COVID-19 is a tragic natural disaster. For investors, a natural disaster is profoundly different to the typical end of cycle scenario that is usually precipitated by a tightening of monetary policy or a financial crisis.
Understanding the massive coordinated government response, in an environment of no blame, has been crucial to successfully navigating market volatility in 2020. Appreciating the impact of the rapid development of COVID-19 vaccines, and the behaviour of consumers as governments reduce mobility restrictions, will be key to theme and stock selection for 2021.
A Natural Disaster
Natural disasters occur with little warning. The impact is rapid and devastating. The first known case of COVID-19 was confirmed on 10 December 2019. Initially we viewed a new strain of coronavirus at best as an isolated incident in Wuhan, and at worst, a repeat of the SARS outbreak in Asia in 2003. With hindsight, these were the early tremors of a global pandemic. Global equity markets peaked 64 days later on 12 February 2020, and fell 34% in just 29 trading sessions as they assimilated the shock of the pandemic’s likely implications on public health and the economy1. Initially, investors fled to the defensive consumer staples and healthcare stocks, the familiar playbook when markets collapse. Although we had not anticipated the global impact of the pandemic, the Responsible Global Equity Fund proved relatively resilient to the market fall. The fund benefitted from its concentration in thematic growth stocks with sound finances, such as the flavour and fragrances business Givaudan and personal care company Colgate. The oil price fell from $66 at the beginning of 2020 to a low of $19 by mid-April; the portfolio had no holdings in the oil and gas industry, which dropped over 50% in a matter of weeks2.
The Relief Effort
As with any natural disaster, governments’ role is to mobilise the resources needed for the initial relief effort, and to offset the immediate economic consequences. This is not like an economic contraction caused by an increase in interest rates, where cooling the economy is necessary, or a financial crisis where moral hazard is perpetuated by bailouts. The shock and awe of aggressive monetary and fiscal policy in combination was immediate, sizeable and effective. By 15 March the US Federal Reserve had cut interest rates to zero. Through 2020, total global quantitative easing exceeded USD4 trillion, according to Morgan Stanley. Governments implemented furlough schemes to protect workers’ incomes, reduced taxes, provided grants and loans for affected businesses, and funded a huge step-up in healthcare spending. The effect on global equity markets was immediate. From the market lows on 23 March 2020 it took just 111 trading days for the MSCI All Countries World Index to recover to prepandemic highs3.
The ‘relief effort’ phase of the market recovery was initially led by a narrow group of companies that benefitted from large numbers of people working from home. The Responsible Global Equity Fund benefitted from the Digitalisation theme, with companies such as Amazon and the video games company Activision notable performers. In the early days, pantry loading by consumers dramatically increased sales at CostCo. Thereafter, Home Depot benefitted as people spent money on their homes and UPS enjoyed a surge in parcel volumes and better pricing.
Inevitably there were stocks in the portfolio that suffered from falling sales, as consumer and business behaviours changed in response to mobility restrictions. In our Evolving Consumption theme, we have long invested in travel and experiences stocks such as Samsonite and Booking.com, and food-away-from-home companies such as Aramark. The speed at which their share prices fell, and the knowledge that pandemics eventually pass, meant we were reluctant to sell long-term investments in good businesses if they were prudently financed. Our response was to model stress scenarios rapidly for a quarter of the companies on our global buy list – those most affected by the pandemic. This gave us the confidence to remain invested in the vast majority of these companies and crucially set us an indication of the prices at which they became compelling for additional investment.
Recovery
The ‘post-pandemic recovery’ phase of the market recovery is already underway. Markets discount the likely environment six to twelve months into the future and tend to be priced through a combination of probability and visibility. We were most fortunate to have Alex Hunter, who leads our Ageing theme, on the Global Equity team. Alex has analysed healthcare companies for many years and is currently studying remotely at Harvard Medical School. Alex followed closely the improvement in hospital treatment and the development and trial dates of multiple vaccine development programmes. Our insights suggested the market was overpaying for near-term certainty and was not positioned for vaccine success. This provided us with numerous opportunities to buy cyclical companies at attractive prices that would benefit from an eventual reopening of the global economy. The value of a company is, after all, the stream of its cashflows over 20 or more years and not just the coming 12 months.
The Roaring Twenties
2021 will be a year of recovery and to some extent normalisation, even if new consumer habits have been formed and digitalisation has taken a giant bound forward. Markets move fast and the performance of the global equity market has already broadened out, with a rotation from defensives into cyclicals, or more correctly from COVID-19 winners into the losers that suffered the greatest profit attrition. There is more to come as the winter second and third COVID-19 infection waves abate.
As the global roll-out of the vaccines accelerates, it will produce a non-linear decline in the reproduction rate. This will allow governments to relax social distancing measures and improve mobility faster than generally assumed. The relaxation of government restrictions will release enormous pent-up demand for consumer services. Many consumers have accumulated savings that will be spent in restaurants and bars, on transport, in hotels, on entertainment or for elective medical procedures. These service industries employ large numbers of low-skilled workers that will be re-hired as demand surges, reinforcing rising consumer confidence. A similar effect was seen after the First World War and the Spanish Flu with the Roaring Twenties.
Thematic Recovery Stock Opportunities
Companies in the sectors that suffered the greatest demand contraction have cut costs hard. Earnings expectations for the companies most impacted remain below pre-COVID levels in many cases. The operational gearing of a demand recovery is typically underestimated by consensus. Over the last six months we have taken the opportunity to add high quality thematic stocks to the portfolio that will benefit disproportionately from the recovery phase, at attractive prices. These new investments were funded by the sale of companies that had been strong in the disaster phase such as Activision, Costco, Fresenius Medical Care, and Novozymes.
Medtronic is a US medical devices company that provides products and instruments for surgery. COVID-19 has led to a postponement of elective procedures; a catch-up phase is inevitable as many of these operations cannot be deferred indefinitely by an ageing population.
Middleby produces automated kitchen equipment for the restaurant industry. Their quick service restaurant customer base has proved resilient but there is an opportunity in full service dining and consumer markets as the industry recovers.
Alstom sells equipment for the passenger rail industry that was impacted by passengers working from home and a short-term hiatus in new contracts. Rail is a long-term industry supported by government financing, has an important part to play in reducing emissions from the transport sector, and is an effective conduit for fiscal stimulus.
Not A Shift To ‘Value’
The Responsible Global Equity Fund has successfully navigated the volatility and rotations of the COVID-19 pandemic. The broadening out of markets we have seen since the Pfizer BioNTech vaccine trial data was released on 9 November has not led to the long-anticipated shift from ‘growth’ into ‘value’.
For such a fundamental regime change to occur would require a directional change in the outlook for inflation, something we would not forecast today. The opportunities taken in 2020 came from our thematic approach, preference for resilient companies, valuation discipline and a recognition that COVID-19 was a natural disaster and not a normal stock market event. We are now using our thematic framework to find sustainable companies that can thrive in a roaring 2021.
1 Bloomberg, January 2021
2 Bloomberg, January 2021
3 Bloomberg, January 2021