It was my birthday this month. I’m not one to make a big fuss but it has historically been a good excuse to get a few friends together at a pub and enjoy some early summer sunshine. This year was perhaps the most extraordinary birthday I’ve had, yet the most forgettable. I know I must be maturing into a new stage of life as the slippers, that I asked for from my younger brother, elicited the response “have you slipped to the age of 60” and are described by my wife as “granny boots”. Next year I’ll be happy with a pipe and a packet of Werther’s Original, as long as I’m enjoying them in a pub garden.
There have been some positive developments over the course of May. Several countries have allowed restaurants and schools to reopen, travel restrictions are slowly easing and live sport is returning to our televisions. There has been limited evidence that this is causing a second wave, although it is still early days. Hopefully, increased vigilance and good citizen behaviours can help prevent flare ups. It was comforting to see New Zealand report zero patients in hospital with Covid earlier in the month.
Trends in the UK are heading in the right direction. Regionally there is variance but London, which was one of the regions hit first and at one stage was the national epicenter of the virus, has massively improved with research by Public Health England indicating the R value is just 0.4. There is every reason to believe this is replicable across the nation.
The cost of closing the economy is enormous. By its expected end, in October, the Institute of Fiscal Studies estimate the furlough scheme alone will cost £100bn, equivalent to c.5% of GDP. This is just one of the many fiscal support measures. This impacts the future ability of the government to spend on public services. The cost of lockdown is not just economic. The mental and physical costs will be significant with diagnosis and care for other ailments curtailed by the current measures. It is critical that lockdown is eased in an effective and safe manner to help alleviate the pressures of lockdown.
Last month I talked about the WTI oil future briefly becoming negative. The supply side response has been staggering. All major producers have significantly curtailed supply which has led to the market moving towards balance and inventories being drawn down, easing the capacity issues that led to the negative oil price in April. Demand is slowly picking up but it has been the supply cuts that have made the difference. It will be interesting to see if some of the supply has come out permanently and whether key producers can remain disciplined as demand grinds up. Goldman Sachs estimates capital expenditure in long cycle oil projects has fallen by 60% over the last 5 years. Clearly energy transition to greener alternatives will pick up some of the slack but, as I mentioned last month, the oil market could be quite tight over the next few years.
An area of concern is the ramping up in tension between the US and China. The US has vocally laid the blame for the Coronavirus at China’s door. China has denied this and has responded by increasing its grip on Hong Kong passing a security bill, which makes it a crime to undermine Beijing’s authority in the territory. This has been widely condemned by the West and the US has questioned whether Hong Kong has a wide degree of autonomy from the mainland and therefore should lose its special trading status and be treated the same as China under US law. This escalation has so far not materially impacted the market but it reminds the world that the two biggest nations are likely to rub against each other frequently.
The long and the short
At the moment I am not naming specific stocks as the market environment is so dynamic.
A debate that has been building to a crescendo for a number of years is value vs growth. In our portfolios we target value and what we think of as unexpected growth. Unexpected growth can be thought of as companies that beat expectations. If a company is expected to grow 50% but only delivers 30% then it is likely that the stock will underperform, as it de-rates and re-bases to a lower earnings level. However, if a company delivers 5% growth when only 3% was expected then the opposite is likely to occur. Having a balance of both value and unexpected growth means we are not reliant on a “type of market” to perform.
In the last few days of May there has been a sharp reminder that this is the type of market in which cheap stocks can deliver their best returns. Value works best when fear is at play. There are stocks in the market currently at Price to Book multiples which are at half of their normal level. In some sectors, such as life insurance and home construction, we believe the medium term fundamentals of these businesses remain attractive. However, it is deeply uncomfortable to buy into these stocks when there is so much uncertainty. If lockdown eases, and normalcy returns, brave investors could buy heavily discounted stocks and make superb returns. This is high risk, and we do not advocate bottom fishing, but we believe having some value in your portfolio may be beneficial.
Sources: London R number – Sky News – 15 May 2020, New Zealand data – CBS News – 27 May 2020, Furlough data – BBC News – 12 May 2020
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