Economists trying to forecast the impact of coronavirus often sound more like geographers. Or typographers. Bank of England governor Andrew Bailey maps a depression that is “V-shaped”. OECD secretary-general Ángel Gurría thinks the valley is “more like a U”. UK national statistician Ian Diamond can even see a cliff edge in the form of an “L”.
But stock market commentators have started using the language of psychiatrists. After the Dow Jones index rallied 27 per cent in seven weeks from its March 23 low, John Cassidy of The New Yorker asked: “Have investors . . . lost their minds?”
For wealth managers, then, this potential mismatch in the shape of economic and share price recoveries means rethinking the science of portfolio allocation.
Rothschild & Co’s global investment strategist, Kevin Gardiner, can understand the topographical approach. “Stock markets seem already to have started to ‘look across the valley’,” he admits. “While the human costs will be with us for a long time, in the narrow, impersonal terms of its market impact [the Covid-19 crisis] might yet prove to be one of the shortest.” He suggests the valley’s upslope may appear steep because “some of the biggest losers when markets fell at the start of the crisis have been the biggest immediate gainers”.
Cash has also flooded back into a V-shaped market recovery at a pace that is anything but glacial, or U-shaped in geographical terms. In the UK, inflows to equity funds hit a record monthly high of £2.6bn in April — six times the average, according to trading network Calastone.
History, however, suggests the investment terrain will not turn out to be symmetrical. Market watchers at research company Style Analytics point out that full market recoveries take two to three times as long as crashes: it took 48 months for share prices to regain their level after the dotcom bust, and 26 months after the global financial crisis.
So, with Rothschild & Co admitting the latest recovery is not “a perfect beta bounce” — as some fallers are not coming back so strongly — the fastest route to pre-coronavirus portfolio values will be a selective one.
“The recovery from the pandemic will be uneven,” cautions Stéphane Monier, chief investment officer at Swiss bank Lombard Odier. “This is not a typical end-cycle recession. Sectors likely to outperform in the current crisis are not the usual cyclicals and financials but rather those that will continue to generate value and sustained growth beyond the current shock — sectors like IT and healthcare.”
Alicia Levine, chief strategist at BNY Mellon Investment Management in New York, notes that the five largest tech stocks in the S&P 500 outperformed the rest of the index by 31 per cent in the first five and half months of 2020 — indicating quite how far investors are backing trends over cycles. “The outperformance of tech, healthcare and other non-cyclicals during this rally tells us that investors are still cautious about how the US and the corporate sector come out of the economic crisis,” she admits. “We can have more conviction in the rally as we see cyclicals and small caps beginning to work.”
In the meantime, wealth manager London & Capital is also seeking healthcare and technology stocks, and providers of consumer staples. “These sectors are clearly the least vulnerable from an earnings point of view in the current environment,” says partner Iain Tait. Of the large-cap health stocks, Vermeer Partners, another London-based wealth manager, favours medical device stocks Zimmer Biomet and Smith & Nephew, given that demand for elective surgery has been deferred rather than cancelled, suggesting a strong, quick recovery.
Alongside these trend-driven sectors, Tait sees the greatest recovery potential in other industries where demand has only increased during the Covid-19 lockdown. “We would highlight three sub-sectors,” he says. “Luxury goods, housebuilders and logistics companies. These will have some pent-up demand.” He also notes that this demand will come from buyers least affected financially by the pandemic.
Simon King, chief investment officer at Vermeer, describes these opportunities as plays on “reopening trade”, and includes industrial stocks as well as construction and infrastructure companies. “Investment in infrastructure and a desire to get housebuilding going quickly will form a part of all developed governments’ strategies, particularly in the UK, so construction-related sectors should benefit in the short and long term,” he argues. He picks Persimmon, Vistry, Balfour Beatty and Breedon as shareholdings. Among the industrial groups “exposed to strong end markets” he names Melrose, DS Smith and Linde.
Wealth managers assessing the lie of the land appear equally sure where demand will subside. “Areas we think will be slow to respond would be property, transport, energy, hotels and retail,” says King. “They also face long-term challenges to their business models. Commercial property, particularly traditional office space, could take some time to recover, given the inherent change in people’s working practices that Covid-19 has brought about.”
Others agree. “Will shoppers that were forced to migrate to online shopping come back to the shopping mall, retail park, high street?” asks Tait. “I would also avoid office and retail property exposure for similar reasons.” Levine at BNY Mellon thinks all real estate investment trusts look badly exposed. “The underperformance of Reits is something to keep an eye on as it suggests a very slow recovery, significant bankruptcies and constraints on the ability of consumers and business to pay rent.” Vermeer believes British Land and Land Securities are on difficult ground here.
Tait sees changed behaviours and social distancing having equally “severe effects for the transportation business model” — most obviously, that of airlines. With “the outlook for air travel very poor and the recovery path a long one”, Vermeer cites British Airways owner IAG, low-cost carriers easyJet and Ryanair, and aerospace groups Boeing and Rolls-Royce as most at risk.
King also thinks there is “a very realistic chance that peak oil demand has been dragged forward and we would be wary of all the oil majors”. At Rothschild, too, Gardiner questions whether coronavirus has hastened “the slow passing of the oil age, and an increasing focus on sustainability generally.”
How long equity portfolios will need to reflect this new landscape will be measured in years rather than months, most believe. “We expect markets and portfolio values to fully recover when the economy hits pre-Covid growth rates again, and that’s 2021 in our base case,” says Monier. He holds out hope that “a therapeutic breakthrough could accelerate the recovery process” but also warns “a strong second wave could slow it further, with recovery in portfolio values delayed”.
Levine suggests corporate earnings could recover faster than they have after recent recessions, if central banks provide stimulus. Since 1945, the average wait for profits to return to normal has been 13 quarters. But even that has wealth managers looking across the valley and seeing the other side further away than April’s rally suggests. “There is a strong recovery in equity markets and asset values, but this feels premature,” says Tait. He believes there will need to be a clear recovery in corporate earnings before stock markets can return to pre-coronavirus levels — something he does not expect until at least late 2021 or 2022. “The risk of disappointment in the speed and magnitude of the recovery is high,” he warns.
Levine also tells investors to be aware of further downside risk, as more businesses fail. “Yes, policymakers have provided unprecedented support that has helped to stabilise sentiment,” she says. “But it is still unclear how global economies will gradually reopen, how cautious businesses and consumers will be, and when testing, treatment and/or a vaccine will be widely available. The longer demand takes to return, the higher the likelihood of insolvencies and impairments.”
If the economic trajectory does indeed look more like an “L” than a “V” or “U”, portfolios will need to combine recovery stocks with cash and lower-risk bonds as well. King at Vermeer likes to remind clients of their investment “ABC”: “A well-diversified, balanced portfolio with good exposure to international markets”.
This article is part of FT Wealth, a section providing in-depth coverage of philanthropy, entrepreneurs, family offices, as well as alternative and impact investment.
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