June 25th, 2020
June 25th, 2020
As the second quarter draws to a close, it is worth reflecting on the sharp rally we have seen in global stock markets over the period. Markets hit a low on 23 March. Since then, the UK market is up by nearly 30%, while the US has recovered by nearly 40%. From the start of April, the numbers are 11% and 20% respectively. Even though most economists don’t believe we will see a V-shaped economic recovery, stock market performance certainly resembles it. Shares are pricing in continued economic improvement as restrictions on populations continue to ease, but also that any increase in Covid-19 cases will be dealt with at a local level rather than through wholesale country lockdown. In other words, from an economic perspective, the worst is over.
Combine this with the vast amounts of liquidity being provided by central banks, as well as direct support from governments, and it is easy to see why markets might have recovered so quickly. It hasn’t prevented irrational behaviour though. Hertz, the car rental business, recently filed for bankruptcy causing a collapse in their shares. Investors started buying again, prompting the company to ask permission to issue $500m of new stock, even though the shares were likely to be worthless by the company’s own admission. At present, the US regulator has intervened and the share issue has been postponed.
Away from this type of behaviour, and the impending corporate reporting season is expected to reveal the full impact of the economic downturn. If GDP estimates are to be believed and the historic pattern of profit trends is repeated, earnings per share (EPS) could fall by as much as 50% in 2020 before rebounding by 40% in 2021. This would leave EPS at the end of next year around 30% below 2019. This assessment is based on looking at things from a top perspective, i.e. looking at the economic fundamentals and working things out from there. The other option when looking at earnings is to start from the bottom up – i.e. what are analysts expecting in terms of the companies and sectors they cover. Despite significant downward revisions to bottom-up analyst estimates, these now suggest a decline of less than 20% this year. As many companies struggle to survive and some face major new challenges to their business models, others are using their share price strength to raise capital and position themselves for the upturn, even though this appears at odds with widespread dividend cuts and suspensions.
Markets have exhibited some renewed volatility in June, with a sharp sell-off at the beginning of the month prompted by concern that Covid-19 cases were rising across a number of southern states in the US. However, a subsequent bounce has ensured that the month has once again proven positive thus far for investors, with gains posted across the strategies. In last month’s newsletter, we struck a slightly cautious tone when discussing our short-term outlook, a view borne from the speed and magnitude of the recovery we have seen coupled with the somewhat exuberant levels of investor sentiment on show. On balance, this view remains broadly unchanged. Since our last update, we have been busy implementing adjustments to the positioning of the strategies. At the headline level, this has resulted in a modest reduction in the allocation to equities, an increase in the exposure to fixed interest (“bonds”) and an increase in the cash fund weighting. These headline changes have also been made in conjunction with a number of fund switches, resulting in an increase in the exposure to large companies with strong visibility of cash flow that should be well placed to survive and benefit from the challenges ahead.
Finally, we are pleased to inform you of the recent reopening of the BMO Property Growth & Income fund, the strategies’ sole commercial property fund holding. The fund was suspended on Wednesday 18 March alongside a host of other closures within the sector, as valuers of property funds determined that they could not accurately value physical property assets at this time. This position has since changed for the BMO fund, with certain property sectors no longer subject to material uncertainty over their valuation – most notably the industrial sector, which is where most of the fund’s direct property holdings are held. As we mentioned back in March, BMO is a very different proposition to other mainstream ‘bricks and mortar’ funds. Only a quarter to one third of the fund is typically invested in physical property, with the remainder held in property shares. These are listed and traded on stock exchanges, and while they may trade at a discount to their net asset value (potentially reflecting uncertainty around the net asset value of the underlying properties) there is always a clear price for investors wishing to buy or sell. We continue to like the hybrid physical / listed property structure that the holding offers to investors, and have reinstated the position within the strategies.
About the writers:
Simon Doherty Chartered FCSI:
Antony Webb Chartered FCSI: