Written by Callum Abbot

April, 2020

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The long and short of it: Review of markets March 2020

The beginning of a period of unprecedented social lockdown that will mark a moment in human history. This is not to say that the economic impact is necessarily going to be as harsh as in the Great Financial Crisis of 2008 or change the political map like the fall of the Berlin Wall, but it is the all-encompassing nature of the human response to Covid-19 that makes this period so significant.

I looked back at my previous two blogs. In January, I was fairly dismissive. I expected a Sars-like event, and I was wrong. In February, I recognised the material impact containment measures would have on the economy and companies. I did not, however, fully appreciate how pervasive the measures would become.

At the start of the year, I would have struggled to believe I would be working from my London flat in a makeshift office in my bedroom with no idea when I will next see my colleagues in person. I am lucky that I am with my wife and young son and have a small garden to go into, but no doubt this will be a testing time for many people facing isolation.

There are many unknowns. It would be foolhardy to take a single position, when we know so little about the virus nor the duration of the human response.

Fund management always involves accepting there are things you cannot know and building portfolios to manage through these unknowns, with due regard for risk and return. Violent market events inevitably lead to price inefficiency, which we seek out.

In this environment, it is vital that we stay balanced and calm in our decision-making and are open and responsive to new information, which is coming out at a high velocity. In the heat of the moment, it is easy to let fear control your decision-making. When a stock’s price drops over 20%, sometimes on consecutive days, the easy emotional response is to sell out of the position.

I ask myself, however, if at some point in the future do I still expect to go on holiday abroad, buy new clothes and go to the pub for a few drinks with friends. The answer to all of these questions is a resounding yes for myself and, hopefully, for most people. I accept that this crisis will have long-term impacts on some facets of humanity, but change is the only constant. Many things will return to what we considered normal just two months ago.

If I am right in this assumption, then most companies have a cash-generative future. The value of a company is not just about the next few months of its trading. It is a function of all its future cashflows. Indeed, if you build a discounted cashflow model and put the next few months’ cashflows as zero, or even negative, the impact on the overall valuation would not be monstrous.  

The follow-up question then has to be, can companies and consumers bridge the troubled water to normalcy? The answer is that it will depend on how long it takes to cross the water. What gives me comfort is that fiscal and monetary policy is being put in place that does everything it can to keep consumers and businesses solvent so that they can participate in a recovery when it comes.

This is not to say that we have a portfolio made up of only cyclical and consumer stocks nor are we only buying defensives – although the market did this aggressively for much of March. We have always tried to have a portfolio that does not take undue macro risk, and we use our full repertoire of tools (including shorting) to achieve this.

We are now looking at companies’ balance sheets, their available liquidity and their monthly cash burn and working out how long they can continue before they need further support. Then we are comparing the valuation of the company to its long-term prospects.

The good news is there is likely to be plenty of support for companies. In 2008, banks were withdrawing credit lines from the market. By contrast, in the US, nearly $180bn has been extended in credit lines to corporates since 9 March. This is not a credit crunch yet.

Governments and central banks are spending more than they have in any previous modern crisis. Companies are working with governments and banks to cut costs but continue to pay staff where they can.

Meanwhile scientists and manufacturers across the world are working on ways to test, treat and vaccinate against this virus. Only by understanding the virus can we have an effective policy response. At the moment, we are using the extreme response of containment to control the virus, but better data will help nuance the response and may facilitate less draconian measures. Neil Ferguson, an Imperial College expert who has been critical in influencing government policy, suggested that policy action, including containment measures and NHS capacity increases, mean it is likely UK deaths could be 20,000 or less, rather than the 510,000 his team originally forecast.1 Human endeavor has prevailed through many trials, and I believe it will again.

Given how volatile stock prices are at the moment, I will not do the usual long and short position. This is a market environment where long and shorts opportunities are frequently presenting themselves, which requires active management of the fund. Therefore, I will not take a view on a stock that could be out of date quickly.

I do want to mention my long choice in the previous blog, Wizz Air. Reflecting valid concerns about the airline industry, it was down over 30% in March. It remains, however, a high-quality operator with significant liquidity and is well-positioned to last through this trying time. This is an example of where trading for the next few months will be horrendous, but if that choice can bridge this period, it should benefit from less competition and low oil prices, as well as the long-term demand drivers that I mentioned last month.

I will end with a quote that I heard on the Kermode and Mayo’s Film Review podcast, the original source of which is disputed:

Everything will be alright in the end and, if it is not alright then it is not the end.

1‘UK has enough intensive care units for coronavirus, expert predicts’, New Scientist, 25 March 2020.

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