Views from the frontline – 1 May 2020

In a week where the FTSE100 tipped back over 6,000 (briefly!) we have split the update into five themes – psychology and society, health, global economics, the role of technology, and environmental issues.

This reflects the nature of the different discussions we are having, and all provide different and interesting insights.

Psychology and Society

Validea’s Guru Investor

This update focused primarily on psychology and COVID-19 and these are a few aspects we thought were worth sharing.

The first focused on investors’ actions when everything is falling in value, and the desire to move to cash.

They referred to a three-step process:

  1. Purpose – revisiting the plan, and asking why we went on this investment journey in the first place and rather than focusing on the here and now, looking at the longer-term picture
  2. Proof –immersing ourselves in market history and looking at what we know. As an example, over the last 100 years, for 20% of the time there have been recessions where there is a significant drop; the forward returns rise significantly, and if we stay the course and understand the risk, we will be rewarded
  3. Process – we feel we need to do something, but not the wrong thing, effectively the idea is keeping our hands busy, so we do not mess up

The other aspect for us to understand is our risk composure (our ability to take risk). Our actions will repeat unless we stick to the process. If we have panic-sold in the past, we will repeat this, and it is hard to break that cycle.

Some interesting societal observations were:

  • There is a concern this could deepen both the class and wealth divide
  • Those who can afford to stay home, will stay home. Those who cannot, have to return to work
  • The essential workers tend to be at the other end of the class and wealth divide
  • Those with money will tend to favour a continued shut down because they have money coming in, if you do not then you want restrictions lifted

Health

AXA (Healthcare and Biotechnology Team)

Their focus was on current events and what we should be looking at:

  • This crisis is showing the biotechnology industry at its best. There is significant co-operation between companies and authorities. Gilead (as an example) has reported positive results on a therapeutic drug and the FDA could approve this very soon, and this could be in production before the end of the year
  • This is a brand-new virus and it can morph and change. It is not easy to kill the host so it can go where it wants and evades the usual protections we would put in place. There are 4 different strains of the virus currently
  • The way to reduce the spread is by containment (lockdown) so you limit person to person contact. But that cannot last forever. You need testing, tracing, treatment and obviously a vaccine
  • Gilead are developing anti-viral drugs which reduce the recovery time. Amgen are developing a temporary immunity drug
  • There are over 100 vaccines in clinical trials including those by Oxford University, and they are expecting some early data in June. They are expecting more data on therapeutics and vaccines in the coming months
  • For testing there are two types – one tells you whether you have had it, but it does not show who has been exposed or any potential immunity. The second is serological testing which shows how many people have been exposed and any level of immunity
  • Currently the thinking is that you can be re-infected, therefore you may need a booster each year
  • Very different risk/benefit consideration, the FDA will not take any short cuts in approving a vaccine, we will have data but there will not be a rush to approve a vaccine

Global Economics

BlackRock (George Osbourne)

Thoughts on where we are today:

  • There remains a high degree of uncertainty as to how we come out of lockdown
  • Ministers will be cautious about coming out too quickly due to the criticism on going in too late
  • There is evidence that most people favour a continued lockdown, and the government will know it will be harder to re-impose a lockdown once we come out of it
  • There are concerns when we come out that deaths increase, and this impacts public confidence especially for sending children to school and the usage of service sectors
  • This crisis has exposed the bureaucracy within government departments regarding equipment and testing
  • It is likely any lifting of restrictions will require the use of a tracking app like the one used in Asia
  • Many observers have missed that lockdown was fundamentally about protecting the healthcare system, which it has succeeded in doing. The Government will take heart that the healthcare system has been able to cope with this crisis

The economy:

  • The furlough scheme is holding the economy in a zombie state, but it stops job losses at a time where companies are not recruiting
  • There are concerns that upon exiting lockdown, we will see more corporate failures and job losses
  • The new government arrived with a mandate to spread economic prosperity across the country; it now faces a recession and recovery. A great deal of effort will be needed for back to work schemes and firing up small businesses
  • The country will have higher healthcare costs, more debt and higher unemployment. These are long-term economic considerations
  • We have also left the European Union and although it is unlikely that either side wants a no deal scenario, this risk remains by default and markets are not pricing this in

BMO (Chief Economist)

Opening thoughts:

  • We are winning the war against the virus; there is a flattening of the growth rate – Spain and Italy around 1%, the UK is around 2% but expect this to go up as we test more
  • Focus is now on the economic impact – UK GDP for Q1 is expected to be -10%, US was -1% (figures quoted in press are annualised figures) and in Q2 US is expected to be -10%
  • Corporate earnings have been slashed by analysts, expect this to continue but this is a temporary event and stimulus has been massive
  • The recovery will be unusual, and they do not expect this to fully recover until 2021
  • They believe data from China is accurate, however everyone is reporting the figures differently
  • They think markets may pull back in May, but potentially will be higher by the end of the year than now
  • They are worried about deflation, and think interest rates will stay lower for longer
  • They are also worried about consumers who have used credit cards and taken mortgage payment holidays as this could slow the consumer recovery as they pay down debt

How do we come out of the lockdown?

