As investors, much of what we thought six months ago has been turned on its head. But in many ways, our approach to investing hasn’t changed. In particular, the importance of focusing on rigorous research is becoming ever more vital. In this Market Insights podcast, we set out the latest thinking to emerge from ASI’s quarterly Global Investment Group.
Welcome to this Market Insights podcast from Aberdeen Standard Investments.
These extraordinary times need no introduction. But as investors, our job is to think about the long-term implications of our current unprecedented circumstances.
As we pass six months since the Covid-19 outbreak, where are we now – and what lies ahead? And how can we at ASI help our clients to navigate a drastically changed world?
The views that we’re setting out today represent the latest thinking to emerge from the quarterly Global Investment Group, or GIG, chaired by Standard Life Aberdeen’s CEO Keith Skeoch. The GIG’s role is to characterise the current and future risk-return environment at a high level, providing guidance to fund managers with the aim of providing positive outcomes for our clients.
The Covid-19 pandemic and the shutdown it entailed have delivered an enormous blow to the global economy. Both supply and demand have been hit hard. This shock has caused recessions almost everywhere, the depths of which are unprecedented.
Growth numbers from the first quarter bear testament to this, and the impact is likely to have been twice as severe in the second quarter.
But while the economic contraction has been savage and deep, it has also been very short-lived. The trough of the contraction appears to have come in May. Already, we’ve seen a rapid rebound in US payrolls, and we’re likely to see many more signs of recovery in the weeks and months ahead.
But the longer-term consequences of the pandemic will be profound. Keith Skeoch, our CEO, describes the outlook like this:
“As lockdown eases, I would expect quite a sharp bounce back in output and economic activity. And that has probably started now. So you're going to get an initial bounce in output. However, we remain concerned that you will see a sharp rise in unemployment around the world, and you have pretty high debt levels – and that's going to cause some economic scarring.”
We should be in no doubt. The world’s economic output has been permanently damaged by the pandemic. And the effects of the recession will be severe.
The global economy contracted close to 5% compared to the previous quarter at the start of 2020. But the full force of lockdowns, at least outside China, wasn’t felt until late in the first quarter and at the start of Q2. Hence the second quarter numbers could be perhaps twice as bad again. All told, we forecast a peak-to-trough hit to global GDP of about 13%, and a year-average contraction of 7.4% in 2020. This is much worse than the 2008-2009 Global Financial Crisis, and comparable to the Great Depression.
Against this, the fiscal and monetary policy response to the crisis has been fast and formidable.
Federal Reserve Vice Chair Clarida commented recently:
Fortunately, the fiscal policy response in the United States to the coronavirus shock has been both robust and timely. In four pieces of legislation passed in just over two months, the Congress has voted $2.9 trillion in coronavirus relief, about 14 percent of GDP. This total includes nearly $700 billion for the Paycheck Protection to support worker retention at small companies and more than $450 billion for the U.S. Treasury to provide first-loss equity funding for the Fed credit facilities.
On the fiscal side, the world’s governments are spending around 3% of GDP. This is twice the size of the response to the global financial crisis. This has not been evenly spread, however, with China’s fiscal response seemingly less striking. Europe had been somewhat of a laggard in the speed and coordination of its response – however in the last few weeks we have seen a little more coordination between France and Germany and a little more monetary firepower from the ECB.
And despite all the debate about the limits of monetary policy, the response from central banks in general has shown that they’re not yet out of ammo. For now, most central banks are not inclined to adopt negative interest rates, although the Bank of England may prove to be an exception.
So for now, central banks’ focus has been on asset purchases. More is likely to be needed here, and we expect further quantitative easing from the Federal Reserve and the European Central Bank in the coming months.
When we consider the correction in asset markets caused by the crisis and the rise in anticipation of recovery, we should note that while the speed of the shift is unusual, the profile is not.
Both the fall and the subsequent rebound have been accelerated – compressing a pattern of years or months into one of weeks.
The speed of the recovery was helped by the huge fiscal and monetary stimulus programmes, and by the fact that some countries are managing their exit from the virus-induced lockdown better than many had expected.
Along with a permanent impact on the jobs market, we will see a larger proportion of ‘zombie firms’ – those firms kept alive only by government support programmes or by the benefit of artificially low interest rates – a repeat of what we saw after the global financial crisis.
