October 2020 Performance – Core Share Portfolios

S&P 500 valuations look stretched

Note: This is part 1 of our performance report looking at Australian and International direct share portfolios. Part 2 is the asset allocation performance report that will come out after the returns for comparable funds become available. 

Inaction on a second American fiscal stimulus bill and a rise in global COVID-19 cases put pressure on stock prices in October. leading to a second consecutive negative return month on most global equity markets. Countries at the epicentre of the coronavirus resurgence in Europe were especially affected, with losses in Germany (-9%), France (-4.%), Italy (-7% ), and the U.K. (-5%) dragging down the global index. Asia proved more resilient with Australia, Hong Kong and some Asian markets posting positive returns. The US saw stock prices drop despite a relatively good quarterly earnings results season. Of the companies reporting by month-end, 86% had performed above Wall Street estimates vs a five-year average of 73%. Domestically the ASX200 had a good month with a 2% gain supported by the budget stimulus, rate cut hopes, takeover activity and an easing of Melbourne’s lockdown.

Over October our Core International tracked below its Benchmarks, explained by our weighting in European stocks that were particularly hard hit. Our Core Australian performed in line with its Benchmark albeit slightly below. Currency proved a tailwind for Core International as the AUD weakened.

An extraordinary clash of conditions 

Investment markets have a host of both positive and negative factors fighting for supremacy. The real question is whether central banks and governments will engineer a continued suspension of capitalism. I was sceptical six months ago. I’m less sceptical now that capitalism will return anytime soon.  On balance, however, there is still plenty of room for caution. 

Short-term government policies to suspend capitalism (increased hurdle for bankruptcies, mortgage holidays, eviction moratoriums, banks not recognising bad debts, etc.) have morphed into medium-term policies. And, it is hard to see any government ready to exit. There is a quiet extension to each policy that lapses.   

We took advantage of pre-election weakness to increase our risk exposure a little. But given the rise in markets since the election, the positive factors have mostly been reflected already. And, the positive factors tend to be short-term, the negative aspects tend to be medium-term.

Key positive factors for share prices

  • Government stimulus: Global governments continue to add stimulus. The US has some question marks, and the stimulus won’t be as large as if Biden won Senate majority. But it would seem additional stimulus is highly likely. 
  • Low probability of US tax hikes: Subject to the Georgia senate run-offs, it looks unlikely the US Senate will pass Biden’s company tax rate increases. If passed, these would have reduced US earnings by around 10%.
  • Earnings very good: 3rd quarter earnings were much better than expected. Analyst forecasts haven’t changed much, but that is better than usual! Typically, later year forecasts are far too optimistic and get revised down as they get closer. Forecast growth is 24% for 2021 and then 15% for 2022. 
  • Inequality to remain high: No changes to taxes in the US = economic inequality likely to remain high. In Australia, there are tax cuts for the rich, reduced support for the poor. Travel limitations depressing spending for the rich. Plus stimulus tends to be relatively indiscriminate; some ends up in the right hands, some in the hands of those that don’t need it. Net effect: the rich have more money to invest.  

Profit path 2021

2021 vs 2019 World earnings

2021 vs 2019 World earnings

Other positive factors for share prices

  • Bankruptcies, evictions limited: in many countries bankruptcies are down 30%+, driven by a mix of stimulus and rule changes. Businesses feel richer if they haven’t had to write down bad debts. Not fixing the problem, just delaying the pain.  
  • Mortgage repayment holidays: as above.    
  • Wage growth very low: helpful to company profits.
  • Productivity: forced change/digitisation often results in better outcomes. Having to fire staff usually results in the least productive going first, increasing overall company productivity. 
  • Low oil prices: keeping transport costs down.
  • Vaccine hope: successful trials give hope to an end of the virus.
  • Policy certainty: President Biden is far less likely than Trump to be unpredictable. 

Key negative factors for share prices

  • COVID in the Northern Hemisphere: It is ripping through populations. Importantly, hospitals are reaching capacity, which means lockdowns have begun again in Europe and seem highly likely in the US.
  • Valuation: Share market valuations are extraordinarily high. 
  • Latent bankruptcies: Changing the rules so that companies and individuals who are otherwise bankrupt are allowed to increase their debt does not fix the problem. It also runs the risk that the bad actors not paying their bills start to pull down the good actors.  
  • Low genuine credit growth: credit growth has been poor; banks are still tightening lending standards. But the credit growth also includes mortgage holidays. And companies are borrowing to survive rather than to make productive investments. Which means genuine credit growth is lower than the already weak headline numbers. Economic growth has been tied at the hip to credit growth for the last decade. It is difficult to see what will replace easy money as the only thing holding economic growth up.     

S&P 500 valuations look stretched


Other negative factors for share prices

  • Short term gap in US economic conditions: There may not be stimulus until Biden takes power. If so, there are three months with limited government support while the virus sets new records. This might be enough to tip the economy into a funk and result in more job losses. 
  • Inequality longer-term effects: the short term effect of increased inequality increases savings and investment and (probably) increases stock market valuations. The longer-term impact is depressed demand and profits. And more political upheaval. 
  • Australian stimulus badly targeted: supply-side rather than demand-side. More here.
  • Structural change: leading to weak demand, higher unemployment. There are industries like travel and tourism which will have to deal with lower sales and employment. The means job losses continue as former employees have to give up on finding a job and retrain for a new industry.  

Net effect

It bears repeating: the positive factors tend to be short-term, the negative ones medium-term. Will there be “clear air” for a few months before the consequences begin? Maybe. The stock market has had a lot thrown at it and is still holding up.

On the flip side, the risks are not symmetrical. The upside appears more limited than the downside. 


Core International Performance Insights

Our portfolio tracked just below its benchmark over the month. Currency once again proved a tailwind this month as a  weaker AUD offset declining returns. 

Regionally it was Asia that outperformed this month. Europe saw the worst declines as countries imposed lockdowns to combat the Covid-18 second wave. The acceleration of deaths in Europe now threatens to surpass the initial surge.

Core Australia Performance Insights

The Core Australian portfolio closely tracked its index over the month. The most significant contributor was the jump in Coca Cola Amatil on the back of its parent’s take-over offer. Our portfolios continue to be lower risk than the market. 

During October we removed Telstra and Ampol, included Computershare and built an initial position in Treasury Wines. Towards the end of the month, we took profits on our Rio Tinto exposure as we see risks to the iron ore price and down-weighted Ramsay given its European Hospital network that we see as vulnerable to European lockdowns.


Damien Klassen is Head of Investments at Nucleus Wealth.

Follow @DamienKlassen on Twitter or Linked In

The information on this blog contains general information and does not take into account your personal objectives, financial situation or needs. Past performance is not an indication of future performance. Damien Klassen is an authorised representative of Nucleus Wealth Management, a Corporate Authorised Representative of Nucleus Advice Pty Ltd – AFSL 515796.