  • Five key areas to coming out are testing, tracing, PPE (shortage is easing, as cases come down so demand falls), danger of a second wave and finding a vaccine
  • How they think coming out of lockdown might look:
    • End May/June – more retail opening, limited return for schools, some sport, manufacturing begins to restart
    • July – hairdressers and beauty salons reopen with strict limits, pubs and restaurants with outside facilities reopen
    • August / September – schools and universities reopen with severe restrictions
    • November / December social distancing relaxed for non-vulnerable groups
    • 2021 – all restrictions relaxed

AXA (Economic Team)

Thoughts on recent announcements:

  • Starting to gauge the impact of the shutdowns; the US announced a decline of 1% and the expectation was around 5%, this indicates the potential for a shallow recession – similarly in Germany with a contraction around 2%
  • Italy, Spain and France are looking at a 5% contraction and the concern is that where Germany and the US have used massive stimulus and are looking to exit sooner, countries like Italy, Spain and France don’t have the same financial levers to lift them out. Therefore, it is likely these economies suffer deeper recessions
  • Concerns exist regarding ECB action as there have been no definitive announcements on help to economies, now everything is focused on the banks
  • There appears to be light at the end of the tunnel but there is likely to be a division between those countries who come out of this best, not only whether this is a shallow or deep recession, but more importantly the ability for the country to stimulate the economy as they exit that recession

Jupiter (Economic and Merlin Team)

Current thinking:

  • The current lockdown will end eventually; the pain of this and when it ends are the two unknowns
  • What we know is that governments will do whatever it takes to keep businesses and jobs (where it can)
  • Equity markets are rewarding those companies with visible earnings, those companies with stretched balance sheets will not survive this
  • Markets will not wait for an economic recovery
  • There is a politically correct feeling that paying dividends is bad, which impacts pensions savings and income streams
  • Research from the US and China indicates it is impossible to eradicate COVID19 fully and it will just adapt to survive; this is here to stay and we must learn to live with it

Economic data

  • Some sectors have held up well, healthcare and tech are good examples, but global tourism is on its knees. It makes up 10% of global GDP
  • PMI data in the UK is showing manufacturing at 17 and service at 12. In the global financial crisis manufacturing was 30 and service at 40. Above 50 an economy is in expansion
  • 15% of the UK private sector workforce are now supported by the state. This is 4 million people in the UK, and across Europe this is 30 million people

Eurozone:

  • This remains a concern because there is no common ground, and the rift between the North and South is growing
  • The EU is long on management and short on leadership. New leadership is in place and the end goal must be a United Europe, akin to the US, but not sure this will happen
  • Structural issues are a problem and where unemployment across the Eurozone is 8%, in certain countries like Italy, Greece, Spain and Portugal this is significantly higher. Germany is heavily reliant on car manufacturing which is under pressure
  • Europe has fallen behind the rest of the world, and China creates a larger proportion of global GDP. There are genuine concerns on what the implications are should the Eurozone collapse

Aberdeen Standard (Income Fund Managers):

Headline thoughts:

  • This crisis has been caused by government action. Markets will understand this is a temporary event, and this has created mispriced opportunities
  • Markets will recover before the end of the recession, on average 4 months before. If we wait, we will miss out on the inevitable recovery when it comes
  • There will be a demand to get back to normal, and share prices will not hang around waiting for the recession to end
  • This is an opportunity to buy into great companies at heavily discounted prices, and these opportunities do not arise often
  • The risk lies in a second wave leading to irrational behaviour and heavy market falls

Dividend income:

  • There is expected to be a 30% cut in dividend income in the UK, forward pricing expects this to rise to 49% – finding income in the UK in the short term will become much harder to come by
  • Europe is following a similar path but depends very much country by country. In France companies are stopping dividend income, Germany is continuing to pay
  • In Emerging Markets, they are expecting about a 20% dividend cut but mainly from businesses which are fundamentally challenged due to high levels of debt and weak cash flow, as well as those businesses caught in the eye of the storm

JPMorgan (Guide to Markets)

What is price? Does value exist?

  • P/E as a valuation basis is useless now (and has been for a while)
  • The three main questions to ask about any company are what your expected growth rate over time is, what is the certainty of those numbers and how much risk premium must be taken to achieve that
  • Only then can you get a true value for a company, in this current environment those companies which have a clearer trajectory of earnings will likely become stronger
  • Those companies will be ones that can expand in a low growth environment
  • In terms of value we need to look at this differently – there are three types of companies: those that will survive, those that thrive and those that die. An example would be UBER, it has net cash, no expenses and even though revenue is significantly down it will likely survive. If you take an airline or hotel group, the outcome is less certain. So rather than asking whether value will come back it has to be at a stock level and focused on the three areas – survive, thrive or die

Current thoughts on the economy, there are three areas that they focus on:

