COVID-19 is proving a powerful catalyst for social and technological change
- Despite the damage wrought by the COVID-19 pandemic it could also be a catalyst for change
- The pandemic has hit income investors particularly hard
- Online companies are clearly the immediate winners
- COVID-19 could leave a positive legacy in terms of sustainability
Necessity is the mother of invention, goes the old saying. Amid the destruction wrought by the Second World War, was innovation on an unprecedented scale that shaped the world that came after it. That innovation, though, was based on ideas and trends that largely already existed. Yet it was the scale of the challenges faced by all combatants that lay behind the rapid development of technologies, albeit for war, that subsequently also became cornerstones of peacetime economies.
The world may not be facing destruction comparable to that suffered in the Second World War. However, there is no doubting the immense damage done to individuals, companies and economies. “The evil that men do lives after them; The good is oft interred with their bones,” declared Shakespeare’s Mark Anthony. He was referring to Julius Caesar but will this also be true of the impact of the COVID-19 pandemic?
Future historians might see the pandemic as a catalyst for transformation in society and technology that changed the world, hopefully for the better.
What is remarkable, says Raj Shant, managing director, Jennison Associates, is how quickly consumers and companies have adapted to new ways of doing things. “Even my 80-year-old mother now orders food online and it magically appears on her doorstep the next day,” he says. “She is not going to go back to the old way of shopping.”
Investors need to remember, says Shant, that the best manufacturers of horse-drawn buggies seemed like value stocks until they were killed off by the automotive companies from Detroit.
“We should be expecting lower returns for a lot of asset classes over the next decade because we have very little yield available in the fixed-income markets and risk assets are trading at valuations that aren’t particularly attractive” - Nathan Thooft
The immediate losers are obvious with the travel industry badly hit. They include airlines, hotels and travel agents. “The trend towards cheaper air travel and more mini city-breaks has been reversed and recovery will be slow because people will continue to be nervous about travelling in planes for some period of time,” says William Davies, CIO, EMEA, at Columbia Threadneedle Investments.
In other sectors, particularly e-commerce, the pandemic has accelerated a process that might have taken years into a few months. There is no return to pre-COVID times, in the nature of retail, with the continued trend of online commerce taking the greatest share accelerated by COVID. But Shant says the key point is to recognise is that there is one type of business model that is really working and that is direct to consumer.
“The real need in uncertain times is to be able to see exactly where your inventory is so you are not left with the problem of distributors dumping stock in a downturn for a fraction of the price,” he says. “That damages the brand in a way that can take years to recover from.”
For income investors, the COVID-19 impact has been particularly severe, says Nathan Thooft, senior portfolio manager at Manulife Investment Management. “Dividend players have been punished, relative to growth,” he says. Not surprisingly, investors preferred companies with strong balance sheets such as the tech companies, even though they might not pay dividends. The dividend factor, Thooft says, has been one of the poorest-performing factors not only in the pandemic-induced downturn but also in the recovery.
High dividend players, such as financials and energy stocks, have been in sectors at the epicentre of the economic crisis. By mid-year, more than 100 of the S&P500 stocks had either suspended or cut dividends.
Some of the losers are facing structural changes as well as short-term problems. “No one can tell me the world needs more banking capacity; these are companies that were barely beating their cost of capital in the good times,” says Shant. He adds: “What is that, if it’s not an economic signal that these industries should be shrinking as a percentage of the economy in terms of the amount of capital allocated to them?” In the short term, though, they also face a tsunami of bad debt.
Perhaps the most dramatic impact could be felt in the property sector. It faces the prospect of a radically different world post-COVID-19 in terms of both employer and employee expectations of working life. Flexible working from home certainly brings many benefits and, given the internet’s power, is now possible in a way that was inconceivable two decades ago. But it also comes at a cost. “I think it is a bit too much of a leap of faith to say this changes the way we work completely. We still benefit when the vast majority of people are in the office and building those secondary relationships with the people outside your own team,” says Davies.
The immediate winners are clearly the online companies. Although large tech firms have done well, it is not clear when they should be regarded as over-valued. Shant argues that this is the wrong question. “If you take segments where adoption rates have really accelerated and the future addressable market has massively expanded, then you could argue that yes, these companies might be a bit more expensive than they were before, but it’s never near as much as the questions suggest.”
Instead, Shant makes a distinction between e-commerce players and social media companies. The latter have grown to the point where their size has become a problem of itself and a political issue, a media issue and a regulatory issue. Search engines are also facing intense scrutiny by European courts on data privacy.
As well as creating lots of losers and some winners, the pandemic has altered the investment outlook dramatically, says Thooft. “The reality is we’re going to be in an environment where we should be expecting lower returns for a lot of asset classes over the next decade, simply because we have very little yield available in the fixed-income markets and risk assets are trading at valuations that aren’t particularly attractive.”
That is also combined with the key risk of a second wave of the pandemic. That is Columbia Threadneedle’s central case, says Davies. “If we had total conviction that we will see a second dip, then it would be odd to have any exposure to the more cyclical areas and to financial leverage, especially if it’s linked to operational leverage.”
Columbia Threadneedle, like many managers, is defensively positioned. It invests in companies that have greater control over their own destiny and are less affected by economic peaks and troughs. “They also tend to be those companies which we think are going to be the long-term winners in the 2020s and probably the way we want to be positioned over the next decade.” But Davies agrees that if the stimulus packages lead to a sharp acceleration in nominal growth which will then persist, their portfolios would need to be repositioned.
Where the COVID-19 pandemic could leave a legacy of good is the boost it is giving to ESG and sustainability. Here again, it is merely exacerbating trends that were already prevalent and growing stronger. COVID-19 has caused governments, asset owners and a new generation of retail savers to question whether companies can act purely for shareholders and yet expect to have a government safety net. With companies begging governments for aid, activities such as share buy-backs which have been prevalent in the US will probably be frowned on. “It’s hard for an airline corporate management to argue for a buy-back 12 months after the government bails them out,” says Thooft. The future may look very different from the past in that respect.
Equities: Pandemic winners and losers
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Equities: Pandemic winners and losers