Effectus Capital Management: Our take on markets and Covid-19
by Grant Nader
The News is the Noise
This document is not meant to provide more Covid-19 information but rather to highlight some key points from ECM’s perspective.
Having been through several crisis’ before, I can say from experience the doom and gloom headlines do not improve clear, unemotional decision making.
It is best to focus on the facts and things within our control. Almost everything is for sale regardless of quality or outlook and that provides opportunity.
Comparing the 2008 GFC to this crisis
In 2008, while incredibly scary, the problem and the solution were both financial in nature. A massive systemic liquidity squeeze resulting from the bursting of the subprime housing market bubble risked a collapse of financial markets. After initially falling asleep at the wheel (Lehman’s), the US Federal Reserve and Government intervened with the financial measures required to remedy the situation.
The current crisis also carried systemic risk, but the underlying driver is a health issue. The financial component is the secondary effect a non-financial cause. Timelines are unknown and solutions to Covid19 are still being tested.
The primary risk
The financial risk is that the economic shutdown extends into longer timelines than expected to stem the rate of increase in infections leading to a devastating economic chain reaction such as cash flow shortages, job layoffs and businesses shutting down may be become too deep to fundamentally reverse in a short time frame and the world could beyond a recession and into a depression (with a much longer recovery time). It is critical that the ‘curve is flattened’ as fast as possible while vaccines and treatments are developed. Our base case is that the world gets some measure of control. The question is only how deep and for how long?
It’s not all about vaccines right now
While a vaccine may be 12-18 months away, at least 16 biotech and pharmaceuticals companies are working on treatments and vaccines. It does not pay to underestimate the innovation and technology behind modern medicine, and we maintain a positive medium-term view on the crisis outcome. Any partial treatments with efficacy than can improve the healthcare burden can have a significant impact, for example imagine the collective impact of reducing the people who need ventilators or halving the time a patient spends in ICU. This could greatly free up capacity in the system.
What about the markets?
In contrast to the GFC, this time world governments and central banks have moved with incredible speed and conviction. Both monetary and fiscal stimulus has been deployed on an unprecedented scale.
Monetary policy: The US Fed and the ECB has entered an unlimited treasury and bond purchase program (including commercial MBS’s) and globally central banks have stepped up to make massive commitments to liquidity and financial easing. We cannot accuse them of not doing enough.
Fiscal stimulus: the staggering level of global fiscal stimulus (in the region of $2trillion in the US alone!) holds the key to a potential economic recovery. The developed world countries are using whatever capacity they have (including Germany for a change). We cannot underestimate the impact of this post the worst of the pandemic.
However, despite the massive stimulus, global losses of capital and jobs will be significant. What is critical this time is that as most of the real-world economy in the form of businesses both large and small are kept afloat during this cash flow shock and are still in a functional position for a rapid post-crisis response.
ECM’s approach and view looking forward
In South Africa we are of the opinion that the shutdown is vital to stem a far greater catastrophe and our cautious positioning since January has paid off, but the question is where to from here?
In the short term we are looking for key indicators around the timing of outcomes such as:
- Slowing trends in the infection rates (inflection points) both locally and globally
- New and effective medical treatments and vaccine progress
- Stress factors in the financial market such as high yield credit, liquidity, haven performances
Investment opportunities and pitfalls
In this kind of environment, the weak balance sheets get found out. Companies with solid balance sheets and good cash flows will not only emerge with fewer competitors but will also be able to opportunistically invest and grow at far better prices.
By now it is clear that the losers will include:
- Discretionary retailers (cars, clothes, electronics etc) although some of these lost sales can be recouped on the other side
- The hospitality and services industry: hotels, restaurants, gaming, retail mall owners, logistics (most of these sales are lost forever)
- Banks carry the risk and burden of businesses failing and people losing jobs
- Life and health insurers – this risks and costs of death and healthcare claims spiking dramatically here are obvious but like the banks, it’s difficult to quantify
- The ultimate cyclical play that is resources will desperately need a rapid global recovery.
Some of the beneficiaries that we have identified (and invested in) in South Africa:
- Non-discretionary providers such as food producers, food retailers and pharmaceuticals.
- Risk hedges such as gold and defensives such as tobacco and rand hedges
Beyond the obvious, the major shift towards work-from-home, eat-from-home and teach-from-home is driving greater adoption and utilisation of software enablers and service providers such as food delivery, online education and collaborative work models and even online doctors.
This increased usage will speed up the long-term global user adoption in these industries and technologies. Companies and people will become comfortable with their use and companies will benefit from user-stickiness.
It is also likely that as this increase in connected activity extends beyond the near-term crisis, it will speed up 5G adoption and implementation as well as cloud-based collaboration and business adoption of these services.
- Online content providers offering movies, games, streaming and providers of bandwidth and data to go with this.
- Online commerce enablement
- Collaborative and cloud-based work enablement (think Teams, Slack, Zoom)
- Cybersecurity and software services
- 5G network and equipment providers
- Biotech companies involved in successful treatments or vaccines of the coronavirus will be significant beneficiaries
Long term outlook
We are a long way from the end of this crisis, however, over the longer term the massive and coordinated stimulus measures mean that toward the end of the year we should see meaningful economic recovery. There will likely be other unintended consequences (inflation perhaps) but that remains to be seen.
South Africa’s own recovery will be largely dependent on the rest of the world which means we remain cautious on the outlook at this stage.
It is unclear from what kind of base the recovery will come from and a good dose of risk needs to be priced into any purchases. However, in times of crisis, correlations converge creating opportunity. History has repeatedly shown that in major bear markets or corrections, good businesses with solid balance sheets and time in hand will ultimately provide great buying opportunities.