Resilient Base, Recovery Paced

The start of 2020 was like no other, a year dominated by crisis and response signals. In Australia, the early part of the year was heavily influenced by the bushfire catastrophe and resulting anticipation of stimulus required to offset growth and activity risks. This was quickly dwarfed by the evolution of COVID-19 and the rapid response to it in terms of impact and policy reaction.

The ASX 200 fell -36% peak to trough as containment measures and social distancing effectively stalled activity. Since then, much of the initial post-COVID equity market rebound was either deferred or diluted by an overwhelming focus on forbearance and extension of crisis stimulus.

Morgan Stanley Research believes the combination of strong signals for animal spirits from stimulus and recent positive vaccine developments should take the recent bounce in sentiment and extend and support the recovery for 2021.

Morgan Stanley’s global macro team remains positive on the economic recovery, with activity moving further above pre-COVID levels and surpassing its expected pre-COVID trajectory by the second quarter of 2021. This should be a risk-positive outcome, and we expect above-average returns for equities, as earnings per share continues to recover strongly (25-30% growth in 2021) and multiples are sustained at elevated levels by policy support. The yield curve should steepen modestly, with US 10Y yields reaching 1.45%, and the USD is expected to also broadly weaken.

Morgan Stanley expects Australia's economic recovery to continue in 2021, helped by lower virus incidence and sustained policy support. The near-term data has been better than we expected, particularly in the labour market, and while momentum should slow somewhat, it still results in a stronger base to build a recovery, with output returning to pre-COVID levels by the fourth quarter of 2021. The RBA is likely to extend its quantitative easing and term funding facility programs next year, which should limit the upside from a favourable backdrop for Australian yields and the AUD – we expect 77c by the end of 2021.

Australia has performed well versus global peers over the last several months, and while near-term upside is likely capped due to the run in Index level and as valuation stretch is evident, we do see upside on a 12-month time horizon. Morgan Stanley’s ASX 200 price target for end-2021 is set at 6700 and implies a multiple of 17 times supported by aggregate earnings per share growth of 21%. Morgan Stanley sees current consensus EPS estimates as having largely troughed and a 2021 upgrade cycle as likely.

When assessing the outlook for Australia next year, investors should consider:

• Response to stimulus - Stimulus is now imbedded in the outlook and the key focus moves towards the private sector response. Labour market improvements will slow as crisis support continues to taper - but peak weakness is less than previously expected. We expect a consumer and investment response to build over the coming year, which should assist in a 2021 earnings recovery.
• Shape of the 2021 earnings recovery - One of the key reasons why the ASX200 was unable to fully participate in the equity rebound enjoyed by other developed markets peers was the fact that earnings were continuing to fall. This pulse has now levelled out. Should the stimulus work, the prospect of bottom-up earnings revisions turning positive could spark an upgrade cycle – something we envisage as a 2021 story.
• Positioning for cyclicality - As the global policy response to COVID unfolded, the accelerated and coordinated policy push from fiscal and monetary corners sent a clear signal to start a rotational shift to embrace greater cyclicality in equities. Further rotation around recovery paths can be expected.
• Housing-linked signals - Housing drivers have diverged sharply, with record low servicing costs and government stimulus contrasted with slower population growth and elevated rental vacancies. We think housing will benefit from the cyclical recovery - although exposures still need to be chosen selectively. Apartment prices and construction are likely to lag until migration can meaningfully improve, which is unlikely in the near term.
• Turning Mergers & Acquisitions (M&A) cycle - Global M&A activity is at cycle lows but inflecting. Reaction times for acquirers in this crisis are faster, stimulus settings larger and liquidity pools deeper. Equity valuations look demanding and this could fuel strategic shifts to satisfy investor expectations and fulfil company ambitions. Investors should be alert for apparent value in equities and sectors that may attract corporate suitors but also accept that listed companies with multiple premia and balance sheet capacity will also likely participate in any pick-up in M&A activity.

For more on The Australian macro outlook, or to read the full Morgan Stanley Research report, “Resilient Base, Recovery Paced” (16 Nov 2020), speak to your Morgan Stanley financial adviser or representative. Plus, more Ideas from Morgan Stanley's thought leaders.