David Kearney, head of corporate broking at Goodbody, considers shifting investment strategies and lists some of the possible hurdles to economic recovery.
As the crisis deepens, investors’ views continue to evolve, and have divided into two broad camps. The first is those who consider the current crisis a prelude to a longer consumer led recession, as unemployment kicks in, savings rates tick up against lower household earnings and taxpayers face the burden of paying for “whatever it takes”. Within this group are also the ultra-bearish who view large production declines and massive fiscal stimulus as a potential lethal cocktail for hyperinflation.
The second group are those who view the crisis as a large-scale supply shock and that post-lockdowns we’ll get a production led recovery which will see the global economy revert to trend over the next couple of years.
Over the last couple of weeks, market sentiment was biased to the latter and we have seen an aggressive bounce off market lows based on little more than a view that policy makers were preparing the groundwork to restart economic activity. However, as more data emerges on the economic impact, while perhaps adding to the arguments around restarting economies however slowly, concerns have increased over the medium-term consequences on the consumer.
In any event both perspectives share the view that there remains headline risk around the US and UK in the near term and markets will continue to be volatile. Whether we see recent lows tested, we’ll have to wait and see but it’s certainly possible if we get a glimpse of a more prolonged negative economic effect.
Market prepares for equity offers
There is a considerable portion of the market that thinks in months and years rather than days and weeks and is, and will, continue to invest capital on that basis. We continue to see investors look for high quality investment ideas, with defensive or secular growth and robust balance sheets the main criteria for investments likely to outperform.
Value investment as a style is underperforming and some value investors are starting to admit to style drift to stay afloat, at the least an amber flag on the health of the market.
Income investors have a much smaller pool to play in and are finding life increasingly difficult. So far, just over 20% of the Eurostoxx 600 index have cancelled or postponed dividends, with this number likely to continue to increase.
Among all this, there is a cohort of companies for whom fresh capital might be required to bolster balance sheets or build war chests for growth. Thirty-five companies in the UK announced or launched equity raises in the previous four weeks (of which just over half are a direct result of the crisis) and this number is likely to increase markedly, even off depressed share prices. We are experiencing an uptick in activity from investors looking to understand the different funding and equity offering structures, in a signal that the market is bracing itself for an increase in equity issuance and how participation might be considered.
Hurdles persist to meaningful recovery
Our view of the next two months is predicated on the continuation of national lockdowns, which can only be unwound when:
1. We have a defined downward trend in new cases and deaths;
2. Treatments get approved and into mass production (Remdesivir, an anti-viral drug, near term but not a mass solution);
3. Ventilator production ramps up to war-time settings and consequently the health system pressures start to ease, itself driving death rates down on hopefully tapering new cases;
4. Antibody testing becomes widespread to calculate how much of the population are infected and asymptomatic, with Germany clearly leading the way there (anything above 30% seems to be seen as an enabler for back-to-work in some form, over 60% for a move to a very considerable lessening of restrictions).
We are already hearing that there is increasing lobbying by companies across Europe on getting back to work. From a business and wider social angle, we expect pressure on policy makers to increase towards the end of the month, subject to how various countries apex in the next couple of weeks. But in reality, policy makers are caught in a bind and reversing the lockdown can only come with material progress on 1-4 above. The China/Asia experience suggests that it will take two months at least to unwind lockdown fully.
Once we get a signal that lockdown will ease, equity markets have the potential to surge aggressively again, especially if accompanied by WHO approved anti virals, test kit deployment and huge rise in ventilator volumes.
The sustainability of that surge is dependent on whether the data (which ultimately will lag) shows that production/output is reverting to trend or consumer-led recession is our fate.
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