On the political front, we may also see a rise in populism, or for policies described as populist. This may occur as the pandemic fuels dissatisfaction among voters – damaging the credibility of the centrist politicians tasked with managing the crisis and reinforcing populist policies and ideologies.
This in turn may alter the pace of globalisation. While information is likely to continue to flow at a faster pace across borders, the movement of people will slow – and so too will the integration of trade and capital markets – this has profound implications for the way we trade, who we trade with and the price we pay for these goods and services.
The crisis should, however, also produce some positive outcomes. We may well see an acceleration of digital innovation and commercialisation, as technology companies respond to our changing circumstances and to the challenges posed by the pandemic. Many of us are enjoying the convenience of working from home and the ease with which we can conduct video calls from our kitchens or spare rooms. –As the months have gone by this is feeling more and more embedded.
A lot of what we are talking about here is, in reality, an acceleration of existing trends.
One of these trends being accelerated is that of ESG (or the environmental, social and governance aspects of how we invest and behave as investors).
What you may well see is that as governments take a bigger role in markets and economies, many of them may take the opportunity to tackle environmental problems, including climate change. We are already seeing significant action here, particularly in Europe, where the “Green Agenda” has always been more to the fore – but we will see it elsewhere – it is a global agenda, and one that appears unstoppable.
The social perspective is also very interesting. If companies have been bailed out or supported by governments in this lockdown period, then there will be an increasing scrutiny of them to make sure that they're acting in the interests of a much broader group of stakeholders – beyond just shareholders. Companies who are not seen to be doing this (even companies who did not receive state assistance) are potentially vulnerable.
Governance and how we behave as owners of the companies in which we invest will remain crucial. This is a good thing and will allow us to work in partnership with the companies that we own, or those to whom we supply debt, to best navigate the post virus world for the benefit of all.
It is important to remember, though, that this recovery is still fragile. It is real – but it is hugely dependent on the future path of coronavirus infections.
Investors have noted the huge fall in corporate profits expected for this year, but they also appear to be acknowledging that the picture for next year is much better. Profits are certainly not going back to where they came, but they are at least moving towards it.
As investors look past the 2020 contraction, where do we think they should be looking? And what factors should they be considering?
Let’s take the broader themes first.
With interest rates set to be lower for even longer, there are important implications for bond markets and for the discount rate that we employ when assessing companies’ cashflows. This doesn’t mean that we should pay anything for equities, but it does have important implications for what we should pay.
And we must also beware of leverage. For individuals, countries and companies alike, the crisis has been a re-leveraging event. All that debt holds dangers, so we must be careful as we head through difficult times.
Another key consideration, as I touched on earlier, is that the crisis is accelerating trends that were already underway. Perhaps the most obvious example of this is the shift online.
Now that many of us are working from home, the digital office has become the norm. And with options for entertainment limited in lockdown, digital leisure – via streaming services and social media – has become even more dominant, along with cloud computing and e-commerce.
All of this favours the big technology firms. As Satya Nadella, the CEO of Microsoft, said recently,
“Already we’ve seen something like two years' worth of digital transformation in just two months. And we’ve seen how critical digital technology is in the three phases of this crisis, from the emergency response, to the recovery phase, to reimagining the world going forward”.
The flipside of this is that the losers from this shift are going to continue to suffer the trends that were previously apparent. Some commercial property and companies that offer traditional forms of leisure like pubs and restaurants are not going to recover as quickly as some other areas of the economy. However, there will be winners in all these challenged sectors – we are, after all, not going to stop going to pubs! – But care is merited when selecting those that will make the best investments.
Of course the technology sector is not immune from risk. The dominant market positions of the leading technology companies will continue to draw regulatory attention. Anti-competitive behaviour will be monitored and punished by the authorities. And companies such as Alphabet (the owner of Google) and Facebook have business models reliant on advertising. As advertising budgets shrink, those models will come under cyclical pressure from time to time.
For that reason, one of our watchwords is granularity. Many companies will not recover from this crisis, so a rising tide won’t lift all ships.
That makes it a stock-picker’s market. One in which an active, bottom-up and granular approach should be rewarded.
Our focus is on quality. We’ll be doing our homework to make sure that the dividends, earnings and book value of the companies in which we invest are all robust.
