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Magazine Issues » April 2020

US equities: Is it really the worst crisis ever?

Kids_watching_TVOne response to what may be the worst shock to hit the modern western world is to sit it out, watching TV. Fiona Rintoul analyses events and finds streaming services may be a major beneficiary.

There is something magnificent about the markets’ ability to dissect even the worst crisis coldly, price in the risks quickly and then claim there are great buying opportunities. Let a day or two pass, and investment analysts will be out there calling it. They are unstoppable and, in a way, it is almost comforting. 

And so it is with the coronavirus crisis, which – as we all now know – is huge. Analysts are wielding their scalpels and coming up with predictions and strategies. The US equity market, with its huge size and bellwether function, is central to those. 

So, what lies ahead? 

First, Andrew Pease, global head of investment strategy at Russell Investments, cautions against leaping to the conclusion that this is the worst market crisis ever. 

“Tolstoy observed that unhappy families are unique in their misery, and it’s the same with bear markets,” he says. “They are all different. This one even more so as it’s a pandemic bear market, rather than a financial imbalances or overheating economy-created bear market.”

In other words, this bear market is unprecedented – but aren’t they all in their own peculiar ways? However, beyond the sheer awfulness of the pandemic and the stringency of the measures being taken to contain it, there are several factors that make the current situation, if not uniquely bad, certainly very bad. 

Raphael Pitoun, portfolio manager at CQS New City Equity, sees two differences with previous crashes. First, market structure has changed as bank proprietary trading has significantly diminished, substantially reducing the markets’ shock absorbers, and algorithmic trading is further amplifying moves. Second, monetary policy initiatives are likely to be less effective as interest rates are already low. 

Then there is the political situation in the US. A president unable to rise to the moment. An election in November with an uncertain outcome. 

“The political context is challenged, and coordinated policy response is important,” says Pitoun. 

The speed at which the coronavirus crash took hold is also exceptional. So far, it has impacted European equities more than US equities, but it still represents a huge turnaround for the US market. 

“What has caught attention is how quickly this crash has happened, just weeks after all-time market highs,” says Rebecca Chesworth, head of equity, sector and ESG strategies at State Street’s SPDR ETF business. “The virus-led turmoil has tipped most equity indices globally into a bear market, notably ending the longest bull run for US equities in the history of equities.”

And there are mixed views about the Federal Reserve’s stimulus package, from hostile to cautiously optimistic. The more positive view, expressed by the likes of Eric Lascelles, chief economist at RBC Global Asset Management, is that rate cuts, fresh quantitative easing and fiscal stimuli “may manage to deliver an economic boost worth around 1.5ppt [percentage points] of global GDP”. 

“This is theoretically large enough to plug the great bulk of the hole created by the virus,” says Lascelles. “However, the virus hits growth very quickly, whereas stimulus engages with a lag.” 

The best we can hope for is that “the subsequent recovery could be expedited”. But there is also a view that the response from the US authorities has been counterproductive. Perhaps investors are simply too fatigued by Fed intervention and Trumpian rhetoric to take them seriously. 

“So far, the actions of the Federal Reserve and Trump’s administration have done little to quell the fears that have gripped US society, economy and capital markets,” says Chesworth. “In fact, they have exacerbated the sell-off, created more panic, and put more downward pressure on the industries and stocks that have been hit hard the most; airlines, leisure, and energy.”

Balance sheet emphasis
How, then, can managers of US equity funds and their investors navigate this crisis? Here again, normal rules don’t always apply in this crisis. Normally, investors are best served by asking “what’s it worth?” and ignoring the noise of “what happens next?”, such as presidential elections and trade wars, believes Giles Parkinson, manager of Aviva Investors’ Global Equity Endurance fund. But today that received wisdom carries a caveat. 

