Out of adversity comes opportunity: economic and stock market commentary

As always we sincerely hope that all our clients, their families and friends are keeping safe and well.

On the other side of the windows out of which we now watch the world, spring is in full bloom and the first shoots of the plan to exit lockdown is gathering pace. Covid-19 has had catastrophic consequences that stretch beyond the immediate health and human tragedy issues. Restrictions on movement and economic activity have caused untold damage to economies and to household finances — something which stock markets were quick to factor in with falls of 35% or more in a matter of days in the latter half of March.

Looking around the deserted high streets and at businesses furloughing, at companies like British Airways, Rolls-Royce and Boeing shedding tens of thousands of staff, watching oil prices collapse, witnessing the largest drop in US GDP since 2008 and predictions of a 40% drop in the Covid-19 struck second quarter, it is hard to believe that stock markets have already recovered half of the losses experienced in those dark days of March.

Hard to believe but perhaps not hard to explain given the weight of money governments are essentially printing to stave off economic disaster. It is often said that the stock market is “human nature on parade” and at the moment the parade is dancing to the tune of central banks led by the Federal Reserve Bank of America pumping trillions of dollars into the US economy to avoid a slide into economic depression. Swift and decisive action from central banks and governments over the past couple of months has prevented the kind of collapse in equity and credit markets that accompanied deep economic downturns in the past.

The unique nature of the Covid-19 economic shock and the rapid response from the authorities, along with the likelihood of more support to come, leaves investors assessing two important lessons from past recessions.

History shows that economic contractions take their time in revealing the full extent of the financial damage. Unemployment, defaults and bankruptcies all kick in with a lag. Indeed, the Chairman of the Federal Reserve Bank of America, Jay Powell, alluded to that when he said it was too early to tell if the massive monetary and fiscal stimulus was sufficient to stave off a prolonged and deep recession.

Slow progress in opening economies over the summer months would mean a number of companies and businesses will run out of cash and falter. In the absence of a vaccine, some commentators suggest that a wave of bankruptcies later this year could pull equity and credit markets back towards the lows of March.

However, another important lesson from past recessions is that equity and credit markets start recovering well before the economic data shows an improvement. If lockdown ends smoothly and companies and consumers adapt swiftly to a world of social distancing, the argument for a speedy economic recovery is still in play and the bullish tone in equity markets could well be justified, particularly as it has come courtesy of record amounts of fiscal and monetary stimulus.

JP Morgan suggest that May could easily mark the end of the deepest but shortest recession in more than a century. The upshot is that investors are left trying to gauge what kind of recovery is around the corner and how much financial ammunition remains available to central bankers. In a recent interview, Jay Powell claimed that the Federal Reserve had plenty left in the tank, stating that “there is a lot more we can do, we are not out of ammunition by a long shot and there is no limit to what we can do with the lending programmes that we have.”

But as we begin to regain our liberties will share prices follow suit? Will the recovery which started in April and faltered in the early part of May gather pace again and where should we look for returns in the years ahead? The outlook remains uncertain at best and despite the recovery in April, share prices have been volatile. A range of factors will affect which direction markets head from here. A delicate balance between saving lives and restoring livelihoods will be essential.

Covid-19 and the responses to it has left a trail of destruction. Lives have been lost or permanently altered. Economies are bruised, job losses have soared and public sector deficits are set to serve as an unpleasant reminder of the trauma for years to come. Many are asking what comes next and whether life will ever be quite the same again.

In truth nobody really knows but from the rubble of destruction, opportunities are emerging to rebuild economies, industries and systems with new innovative ways of thinking. As has been done so repeatedly in the past; towns that rebuild better after earthquakes, or Japan and Germany’s thriving post-war economies. Business innovations such as Henry Ford’s assembly line or Microsoft’s Windows operating system.

In exposing many of the weaknesses in the world’s healthcare, economic and financial systems, the coronavirus, devastating as it has been, has offered both the opportunity to build back better and a roadmap for how we may do that. Companies and countries with the nerve to take those chances and create a new and improved future are likely to be well rewarded. Destruction can clear the path to innovation.

