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Slow Emergence from the Bunker

May 4, 2020

• April’s relief rally after a frenetic March
• The slow unwind of the lockdown should at the very least help sentiment
• Policymakers continue to rack up their support
• The depth of the global recession still unknown
• The asset market is framing the future outcomes around survivors, thrivers and victims

April brought a good measure of relief in the markets from a frenetic March. The outlook is looking better for May. Several countries are slated to ease their lockdown. But what will the world look like as we climb out of our COVID-19 bunkers? And what specifically do markets hold for investors?

To be clear, we are not out of the woods. We will live in some fear of a reoccurrence of the virus until a vaccine is found. However, we are starting to see signs of which sectors and assets have a better chance of seeing investors through the crisis. Investors will have to be patient and await more news about the depth of the recession and the degree to which the actions of policymakers have mitigated the worst effects of the crisis. Only then can investors build portfolios for the long term with sufficient degrees of certainty.

April was not the same frenetic scramble for cover as March, as least not as far as markets are concerned. Risk assets ended the month usefully higher. Developed and emerging markets equities were up around 10%, high yield bonds gave up 6%. However, most of the world’s population remains under some form of virus-related order to stay home, move around less, and generally avoid contact with other people.

A frequent argument doing the rounds at present is that things will be just fine for asset prices quite soon because the economy will rebound relatively quickly. There are two tenets for this line of thought. First is that the amount of stimulus that governments and central bankers have poured into the market has been so huge that a robust economic recovery is inevitable. Second, is that the financial markets are good at predicting outcomes, and the rally in the latter stages of April is indicative of the market (correctly) pricing in a recovery.

The most significant support for the idea that everything will be just fine is the pure scale of support from policymakers. G20 is set to provide $52 trillion of spending and guarantees. The massive surge in the size of the Fed’s balance sheet (to over $6 trillion) may not be the very thing that firms need to restart earnings growth.

It is what was needed to stave off a surge in corporate failures and underpin a severely compromised financial system – many areas were faced with disaster if the Fed did not step up. However, while the Fed has grabbed the headlines other countries, more notably in recent days in the emerging markets have stepped in with significant help. Hungary’s central bank will start potential limitless asset purchases. Thailand’s government will pay $4.6 billion in support of its farming community. Indonesia raised $4.1 billion through a sovereign bond placement that will help fund projects such as the $1.4 billion paid to farmers.

The asset landscape (equities and fixed income) can be divided into three main areas now: thrivers, survivors and victims. Once we exit the bunker, the idea is to spot the victims and avoid them first and foremost. For the time being, survivors could be suitable investments to find safe harbour, as the search for thrivers progresses. And we think it may be a long search: many of the new forces shaping the global economy may take a while to assert themselves.


In the short term, those firms most directly in line for government help look to be survivors. An obvious example is the high-grade credit market, where the Fed is actively involved. Even into the better reaches of the high-yield market, support from the Fed should stave off at least the immediate threat of failure that could have resulted due to lack of funding. The banking sector has entered this crisis in far superior shape compared to the last one. Top-tier banks in the US and Europe have solid balance sheets, and only a prolonged downturn will take them towards the brink as the GFC did. However, they will not be impervious to what has happened, and while survival looks likely, investors will have to tolerate a few skipped dividends. Already some banks, have booked eye-watering provisions. HSBC is the highest-profile bank to skip dividends so far.


Among the thrivers are those companies that already have a business model that performs robustly in the absence of the physical presence of customers. The technology giants fall into this bracket, as do the suppliers of consumer essentials. Health care and medical firms must also be in this group. In many countries across the world, it has become embarrassingly transparent that ageing and vulnerable populations present a more significant moral and economic dilemma than previously appreciated. Managed care businesses are well-positioned to benefit.

While not strictly speaking in the “thriver” category, an area of interest for those investors with a sense of adventure is distressed assets. In the case of post-Lehman, some asset values fell heavily, before recovering strongly in the months and even years that followed. Often, the source of distress was less the asset’s fundamental value, but more the initial owner’s lack of liquidity and inability to hold or finance the asset. The current market conditions have some similar features, where some investors are forced sellers, or where the absence of market liquidity has caused prices to drop.

It is not always the case that asset prices recover quickly after such episodes. Much like industrial capacity, the investor appetite for risky investments, and the capital to fund them, may in some cases remain absent for an extended period.

As we peer out of our bunker (preparing to set foot outside bravely) we have noted that certain parts of the structured credit market may be very cheap, leisure properties and operators are going for a song. Commercial and industrial real estate might follow suit soon by offering deep discounts. Of course, the old warning about catching a falling knife applies in all these examples.


As for the victims, well, the list will be extended. With Warren Buffet announcing that he had exited his previous bet on the airline industry, it just shows that even some of the savviest investors were not positioned for the challenges of COVID-19. The internet is replete with newly-minted pandemic ‘experts’ offering a vast array of ways in which the pandemic will change every single facet of our work, social, and family lives. A standard prediction is the rise of work from home. Another view is that there will be a drop in business travel, associated with more remote working. There might be a faster shift to renewable energy, accentuating the demise of the fossil fuel industry. The latter makes for further grim news for the energy sector, already caught in the grip of an oil price war and a sudden stop in global oil demand.

As at today, it would be wrong to draw too many firm conclusions about the longer-term future. The knee jerk action of many companies has been to lay off some staff and drop providing guidance to the markets on future earnings. Some such as oil company Royal Dutch Shell has had to put in place emergency measures to conserve cash flow – the first dividend cut since 1945. When they do, there is no guarantee that they will flow at the same speed again, either initially or eventually.

One can have some sympathy for the view that the sheer scale of the drop in activity numbers from the real economy makes any historical comparison irrelevant, and that the better strategy for investors is to focus on the recovery. The idea is then to find the right price for assets given the prevailing circumstances once the precipitous drop no longer shows up in the numbers. Even so, it remains too challenging to have a view that most if not all assets should realistically return to the previous highs seen at the start of the year.

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