It is remarkable how quickly the alien becomes routine. Having settled into lockdown and working from home, my previous life seems a distant memory. I have to remind myself that I have only been working from home for 7 weeks.
Lockdowns have been effective in bringing down the infection rate of the virus and it appears that most European countries are past the peak. The next step is figuring out how to ease lockdown without experiencing a considerable second wave of infections. This presents a significant challenge that will require the number of cases to be significantly suppressed, there to be widely available testing and the ability to track and trace new infections.
In many countries, governments are tentatively easing restrictions. It is clear that this will be a slow process but should allow incremental economic activity and the creation of a new normal. In China, fast twitch data has rebounded strongly, for example the China Shandong Independent Refineries Run-Rate is broadly back to end of 2019 levels. This gives us hope that economic activity can recover and we can avoid an extended downturn.
Businesses are reimagining their operations to allow for safe workplaces while adhering to government guidelines. In the last week we have seen a number of housebuilders talk about re-opening construction sites – Build UK Contractors reported that 70% of construction sites were open as at last week. General retailers, such as Next, have reconfigured their warehouses so they can operate their online offering. Businesses that innovate will be rewarded with market share and a head start when economic activity recovers.
Central Banks are providing unprecedented stimulus to help bridge this challenging period. The Fed has already eclipsed its 2008 stimulus and the major central banks around the world have broadened and increased their asset purchases to include ETFs and even high yield bonds. This has trickled through to other asset classes and helped steady equity markets. The US market has been notably strong, although concentrated in tech growth names.
The tech heavy Nasdaq 100 index is broadly flat YTD, which is almost unbelievable given the real challenges the global economy faces. The market may be taking the view that COVID-19 will accelerate existing structural changes which will favour technology companies that are driving these changes. However, it is worth considering that Facebook and Google are effectively advertising tools and while Amazon has seen growth in demand it has come at higher costs (like most supermarkets). Therefore, while it is unsurprising these companies have outperformed the falling global equity market year to date, they are not immune to the real economy.
Fiscal support is also significant and austerity seems unlikely to feature for most countries. It is likely governments will look to increase borrowing for some time as they will be wary of disrupting any economic recovery with higher taxes or lower spending, and as we move out of lockdown may indeed pivot their support from protecting supply to stimulating demand.
The other remarkable part of April was the West Texas Intermediate oil price index going negative. This is a function of a massive collapse in oil demand in an already oversupplied market. Globally, oil storage is running out and this is particularly true in the US, where landlocked production has nowhere to go. The negative price was driven by the end of the May futures contract. The contract is settled physically and there was a sudden realization from holders that they would have to pay to have someone take delivery of the oil. The WTI oil price has recovered above 0, but as we approach the expiration of the June contract, pressure is likely to return.
The weakness in the oil market has led to Royal Dutch Shell cutting their dividend by two thirds. Shell has not cut the dividend since World War II, emphasizing how dire the oil market currently is. On a medium term view there are reasons to be more positive. This low price will drive a lot of future supply out of the market through companies going bust and a lack of investment in projects. Further, banks and public markets have become increasingly reluctant to finance oil and gas companies due to energy transition and ESG concerns. This means that when demand recovers, and demand for oil and gas will continue to grow for a few years yet, there is likely to be a supply shortage. Shell is taking the decision to preserve cash today to make sure it is well placed to benefit in the future. It will be interesting to see if other big dividend payers take similar action to rebase their dividends. This could have a material impact on investors that are reliant on income.
The long and short
At the moment I am not naming specific stocks as the market environment is so dynamic.
On the long side we continue to look for a mix of companies. Some that we think have resilient cashflows even in an extended lock down scenario. Others, where the business model is strong, the franchise has value and the balance sheet is liquid enough to survive a protracted down turn environment, meaning on the other side these companies will be well positioned to benefit from demand recovery in a market where weaker competition have been forced out of the market.
Our shorts have remained largely unchanged. Like our longs, we have a diversified book. We are short the stock of companies that are facing structural pressure to their earnings, which, in many cases, have been exacerbated in the current climate., these have often been exacerbated in the current climate. Companies that are operationally weak leading to them regularly missing targets. We also look for companies where growth expectations are unrealistic and the valuation implies perfect execution. Other shorts are simply where they are the weakest operator in their peer group and so there is a relative opportunity.