05 May 2020

    Reality and recovery

    Coming back from covid‑19

    Bad news and strong markets seem contradictory. But markets are forward looking and have rallied due to some signs of stability. We are more cautious. The reality of this crisis will be with us for many months to come, yet investors seem to be shrugging that off. That reality will also mean changes to industry structure with some businesses getting stronger and some unfortunately disappearing. Much of our focus is on understanding how those changes play out and how to position your portfolios for this new world.

    30m people filing for unemployment insurance in the United States, economic growth plummeting and the human toll rising day after day. A 12.7% rise in the US S&P 500 share market index in April, the third strongest month since 1974. The Kiwi share market had its fourth best monthly gain in its almost 20 year history, as measured by the NZX 50 index up 7.5%.

    In the immortal words of Ernie from Sesame Street (apologies for those of the wrong vintage to get the reference) “one of these things is not like the other.”

    The daily news and market prices seem incongruous. Markets are swinging wildly in both directions. The coronavirus crisis has led to some of the swiftest falls and swiftest bounce backs in market history.

    With an initial sell off as coronavirus spread around the world followed by a rapid rally as economic and healthcare stabilisers kicked in, we believe we have now entered a new phase for markets. Reality.

    This phase is about markets, and frankly all of us, adjusting to the longer term implications of living with coronavirus before a vaccine is developed and we can enjoy a broader economic recovery. Even then the world will never be the same. Industry structures will be forever changed and there will be winning and losing companies.

    While that sounds scary it is providing great opportunities to invest in attractive companies at attractive prices. We are seizing the opportunities worth taking.

    Four stages

    While the disconnect between news and markets can be confusing there is a pattern emerging. We see this playing out in four stages.

    1.  Sell off - as coronavirus spread from China, to Europe and on to the rest of the world the share market reacted with a violent sell off. It was widespread and indiscriminate, for example, leading to the fastest 10, 20 and 30% falls in US shares, in history.

    2. Stability – the strong bounce in markets in April is a sign of the stability phase, which we  discussed in last month’s article.  Two factors would be required to find stability. Firstly, markets needed a policy response that would protect the global economy from the rapid cessation in activity as the world went into lockdown. Secondly markets also needed a stabilisation in virus progression; the flattening of the curve.  

    With both bazooka like fiscal and monetary policy responses, and lower daily case counts, stability returned. The outcome of this was investors started to get excited about a rebound in economic activity post coronavirus. That new found optimism was evident in the companies that led the market higher. While in early April it was more defensive, less economically sensitive companies performing well, by month end the most highly exposed companies in the severely impacted sectors of tourism and retail had caught a very strong updraft.

    3. Reality – unfortunately we think there is another more difficult phase before the global economy fully recovers from the coronavirus crisis. Even then things will not entirely go back to the way they were.  The reality phase is not comfortable but means facing realities like for instance, that one in eleven workers in New Zealand services the inbound international tourism market. The reality for this sector is bleak until there is a vaccine and widespread immunity. It means facing the reality that, as US retailer J Crew announced yesterday, already stressed businesses in disrupted industries like retail, will fail. And it means that unless countries are very careful there will, like forest fire hotspots, be further virus outbreaks if activity isn’t at least somewhat constrained as we come out of lockdown.

    There is a much more optimistic side to the reality we face. Coronavirus is a now a global enemy. The smartest minds and powerful economic resources are being brought to bear to find anti-viral treatments and a vaccine. Betting against this being successful would not be smart, in my view. There will be solutions and eventually this pandemic will be behind us.

    4. Recovery – finally there is a more fulsome recovery stage. Recovery, though, does not mean that things will be go back to being the same. The way we live and the way some businesses operate will change, but recovery means more good news than bad; improved businesses and economic growth, and a much needed reversal in unemployment trends. And we can relax at the movies and enjoy a drink afterwards and not think about social distancing!

     Adjusting to reality and positioning for recovery

    Andy Grove, from microchip manufacturer Intel noted that “Bad companies are destroyed by crisis. Good companies survive them. Great companies are improved by them.”

    Bad is an unkind characterisation but there is no doubt that many companies will not survive the coronavirus crisis. On the flip side some companies will emerge from this crisis stronger, both improving their franchise with customers andbroadening the markets that they serve.

    As an active investment manager we seek to beat the market through building a hand-picked portfolio of high quality, growing companies. A critical element in doing this during the coronavirus crisis is understanding how industries and economies are being reshaped, and which companies are likely to emerge stronger as a result of this.

    In some cases that means holding onto existing investments that are navigating the crisis well. This includes companies like A2 Milk and Fisher and Paykel Healthcare in New Zealand or Amazon.com in the United States.

    In other cases it means adding to investments or introducing new companies to portfolios. These companies may be operating in more challenged parts of the economy, like Heico in the aviation industry, but are well managed, have secure financial positions and will, in our view rebound strongly as life returns to the new normal.

    While we are optimistic about the future we should expect a challenging environment, both economically and socially, over the coming weeks and months. There will be bad news along the way and markets will no doubt respond to this. But we will eventually recover from this crisis and your portfolios are well positioned for it.