So where are we looking? As mentioned, one particular area of continued focus for us is technology. With the Nasdaq at all-time highs, technology stocks have outperformed significantly this year. Overall, we take a favourable view of the world’s biggest technology companies– or at least we have positive views on six out of the top seven: Facebook, Netflix, Alphabet, Microsoft and China’s Tencent and Alibaba.
But the sector also encapsulates some of the traits that we seek in broader areas of the market. Our view of the tech giants also informs our assessment of the broader ‘growth versus value’ debate. The March rally was led by growth stocks – but the more recent moves in markets have brought a renaissance in some of the value areas of the market.
However the definitions in this area (Of “value” and “growth”) are, we think, somewhat unhelpful
Our teams prefer to think in terms of “quality” rather than growth - quality market positions, cashflows, management and balance sheets. We believe these traits will continue to be highly valued by investors – particularly given the more difficult economic backdrop ahead.
We remain cautious on real estate – but within this there will be opportunities. While offices remain empty, delivery warehouses are a hive of activity – again granularity will be the watchword.
Given the expectation that the economic environment is set to improve significantly over the next few months, we have become more positive on emerging-market equities. This gives a little more cyclicality and ‘value’ to our house view on equities but keeps the overall focus on quality, as we continue to favour global equities.
We continue to favour investment-grade corporate bonds. Lending to high quality global companies, in our view, gives a fair return for the risk taken. This area of the market is one where central banks also participate – which gives a layer of protection, useful in such an uncertain environment.
And what of the broader outlook? Given the unprecedented nature of this crisis, the uncertainty is considerable.
The principal question is how the pandemic proceeds. Any acceleration or deceleration in the number of infections will be significant.
In the longer term, antibody testing and vaccines will be crucial.
We also need to constantly assess the durability of the recovery. Momentum could shift rapidly, especially if there is any setback in the fight against the virus.
Then there are behavioural questions to consider. Although this rally has been rapid, investor sentiment is very weak. It has been one of the most unpopular rallies we have ever seen –investor participation has not been widespread. This too provides protection, given still high cash levels of investors on the sidelines.
According to surveys, investors expect a slow and uneven economic recovery and are deeply concerned about a second wave of infections. No doubt risk assets would be vulnerable to bad news. But we should balance that by noting that investors are well aware of these concerns.
We will also need to keep a close eye on the credit markets and on banks’ willingness to lend. The latter are better capitalised than during the financial crisis, but are also likely to be much more risk-averse – particularly in lending to new customers. The last ten years have seen the non-bank sector become much more involved in lending, as the traditional banks withdrew from many areas of the lending markets. How this area performs in a more difficult economic environment will be interesting – and it is an area of opportunity for many in this sector.
Consumer spending is another important area to watch. This is heavily dependent on the labour market. The quicker unemployment rates decline, the more people will be able and willing to spend.
Finally, there are political risks. As we noted earlier, one key risk is that electorates react to the hardships of the pandemic and its aftermath by turning to populist politicians in greater numbers.
Beyond that, however, there are risks of a return to austerity policies, which could hamper a nascent recovery. Any indication that such a policy was likely would lead to an adverse reaction in the markets. After the global financial crisis, austerity was the popular choice for politicians. So we will be looking to see whether lessons have been learned.
I spoke briefly earlier on the theme of globalisation. Another important question concerns the direction of globalisation, or indeed deglobalisation, and the degree of disruption – in the long term – to the globalised world as it existed before the pandemic.
Devan Kaloo, ASI Global Head of Equities, had this to say:
“I certainly would like to think that, as the world faces this global pandemic where everyone is impacted, countries would come together to try and resolve the issue. I think what we’re seeing, in fact, is actually the opposite, and it will accelerate the more protectionist leanings that have been emerging over the last few years. Deglobalisation – that is, the rolling back of globalisation – will certainly be one of the key themes that we will need to think about and anticipate.”
Equities podcast (22.07)
And then there is the role of the state in the ‘new normal’ that emerges from the crisis. Social welfare and healthcare – and their funding – will be the key areas of focus here. The US elections in November may offer a first indication of the direction of travel.
So, there is much to think about. This is probably one of the most complex economic and market puzzles in any of our investment lives.
And so, we hope that this window into our current thinking has proved of some use to you. For further information and insights, please visit our website.
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