elevated. This could see Central Banks beginning to withdraw monetary support at a time when the economy cannot handle further tightening without crimping demand and economic activity.

An untimely withdrawal or reduction of central bank liquidity could derail financial markets which have become accustomed to liquidity support. Any failure of governments across the globe to extend or further stimulate their economies through fiscal spending would further erode confidence. This may cause consumer confidence and spending to fall as government support is not fully replaced with gainful employment income. Such a scenario would likely see a level of dislocation in financial markets across the spectrum.

Tightening financial conditions added to supply chains issues and high input costs would be expected to place upward pressure on bond yields, particularly if judged to be more sustainable. An acceleration of bond yields from current levels could see valuation compression in financial markets continue, as well as adversely impacting economic activity. This would be more pronounced in high valuation stocks and company’s unable to exercise pricing power.

Rapid escalation in geo-political tensions or a significant or systemic corporate default (especially due to over-indebtedness in an environment of rising bond yields) could see a liquidation of risk assets within a compressed period.

Above scenarios will see us take a more defensive position and reduce equity exposures replacing them with defensive assets, such as cash. The accelerating bond yield scenario would require a more nuanced shift toward companies and sectors that would be the greatest beneficiaries of such a move. The overall focus will remain on capital preservation.

Bull case

Our most optimistic view for markets over the coming months.

14% Probability

Economies across the developed world continue to exhibit strong economic growth with a reacceleration of economic activity. This would lead to a synchronous global growth environment, where economies that have lagged see accelerated growth. Substantial fiscal support from governments would combine with high cash levels on household and corporate balance sheets to sustain the speed of the global economic recovery. At the same time COVID becomes endemic, resulting in mobility improvements and increased economic activity. In the event central banks maintain measures aimed at supressing interest rates below, we would expect this to further fuel asset appreciation, while any extension of these accommodative policies would provide support for  re-rating of asset values..

Such a market dynamic would see substantial improvement in economic activity globally, particularly in service-oriented businesses that will benefit from social re-opening. Additionally, an abatement in supply chain constraints could see inflation moderate, thus reducing pressure on central banks to withdraw stimulatory measures. This would occur as pent-up demand from business and consumers combine with government and central bank stimulus measures to create a potent environment for risk assets.

This scenario would be cheered by financial markets as improving financial conditions act to fuel demand for growth assets in a low to negative real interest rate environment. We would act by ensuring a growth asset bias with low cash levels.

Stock in Focus – CVS Health

CVS Health Corporation (previously CVS Corporation and CVS Caremark Corporation) is an American healthcare company that owns CVS Pharmacy, a retail pharmacy chain; CVS Caremark, a pharmacy benefits manager; and Aetna, a health insurance provider, among many other brands. The company’s headquarters is in Woonsocket, Rhode Island.

In 2021, CVS Health was ranked 4th on the Fortune 500 list, and 7th on the Fortune Global 500 list. The company employs 295,000 people and has a market capitalisation of USD$143 billion.

Consumer Value Stores (CVS) was founded in 1963 by three partners: brothers Stanley and Sidney Goldstein and Ralph Hoagland, who grew the venture from a parent company, Mark Steven, Inc., that helped retailers manage their health and beauty aid product lines. The business began as a chain of health and beauty aid stores, but within several years, pharmacies were added. To facilitate growth and expansion, the company joined the Melville Corporation, which managed a string of retail businesses.

Following a period of growth in the 1980s and 1990s, CVS Corporation spun off from Melville in 1996, becoming a standalone company trading on the New York Stock Exchange as CVS. In December 2017, CVS agreed to acquire Aetna for $69 billion and completed the acquisition in November 2018. Aetna Inc. is an American managed health care company that sells traditional, and consumer directed health care insurance and related services, such as medical, pharmaceutical, dental, behavioural health.