Balanced Equity Management – Australian Equities Outlook 2021

Alastair Hunter provides the Balanced Equity Management team’s outlook for Australian equities in 2021.

    Alastair Hunter

    Alastair HunterChief Investment Officer, Balanced Equity Management

    Balanced Equity Management - Australian Equities Outlook 2021

    Australian equities, as represented by the ASX 100 Accumulation index, delivered a 0.8% total return for calendar 2020. This compared to a total return for global equities of 15.7%. Australian equities have lagged the global market recovery in 2020 mainly as a result of our cyclical market composition (small technology and large financials/resources exposure). Relative performance was more consistent with global markets post November’s vaccine developments as investor focus shifted to economic recovery thematics which aligned with the Australian market’s cyclical bias.

    Source: Franklin Templeton, IRESS

    A Sharp Eye Towards Interest Rate Levels

    The 2020 calendar year concluded with a number of market uncertainties being resolved (US election, fiscal stimulus programs, Brexit deal, effective COVID-19 vaccines). This leaves the market and economic outlook in 2021 largely dependent on the success of the global rollout of the various COVID-19 vaccination programs in reversing current sharply rising pandemic cases. Global fiscal and monetary stimulus is likely to remain accommodative for equities until vaccines deliver the desired health and economic outcomes.

    We are of the view that equity valuations are high. The key driver of this outcome has been low interest rates and significant liquidity flows from monetary and fiscal stimulus. Whilst the expectation remains for a multi-year period of sustained low interest rates the outlook for equites as corporate earnings strongly rebound appears favourable and tactical asset allocation towards income generating risk assets such as equities will be well supported. However, we are acutely aware of the tail risk of rising interest rates. This is perhaps a low probability outcome until the global economic recovery has matured but given high equity market valuations, it would entail a material risk of a market correction.

    As the global economic recovery gains momentum through 2021, reflation fears will increasing come into focus. Long bond rates have increased ~50 basis points to around 1% in Australia and the US. Equity market resilience could withstand long bond rates towards 2%, but we would be concerned if they cross above that level.

    Positioning for An Early-Stage Value Rotation

    In our view, the value rotation is in its early stages. The recent relative outperformance of value over growth, whilst large, needs to be viewed within the context of the sustained relative underperformance by value over the past 3 years. As has been the case with cycle driven outperformance by value (2008-9, 2016), we believe that the preconditions currently exist for a prolonged (but non linear) value outperformance well into calendar year 2021.

    Relative Performance of Value vs Growth Styles (June 06 – Dec 20)

    Source: Franklin Templeton, Bloomberg

    We have trimmed our exposure to the recovery sectors in response to the reduction in upside to our valuations post their November outperformance. However, our portfolios remain tilted to companies where we view the market is still undervaluing their sustainable earnings into the normalised economic period ahead.

    We prefer companies within the Industrial sectors that are exposed to the economic recovery and vaccine rollout upside. Telecommunications is a sector that also looks attractive to us. As market rotation occurs and PE dispersion declines, we will be looking for opportunities in the healthcare, technology and staples sectors as their relative valuations to return to more attractive levels.

    Within the REITs we see valuations in the shopping centres sector remaining overly negative on their medium-term prospects. We retain more negative views on industrial, office and residential exposed REITs on valuation and economic outlook grounds.

    The outlook for the Banking sector has improved with impairment losses now likely to undershoot prior expectations resulting in upside risk to earnings and dividend outcomes in 2021. However, low interest rates and subdued credit growth will weigh on bank earnings as revenue pressures endure. Bank dividends, a key source of tax efficient income for many investors, are likely to rebound sharply in 2021 and 2022. In a sustained low interest rate environment, a restoration of income attraction thematics may quickly boost bank share price performance as sector asset quality concerns abate with growing confidence in the economic outlook.

    We see valuations as attractive in the general insurance stocks which are expected to exhibit strong earnings recovery from weak FY2020 results (investment losses, bushfires, COVID-19 claims, and costs). Business interruption insurance claims are the main concern, although we view that the current share prices reflect material loss assumptions.

    The resources companies are benefiting from buoyant commodity prices, which in most cases are currently trading at or above our long-term assumptions. Strong Chinese demand is driving this outcome, along with global economic stimulus packages aimed at sectors such as infrastructure and construction that drive demand for commodities. We expect Australian mining companies to perform well relative to the broader Australian market and we are overweight the sector.

    Iron ore remains well above our long-term forecasts and is likely to remain so as supply disruptions and strong Chinese demand supports elevated prices. However, we continue to reduce stock exposure to iron ore as prices (>$160/t currently) are at levels that are not sustainable into the future and the risk of a significant correction is high.

    We are constructive on the energy sector and oil is one of the few commodities where spot prices are in line with our long-term assumptions. Demand destruction from economic recession will moderate over time and rationality is evident on the supply side, suggesting potential for oil prices to trend higher. We are mindful of the current pivot in the climate change debate and longer term decarbonisation impacts on this sector.

    In the gold sector, we have moved to a modest overweight position during the recent pullback in gold equity prices. We see gold equities as providing defensive qualities to reflation risk, exposure to ongoing liquidity support from Governments and central banks, and attractive relative value at spot gold prices.

    As balance sheet strength returns across the Australian market and economic uncertainty diminishes, we will proactively engage with Boards and management to ensure companies return to paying sustainable dividends, utilising DRP schemes to manage prudent capital levels and ensure franking credits flow through to shareholders. Balance sheet strength and low borrowing costs are supportive of merger and acquisition activity increasing in the market, including cross-border transactions.

    The Australian Economy – A Critical Period Ahead

    Australia’s economic recovery has stuttered as re-infection waves spark local and temporary State border lockdowns. Australia is entering a critical period ahead as the economy moves ex-welfare support and interest/rent/tax deferrals come to an end. Australia also has a very delicate political path to navigate to avoid seeing our large economic exposure to China turn sour (as many non-essential goods exporters have already endured). By mid-2021, a clearer view will be evident of the strength and duration of the domestic economic recovery.

    Learn more about Link:Link:, an actively managed, low-cost approach to Australian equities.

    Important Information

    Franklin Templeton Investments Australia Limited (ABN 87 006 972 247) (Australian Financial Services Licence Holder No. 225328) issues this publication for information purposes only and not investment or financial product advice. It expresses no views as to the suitability of the services or other matters described herein to the individual circumstances, objectives, financial situation, or needs of any recipient. You should assess whether the information is appropriate for you and consider obtaining independent taxation, legal, financial or other professional advice before making an investment decision. A Product Disclosure Statement (PDS) for any Franklin Templeton funds referred to in this document is available from Franklin Templeton at Level 19, 101 Collins Street, Melbourne, Victoria, 3000 or www.franklintempleton.com.au or by calling Toll Free 1800 673 776. The PDS should be considered before making an investment decision. Any research and analysis contained in this presentation has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Any views expressed are the views of the fund manager and do not constitute investment advice. The underlying assumptions and these views are subject to change. Franklin Templeton accepts no liability whatsoever for any direct or indirect consequential loss arising from the use of this commentary or any information, opinion or estimate herein. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not an indicator nor a guarantee of future performance. Any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets is not necessarily indicative of the future or likely performance.