  • Infection contained – here they are looking for a vaccine, and that countries meet criteria for shutdown exit strategy
  • Policy response – here they are looking at a credible ECB backstop, details of an EU joint solution and Brexit negotiation extension
  • Economic resilience – looking to the earnings season, and unemployment data

Food for thought:

  • Paper called “Containment efficiency and control strategies for Corona pandemic costs” https://arxiv.org/pdf/2004.00493.pdf
  • Three areas to coming out – ramping up testing, tracking and when infection rates come down
  • South Korea, Norway, Denmark and Austria are in the right place to start easing. UK and US are not anywhere near meeting this criterion and there is a worry we exit too soon

This time IS DIFFERENT:

  • In other recessions, markets dropped as earnings come out
  • This time, markets dropped before earnings were reported, and we know that Q2 will be the worst on record
  • We may have already reached the bottom because of these factors
  • Also, there are two factors which are missed – the level of stimulus and the positive rate of change in Q3 and Q4

JPMorgan (Japanese Team)

Views from Japan:

  • There is a state of emergency, but life is very different to the UK, and very little panic
  • First death 15th January, now 400
  • 42 new cases in Tokyo and these are falling
  • Reasons could be the number of hospital beds which are 14 per 1,000, in the UK this is less than 4 per 1,000, there is no social contact when people meet, and people wear masks
  • Shops are well stocked, with restaurants, barbers still open
  • Acceleration of themes likely to be online entertainment, online shopping, automation, healthcare, cashless payments and enterprise software

Schroder (Economic Team)

What aspects of the oil crisis should we consider?

  • On the positive side, lower oil prices should feed into lower energy prices and fuel costs
  • The problem is not with the consumer but more the lack of demand which is causing solvency/liquidity issues for oil companies
  • Some companies cannot afford helicopters to get workers to the rigs
  • The impact of job losses and company insolvencies could impact the economy and therefore counter any positive aspect of lower prices

Where we are today:

  • Starting to get PMI data, GDP figures are coming out this week, and many central banks are meeting in the coming days
  • At the same time, we are seeing easing of restrictions in Spain, Germany and parts of the USA. Italy is considering opening bars, restaurants etc in June
  • Germany have now backed an EU recovery fund but still need to know more about the scale of it, whether it will be loans or grants, how it is paid for etc
  • Still concerned the markets are not reflecting all the bad news that is coming
  • Short term they are expecting a deflationary environment but longer term they are worried about hyperinflation
  • Much depends on the ability for companies to survive, jobs being retained and how the levels of debt by governments impact future growth

Templeton (CIO Series)

Current thoughts:

  • They remain concerned that the market is too optimistic
  • There are more challenges, but we will get through this. The world we are facing now will be different to the world we have just left
  • Areas they are focusing on are unemployment, activity and trade data. This will determine what damage has been caused and when a return to normality may come
  • Also focused on behavioural impact on consumer spending, especially where there are more bankruptcies than perhaps has been factored in and permanent long-term unemployment
  • They think there will be a greater shift to de-globalisation which has long term implications, they think the geo-political dynamics will become stretched and supply chains will alter dramatically
  • They are concerned higher debt levels will squeeze future global growth

JOHCM (UK Team)

Very easy to be negative but there are three factors which cannot be priced in, though all of which could change things very quickly:

  • How people behave when we come out of this
  • The pace at which scientists understand coronavirus, and if there is a material change in the way it is managed
  • The speed of when a vaccine becomes available

Role of technology

Invesco (NASDAQ-100 Team)

Key messages:

  • The NASDAQ-100 reflects how technology has changed – for example 46% is in IT, 21% in communication services, 15% in consumer discretionary and 7% in healthcare
  • Technology is not the tech bubble all over again, these tend to be high quality, cash rich companies
  • These are innovative companies – Amazon is not just a shopping outlet but also has webservices, Apple is constantly changing, Tesla could be an auto manufacturer, space company, energy provider etc
  • These are global companies with nearly 50% of revenues generated outside of the USA
  • In this environment technology focused companies can take more market share, and come out stronger

Environmental Issues

BMO

Thoughts from the team included:

  • Moving forward the risks that society face will focus more on environmental and technological threats
  • Where there are long-term structural challenges there are also significant tailwinds, which will likely accelerate post COVID19 especially in technology and healthcare
  • Greenhouse emissions will drop by about 5% this year which is short term and much still needs to be done to reduce it to the target of below 2 degrees
  • 2020 was the year countries would come together with environmental action plans, this is now delayed and potentially as a result of COVID19 enable more concrete action
  • Some themes being explored are whether investment is channelled towards the green recovery, and behavioural changes (changes in business conferences, business travel, commuting etc)

Fidelity (CIO Update)

  • They believe this could be a pivotal moment where there is a greater focus on sustainability
  • They think society will demand better sustainability
  • This will likely lead to focus on global supply chains, how employees are treated and as a result companies focus more on taking care of employees vs margins. For consumers this could lead to higher prices
  • There are trends which are likely to stay and there will be obvious winners especially around worker flexibility and working from home, re-localisation of supply chains etc

Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.

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