Taking measure in a fast-moving crisis
Q: Do you expect monetary and fiscal policies in the European Union and U.K. can lessen the negative impacts from the coronavirus shutdown?
We are encouraged by the swift, global coordinated efforts by central banks and governments to address this unprecedented situation. Nonetheless, this is a case where the world’s largest economies have either stopped or slowed to a crawl in a matter of weeks. Monetary and fiscal responses serve as a bridge until global economies can start up again. The urgency of the response is a big positive.
This coordinated response, however, can’t offset a negative economic impact at least through the first half of this year. By way of comparison, during the 2008 financial crisis, the hit to U.S. gross domestic product peaked at -8.4% during the fourth quarter of 2008. We expect an even greater decline in second-quarter U.S. GDP this year, and even worse in Europe. So the known is that there will be a severe financial consequence. The unknowns are the ripple effects from the economic shock as the breadth of the damage will be wider this time. We know that the situation will resolve but the timing of the resolution is crucial in determining the shape of the recovery. If containment measures are effective and/or there is a breakthrough on a treatment for the virus, a “V” shaped recovery is still a possibility.
Given all of the uncertainties around the timing of containment and the extent of the downturn, we’re choosing to adopt a more cautious outlook. We are mindful that the market will price in the rebound before it begins to show in the economic releases and therefore are focusing on what we think could be some lead indicators, which are discussed below.
Q: What sectors and countries are better equipped to weather this economic fallout?
At this point, most companies are in survival mode, regardless of what sector they are in. This means balance sheets are key to assessing a company’s ability to withstand the downturn and emerge as a stronger competitor once the economy bottoms. Generally, companies that have low financial leverage and a defensive earnings stream should prove to be resilient. At the sector level, we see Consumer Staples and Utilities companies to be in a relatively strong position. The Technology sector also is attractive. Consider how technology is allowing so many workers and consumers—and therefore companies—to continue operating remotely/online through this situation. Tech companies are playing a huge role in normalizing lifestyles. Also, the majority of tech firms benefit from healthy balance sheets and low operating costs.
The sectors in a weaker position are Financials, Energy and Industrials for obvious reasons. But again, it’s a matter of looking at individual balance sheets—avoiding those companies with high fixed costs and financial gearing. Value is starting to emerge in some areas within these sectors as the sell-off has been indiscriminate. We have recently taken advantage of the sell-off in Financials to increase our weighting in stock exchanges where competition is benign and earnings are positively correlated with market volatility. We also re-entered the Energy sector via a new position in a renewable fuel company, which should be a long-term beneficiary from the global effort to lower carbon emissions. We’re still underweight these challenged sectors but there are opportunities as long as investors are highly selective.
As for countries, we’re watching China. Despite being export dependent, China likely will be the first country to lead world economies out of this massive slump. It’s an interesting case study right now because while progress is slow, companies are starting to get back on line. For example, Starbucks has reopened stores in Wuhan. Apple is opening its retail stores across China. There is some fear that as people come back into the marketplace, the virus could resurface. If that doesn’t occur, China will signal that economic activity can resume and rebound following a period of containment. As a result, multinational companies that depend on China for a substantial amount of their income will benefit as will the pure play Chinese domiciled companies.
Overall, in most of Southeast Asia—South Korea and Singapore, in particular—the response to this crisis has been robust and appears to be fairly effective. It seems that Asia, as a whole, is in the forefront in terms of this fight against the virus and is somewhat closer to economic normalization.
Q: Is it too early to assess opportunities?
On one hand, it is impossible to call a bottom in such an unprecedented, global situation. But as is always the case, the market will begin a rebound before clear economic data is released. Our response is to slowly put our cash positions to work in businesses we view as offering defensive growth. Bottom line, it’s about the quality of a company’s balance sheet. Even in normal times, it’s important to avoid highly cyclical and leveraged companies.
Q: What about impacts from a rising dollar?
It is no surprise that the U.S. dollar is at a multiyear high relative to other currencies as there has been a flight to safety during this period of global economic contraction. Even though we don’t normally hedge our exposure to the dollar, we do invest in a large number of multinational businesses that have U.S. dollar exposure. So while these companies experience a negative impact from their exposure to U.S. business shut downs, it is partially offset by being able to translate the strong dollar into their local currencies. The strong dollar is a larger headwind for U.S.-based multinationals and in particular, foreign listed companies who have U.S. dollar-denominated debt that’s mismatched with their dollar earnings exposure, neither of which are characteristics of the companies we’re invested in.
Q: What are you watching?
We know the macroeconomic data for the next several months will be starkly negative. As a result, we are looking for signs—e.g., virus levels reaching a peak and then declining—that give us better clarity as to when economic normalcy can return. This includes how soon China’s economy comes back on line. We’re also keeping a close eye on Italy to see how long that country’s particularly tragic experience with the virus will resolve. And of course, we’re looking at progress on the medical front to see how treatment pipelines are developing as well as news on when a vaccine might be introduced. Positive news on those key issues should help provide a floor on the market and reassure investors that the worst is behind us, leading to a rebound in growth.