“In our opinion, the underlying profitability and cash generation of most companies hasn’t changed materially, but many companies do not have the balance sheet to see them through to the other side of the recession that has already begun,” he says. “At the current time, ‘what happens next?’ of cash burn and liquidity has assumed an unusual degree of crucial importance.”

For this reason, the very traditional factor of quality could be key in the coming months and years. For Matthew Benkendorf, CIO of Vontobel Asset Management’s Quality Growth Boutique, a business’s value does not lie in its daily cashflows, but in its longevity and sustainability. A quality business should be able to survive declining sales or profits for a week, a month or even a quarter or two. 

“If a company cannot service its debt or roll over financing during a short-term period of duress, it will not survive,” he says. “A quality business tends to have very moderate or even no debt. And high-quality companies tend to have repeat business, brand recognition and pricing power – all of which allow the business to thrive in the long run.” 

Beyond that, certain companies and sectors are of course in a good position to benefit from the crisis. Benkendorf believes there will be a shift in consumer demand in e-commerce, particularly in everyday items like fresh food. 

“Companies such as Amazon should be well-placed to benefit from this,” he says. “Even businesses such as Nike that have been rolling out an omnichannel e-commerce model, and have e-commerce revenues close to one-third of their sales, are expected to be well-placed to benefit from growth in e-commerce. For home entertainment, there could be an increase in demand for streaming services like Disney+.”

Meanwhile, sectors such as healthcare remain relatively safe. According to Chesworth, the sector has outperformed on most days of this crisis, with new monies committed through sector ETFs and institutional buying of healthcare stocks.

“Recent performance and flows reflect an easing of the US regulatory overhang, as progressive candidates’ plans for universal healthcare are less likely to be implemented, as well as a potential upside to some health businesses from the Covid-19 pandemic,” she says.

The upside could include a reassessment of healthcare in the US. Pitoun suggests that the outbreak might highlight some structural issues in the US healthcare system. 

“This might help the Democratic camp and push President Trump to have a more ambitious agenda on this topic,” he says.

Investors can also find safety in consumer staples, such as food, and in utilities, which offer relatively high yields as bond yields head towards zero. Technology and internet companies will also benefit from people staying home, believes David Pearl, co-CIO and portfolio manager at Epoch Investment Partners, though in broad terms he thinks it’s too late to get defensive. 

“Investors should instead consider positioning for the rebound by owning economically sensitive stocks, which have gone down the most,” he says. “Financials have unduly sold off with the stigma from the financial crisis, but they are tremendously well-capitalised with ample cash and no credit issues.”

Once the crisis lifts
Pearl also sees some of the worst-hit sectors offering opportunities when the crisis is over. “Industrials have fallen for obvious reasons, and aerospace has been the worst of the worst, but that should recover as people start travelling again,” he says. “Consumer discretionary should benefit as buoyant US consumers return to the stores.”

With signs that China is recovering from the virus, combined with a truce in the US-China trade war, Pearl also sees opportunities in semiconductors. 

“Semiconductors look extremely attractive, and we think they will see a substantial rebound from Chinese demand and trade,” he says.

Looking beyond coronavirus, patience, calm and a long-term view will be essential – as they are in any crisis. The markets are in the grip of fear right now, but, as ever, in the long run, investment will come back to fundamentals. 

Russell Investments’ Pease believes that a lot of bad news is already priced in, limiting downside potential from here and providing a platform if the situation does start to improve. 

“Valuations on risk assets have significantly improved, and we are now inclined to start modestly increasing the risk in our portfolios at more attractive levels,” he says.

And while coronavirus may be bad, for a lot of investors, it’s not half as bad as the thought of a socialist in the White House. With Bernie Sanders looking unlikely to secure the Democratic Party nomination, a longer-term headache that might hurt markets more than coronavirus has been removed. 

“A Biden-versus-Trump contest likely will be largely neutral for markets,” says Pease. “A Sanders-versus-Trump election would have been an additional worry point, placing uncertainty over the strength of the eventual market rebound.”

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