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Investor Update
Extraordinary Coordination – MST November Newsletter

There continues to be a two-steps-forward-one-step-back process in dealing with the pandemic. A rising number of new cases in the northern hemisphere suggests we are currently taking a step back. There are now roughly 500,000 new daily cases of the virus which is a record. The recent increase in the number of cases can potentially be considered the 3rd wave of the virus and, it is causing social distancing restrictions to be implemented once again. With new restrictions we should also expect a slowdown in the recovery the global economy is now enjoying, but it is also becoming clear that humanity is better at dealing with the virus than before. The ‘death rate’ of the virus has continued to fall as treatments have improved and those most vulnerable are self-imposing social distancing measures.

Providing further reason for hope is a vaccine for the coronavirus. Never has the global pharmaceutical industry, with considerable help from governments, concentrated so much capital on just one problem. There are four front runner vaccines and there is hope emergency doses, for healthcare workers and the elderly, will be available before year-end. Communication from the Australian government leads us to forecast most of the domestic population will be able to receive the vaccine before the end of 2021.

US: MEET THE NEW BOSS

While counting in the US election continues it appears Biden will become President and senate control will be retained by the Republicans. As they have done in the past, we expect the Republican senate will be effective in blocking many of the bills put forward by the Democrats including the U$2.2t fiscal proposal which was attempted before the election. Instead senate Republicans have proposed a much smaller $500bn package. While the smaller
stimulus package will mean US policy makers will miss a chance to broaden and sharpen the burgeoning economic recovery, the change may not necessarily be negative for stock prices. While there will be less fiscal stimulus with a Republican controlled senate, we should expect more monetary stimulus. This will involve an even longer period of lower-for-longer bond yields and discount rates. The consequences of this will be positive for financial assets without immediately being positive for the economy. Lower-for-longer bonds yields will probably result in higher equity valuations, and greater support for ‘growth’ stocks, like the Technology companies. A lower cost of funding should also encourage more M&A activity, of course financed by cheap debt.

The diminished ability to legislate change in the US, should mean some of the policies investors were anticipating, will not eventuate. The Democrats were proposing a carbon neutral electricity sector by 2035 and an adoption of the Paris Agreement. Both environmental proposals would have weighed on fossil fuel production by the US and served to benefit non-US oil & gas companies, in our view.

Also, the Democrats were proposing further restrictions on Financial regulation which would have included a tightening of the Volker rule and supporting Glass Steagall. While the Democrats can still introduce stricter regulation via executive orders, the scope of these will be limited.

Trump has introduced restrictions on immigration via executive orders and we expect a Biden Presidency to reverse these. The travel ban on several Muslim countries will probably also be reversed. These changes will be obvious positives for the housing sector in the US. A Republican senate will no doubt hold up legislative change in the US. Meanwhile, we expect individuals with more orthodox approaches to be appointed to key positions like Treasury Secretary and Governor of the Fed. In the US we are entering a period of policy predictability, in our view. As a consequence ‘hedges’, like gold, are likely to be less popular.

AUSTRALIA: EXTRAORDINARY COORDINATION

While the outlook for the US economy is in a wait-and-see-mode, in Australia we are witnessing extraordinary coordination by policy makers that will ensure a sharp recovery, in our view. The Australian Treasury announced the biggest fiscal deficit since WW2. At 11% of GDP the budget short fall for FY21 will be almost three times larger than during the global financial crisis 20 years ago. The level of government indebtedness is set to grow precipitously and would have previously been a signal for higher bond yields, but not now. Phil Lowe, Governor of the RBA, followed Frydenberg’s fiscal easing with a promise to ease monetary policy as well. It appears the central bank is set on holding down the cost of funding for fiscal authorities to circumvent free markets. Economists call this financial repression and is it is good for borrowers and bad for savers. We believe the Australian economy will be in a situation of financial repression for several years. Savers need to work harder to find investments that provide an adequate return. The combination of broad fiscal support and uber easy monetary conditions should support domestic demand in Australia.

The extraordinary coordination between fiscal and monetary authorities in Australia, provide us with more confidence that Australian corporate earnings will enjoy a V-shaped recovery. We know of the nine previous profit recoveries since 1940 seven were V-shaped, one was a W and another was an L-shaped recovery. There are early signs of a sharp rebound in corporate earnings in Australia with analysts upgrading their outlook and companies restructuring to increase operational leverage to an improvement in revenue. We are forecasting 20% gains in ASX 200 EPS over the coming 12-months and double-digit profit gains for the 12 months following. This is higher than current bottom-up consensus forecasts. Against a backdrop of rising earnings, we believe Aussie equities will continue to rally and introduce our Dec-2021 forecast for the ASX 200 at 7000. This should mean investors enjoy capital gains of 15-20% from here. At 7000 our long-term measures suggest the equity market will be closer to fair value.

COVID RECOVERY

The prospect of society learning how to live with the virus, which may involve a vaccine, suggests investors should tilt portfolios towards those stocks set to benefit from a post-COVID economic normalisation. This should include companies which are still suffering from social distancing measures like the gaming stocks, the travel companies, and hospitals. Many of these companies have performed well over the last few weeks but remain attractively priced
when compared to estimates of mid-cycle cash-flows. While the COVID recovery will be good for some companies that have suffered in 2020, it won’t be good for all, in our view. An area we believe will be left behind as the market recovers include the Banks. The behemoths of the Australian equity market face the task of trying to sell more debt to already highly leveraged Australian households. While the banks may appear to be cheap when compared to their
historical valuations, the prospect of achieving historical levels of profitability appear low.

LET’S MAKE A DEAL

Global M&A activity has been subdued for several months, but now companies are reengaging their animal spirits. We believe we are at the very start of the next M&A cycle and deal activity is set to be supported by cheap funding, still cheap equity valuations, solid balance sheets and a need to restructure given the economic changes wreaked on the global economy by the pandemic. In Australia too, animal spirits have awoken with several large deals announced in the last month. We expect more to come. Our screen of potential targets includes AMP, Ampol, Crown, Downer, Oil Search and, Santos.

METHODOLOGY & DISCLOSURES

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OTHER IMPORTANT DISCLOSURES

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