Just as Captain Tom Moore battled personal challenges to walk 100 laps of his garden, and in doing so warmed the hearts of the nation, there are plenty of encouraging stories of fortitude in business. Gyms that have gathered new members by offering online fitness classes; restaurants offering delivery services for the first time; a return in demand for local corner shops; and the farm that made more money in April by loaning its goats for entertainment in online conference calls than it did in April 2019 when it merely offered traditional farm visits.

Many challenges lie ahead of which Covid-19 is just one. US-China trade tensions, the UK negotiating a trade deal with the EU before the end 2020, the US presidential election in November, Hong Kong’s ongoing relationship with China. Problems that all seem to have taken a back seat to the economic disruption caused by Covid-19 but which in themselves have the potential to cause further volatility in stock markets.

Investors should not underestimate that the way to achieve their financial goals might well be markedly different now as the disrupters take an ever larger share of the pie from those that are disrupted. The ability to distinguish between both will be crucial and favours the active investment management approach championed by my colleague Sam Petts in his recent article.

To navigate the future safely, at least from an investment standpoint, it will be vital to identify challenged sectors and avoid industries that will see a long term impact to their business models. In the short term it is evident that the leisure and travel industries will have serious issues. Restaurants for instance will reopen gradually but many will not survive and even after the virus is under control there may be a long lasting reduction in demand for travel.

Investors will need to be wary of debt risk. Many businesses fail after an economic shock often through the lack of short term funding. Central banks have pledged support but this does not always reach its target and governments are wary of bailouts for large corporations. Manufactures with complex supply chains could face a delay in suppliers returning to full production.

More positively it is possible to identify sectors which will prosper in the post Covid-19 world. These include businesses that allow us to work from home. Providers of telecommunications and antivirus software, cloud computing hubs and remote IT help desks. Disruptive groups in the world of digital revolution and businesses in artificial intelligence, cyber, digital technology will all play a vital role in stock selection over the next decade.

Many established companies face a scramble to cut costs, to husband cash and reduce employee numbers. Some companies, indeed many companies, will never recover but the strong will survive and prosper. The digital revolution has been given a massive boost, persuading or forcing people to use technology for shopping, for social life and entertainment and for business.

It would be wise to pay heed to the power of survivability and the acceleration in disruptive innovation driven by advances in technology. It took 75 years for the landline telephone to hit 50 million users; 62 years for cars, 46 years for lightbulbs and 22 years for television to hit the same milestone. By comparison YouTube, Facebook and Twitter hit that 50 million user mark in four, three and two years respectively.

Finally, we need to monitor carefully government interventions. The state has chosen to extend its role in markets very sharply during this crisis. Telling us all to stay at home is clearly justified on health considerations; paying wages to furloughed staff is generous; instructing financial companies not to pay dividends is harder to justify.

The 1970s taught us valuable lessons. It may take a while, but strong businesses do get through difficult times and can prove ingenious at coping. The seeds of radical change are often sown in the depths of a crisis. In 1975, Margaret Thatcher took control of the Conservatives and Brian Clough was appointed manager of a second division team called Nottingham Forest. Four years later Forest were crowned European Champions, and as for Mrs.Thatcher…!

I will finish by leaving you with the wise words of John Stuart Mill, the British philosopher and political economist of the 19^th Century who said “What has so often excited wonder is the great rapidity with which countries recover from a state of devastation, the disappearance in a short time of all traces of mischief be they earthquakes, floods, hurricanes or the ravages of war. An enemy lays waste to a country by fire and sword and destroys or carries away nearly all moveable wealth existing in it; all inhabitants are ruined and yet in only a few years everything is much as it ever was before”. Today’s enemy is Covid-19 and it has laid waste to a way of life we thought was unshakeable, but it will be beaten, we will bounce back and return to a world that will be different in some ways but better for it.

We do not underestimate the challenges that lie before us but we do firmly believe that the Clarion Portfolio funds and model portfolios are well positioned to take advantage of the opportunities that lie ahead.

Please stay safe and stay well.

Keith W Thompson

Chairman Clarion Group

May 2020