As May has come to a close, it has seen widespread easing of lockdown measures around the world. It is yet too early to gauge how the virus will react to such measures and to what extent a second spike will emerge. It is likely that waves of new infections will occur, but the hope is that they will be localised and more easily contained, given experiences of the last few months. The world appears to have moved from uncertainty and despair of the situation to a phase of learning to live with it – at least until more effective treatment is developed, and a vaccine is ultimately found. Markets have responded accordingly, with the wild swings of March and April, calming in May.
We have been spending time assessing the nature of this crisis, relative to others. The financial crisis in 2008 could be considered a systemic shock – which changes the whole level of the stock market. Everyone gets poorer and it is bad for us all. The other type of shock is idiosyncratic, where the effects vary across different sectors, different parts of the economy and across the world – and investors have to decide who are the long-term winners and who are the losers. It is this (systemic) type of shock Central Banks are desperate to avoid. We have seen from the policy response to COVID-19, that huge attempts are being made to stop this idiosyncratic shock becoming systemic.
The rise in the value of risk assets (equities) since the market bottom in March, has been led by those companies best placed to either capitalise or weather the effects of COVID-19. These have been sectors such as technology, consumer staples and utilities. That still leaves a big part of the market relatively close to the lows of March. As (bad) luck would have it, it is those sectors that have not fared well in the years prior to the pandemic that have been hurt the hardest – financials, energy and industrials to name a few. These sectors have been firmly in the value camp for a number of years now, with valuation dispersion (relative to quality/growth business) now at historically divergent levels. Favouring ‘value’ stocks (which offer a useful level of income and an underpinning of asset value) over ‘growth’ stocks, has been a winning approach over the very long-term, but this has not rewarded investors over the past decade. Whilst a number of businesses in these sectors are in poor condition, there are pockets of real opportunity emerging – and it is these areas that we are assessing, with a view to a partial allocation of capital in favoured managers best place to exploit such opportunities over the medium-to-long term.
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