Two Scenarios

There are arguably two scenarios for the market that could play out between now and Christmas and making money in the stock market will depend on which one transpires. Here is a description of what those two scenarios might be and how you would play the stock market under both. The problem, of course, is that we do not know yet which one is going to play out and the market has become a bit bipolar, believing its SCENARIO ONE one day and SCENARIO TWO the next. No-one knows which way to jump. As Hamish Douglass said in his recent letter to shareholders: “Investors should be prepared for a wide range of potential outcomes in the next 12 months. There is a real possibility of a collapse in equity markets, just as there is for a continued grind higher in equities supported by low interest rates.” The two scenarios are almost polar opposites: The first one we'll call SCENARIO VACCINE - it's not quite accurate but it'll do - In this scenario, one way or another the virus ceases to be an economic issue. Lockdowns end and everyone gets back to normal. That could happen a number of ways, the virus is brought under control by vaccine, containment or is ignored through the acceptance of mass infection. Consequences:
  • Economic rebound.
  • The stock market goes up.
  • Risk-on assets recover.
  • Emerging markets up.
  • Stock market stocks go up (Stocks like MQG, MFG, ETFs).
  • Value (oversold) stocks rebound.
  • Cyclical stocks rally – Resources, Financials, Housing, REITs (mainly office and retail), Retailers, Healthcare.
  • Growth and quality stocks jump – Healthcare.
  • COVID-19 hurt sectors rebound – Energy, Travel, Tourism, Gambling, Hotels, Restaurants, Education, Employment, Auto.
  • A$ up, US $ down.
  • Interest rates bounce.
  • Technology underperforms (might still go up).
  • Defensive sectors underperform – Food, Staples, FPH, A2M, COL, WES, WOW.
  • Chinese exposed stocks outperform.
  • Income stocks underperform as the focus turns to recovery and growth and away from income.
  • Sectors that benefit out of monetary accommodation fall – Gold.
Let's call the second one SCENARIO VIRUS - The virus is not contained and continues to be taken seriously. Lockdowns and the economic damage continue, sporadically, in different states, countries and at different levels at different times.
  • Economic malaise/risk.
  • The stock market goes down or sideways.
  • Risk-on assets flounder.
  • Emerging markets down.
  • Stock market stocks underperform.
  • Value (oversold) stocks stay down.
  • Cyclical stocks underperform – Resources, Financials, Housing, REITs (mainly office and retail), Retailers.
  • Growth and quality stocks are ignored – Healthcare.
  • COVID-19 hurt sectors stay under a cloud – Energy, Travel, Tourism, Gambling, Hotels, Restaurants, Education, Employment, Auto.
  • A$ down, US $ up.
  • Interest rates near zero and going negative.
  • Technology performs and outperforms.
  • Defensive sectors outperform – Food, Staples, FPH, A2M, COL, WES, WOW.
  • Chinese exposed sectors continue to perform.
  • Income stocks hunted as income becomes hard to find.
  • Sectors that benefit out of monetary accommodation rise – Gold.
The rather confusing element to the market at the moment is that we flick daily from one scenario to the next from day to day as the virus news rolls in. One days the focus is on rising cases. The next it is on vaccine hopes. It's stop-start. No-one knows where to jump from one day to the next. So how do you play it? The overwhelming theme at the moment is scenario VIRUS – the virus is hanging around for the moment. Cases in the US are dulling the V-Shaped recovery hopes. Cases in Australia, whilst a bit irrelevant except to Australia, aren't helping. The key to the market is timing the moment we flick from scenario VIRUS to scenario VACCINE. We are not there yet. Hence our rather cautious attitude towards the market. The sectors that thrive under scenario VIRUS have already got away – Technology and Gold. The Defensive sectors that outperform in scenario VIRUS are of little interest having already outperformed - they are not growth sectors. They may be of some interest to us as income stocks over the results season but they are not compelling enough to be considered growth stocks. The good news is that there is significant money to be made getting the timing right. The recovery in the COVID-19 affected sectors will be a tremendous money making opportunity as it was between March 24 and June 12 (Energy, Travel, Tourism, Gambling, Hotels, Restaurants, Education, Employment, Auto) and the recovery in the bigger cyclical sectors (Financials, Resources, Healthcare, Housing market) will be significant for the index level and a moment for longer-term income investors to buy for the long-term. Banks in particular will re-price when bond yields start to rise. Technology will underperform although whether you actually lose money in technology is another thing, from their momentum highs they may well correct when the focus turns to more solid investment. Gold will drop as money printing expectations fade. How do you time this? Read the newsletter. We will be all over it. The lead indicator will be a rotation in sector performances., a rise in the currency (A$ going up) but more significantly, the bond market. When bond yields start to rise meaningfully. That will indicate a change in long term economic optimism. You will see it in the bank sector. You will also see it in the acutely sensitive recovery sectors…sectors like energy and travel, which is why the one day ‘pop’ in travel and energy when the market became optimistic about the Australian economy on Tuesday was interesting, although it only lasted a day. We will also be all over it. Keep reading the newsletter, We’ll be jumping up and down on the day we think its time to rotate and that’s when we will put our funds back into the market. Until then we are not investing. The opportunity in technology has gone, to be replaced by more price risk than we care to take, and we do not see the outperforming low growth sectors worth the bother. Despite that we are relatively relaxed about the market if you are invested. We don't see the ‘Precipitous Correction’ risk any more (we did but don’t now), and we are only really out of the market because we got out, and from the outside, for now, we see more downside risk (virus persistence, economic reality coming, money printing cancer, prices too high in some sectors) than opportunity. One day that will change. When it does you will find us here, doing something about it.

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