Investors say market momentum to flow into 2021

Ever since markets bottomed out in March 2020, thanks to the US Federal Reserve’s “whatever it takes” stimulus announcement, equity prices have been strong as investors ignored the present and looked six to 12 months down the road. The information technology sector, in particular, has outperformed as have commodities such as iron ore and copper.

“The most confounding thing about financial markets in 2020 was that, in totality, the mood of the global equities market seemed completely different than the mood of everything else happening to humanity,” Olivia Engel, global chief investment officer active quantitative equity at State Street wrote in a note to clients.

She says 2021 stock prices will start to reflect fundamentals – rather than expectations – as markets stand on the “threshold of a new investment reality as COVID vaccines roll out and monetary and fiscal conditions change in response to a global economic recovery”.

Investors will soon learn whether the market’s eye-watering valuations are justified or whether they are a frothy side-effect of unbridled optimism due to low-interest rates.

The 2021 reality for Australian companies should become clear within a few weeks as first-half reporting season kicks off.

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Morgans analysts Andrew Tang and Tom Sartor have an optimistic outlook but note there is a “risk of surprise in company results that have significant leverage to the recovery”.

“Overall, we expect outlook commentary to be better than what was provided in August, and we think some companies will provide first time guidance,” they wrote in a recent note to clients.

Forecasts for earnings in the industrial and energy sectors have the widest range, meaning analysts are unsure of how these companies will fair. But there is strong consensus expectations for dividends from the telecommunications, consumer staples and utilities sectors. There is less certainty on the dividends expected to come from energy, industrial, financial and material sector companies, except for the iron ore producers enjoying strong prices.

On average, the 12-month dividend yield forecast for the ASX is currently below average at 3.4 per cent. The Morgan analysts note utilities, telecommunications, energy and materials are expected to pay the highest yields. And among the banks, Westpac is expected to pay the highest yield of 5.8 per cent, followed by ANZ, NAB and Commonwealth Bank. Bank of Queensland has the lowest expectation at 3.5 per cent.

“The key major resource companies are already comfortably de-geared such that most of their surplus sale proceeds are likely to make their way back into the hands of shareholders. We expect above-average dividends by the major miners,” they wrote.

Specifically, Morgans expects BHP to deliver “bumper earnings” with strong cash dividends of about 76.8¢ per share compared to 65¢ in the first half of 2019-20. Fortescue’s first-half dividend could be as high as $1, up from 59.3¢ in the previous corresponding period.

“We see real potential for Rio Tinto to announce a special dividend at its full-year result, in addition to a healthy ordinary dividend,” Morgans analyst Andrew Prendergast wrote. Chinese demand remains the key risk for all three miners.

Peter Gardner at Plato Investment Management shares the enthusiasm for iron ore miners and says 2021 will be much better for people living off capital. However, he expects bank dividends will not return to 2018 levels anytime soon.

“The dividend landscape has shifted significantly and just a few years ago who would have thought the strongest dividend payers in 2021 would be iron ore miners and certain consumer discretionary stocks?,” he says.

“But that’s exactly where we expect the strongest dividends to flow from over the next twelve months.”

Gardner adds economic stimulus around the world is evolving from income support to infrastructure spending, which creates strong demand for iron ore. “Even if the iron ore price was to come off significantly from today’s price some of Australia’s best miners will still be generating a lot of cash.”

Spheria Asset Management’s Marcus Burns is also tipping an increase in mergers and takeovers thanks to an abundance of liquidity and extremely low-interest rates.

“In addition to private equity being in the fray, many corporates now have extremely well-positioned balance sheets as they’ve foregone paying dividends during most of COVID-19 and some also having raised too much precautionary capital during the COVID-related sell-off in early 2020,” he says.

This could be lucrative if investors have shares in the target companies, which are usually cash-generating with modest gearing.