UK investors were hoping for a much better 2020 after Brexit trials and tribulations, so obviously the past month has been disappointing. As the coronavirus has spread across the globe, we are in the middle of the perfect storm. Prior to the coronavirus outbreak, average corporate earnings had been rising well above inflation and we had very low levels of unemployment in the United Kingdom.
Like many observers, my first reaction to news of the coronavirus outbreak in January/February was to look back at the playbook for similar events, such as Severe Acute Respiratory Syndrome (SARS) in 2003. The feeling was that this is something that will probably be relatively short-lived; it will probably last two or three months, and the markets would quickly recover.
Obviously, in hindsight we have been far too relaxed about the situation. As we all know now, we’re seeing a wide spreading of the disease, and a lot of decisions taken by policymakers almost instantly with little global coordination going on. Every country has got different agendas, so we’ll just have to see how things develop.
Linked to the coronavirus outbreak, when it became clear that demand for oil was going to be impacted, price wars broke out. While producers suffer from prolonged low oil prices, in general, lower prices represent a tailwind for the consumer and in parts of the world dependent on oil imports. However, what we’ve all learnt is that in the energy market, oil prices can fall very, very quickly and also rise very, very quickly.
We are clearly seeing a return of volatility in the market, the likes of which we haven’t seen in many years. While the coronavirus seems to have overshadowed everything right now, in the United Kingdom we still have a debate going on with pro-Brexit and the post-Brexit trade, and in the United States, the presidential election is coming up in November.
It seems like China and other parts of Asia are really now in “phase 2” of the coronavirus outbreak, wherein things are starting to stabilise and people are starting to go out again. The United States and Europe are still in “phase 1” with people in lockdown mode, and many investors are in panic mode.
The Central Bank Response
Central banks across the globe have responded very quickly and aggressively. The US Federal Reserve and Bank of England have each reduced interest rates twice this month, to near zero, along with other stimulus measures. On 19 March, the European Central Bank announced a huge stimulus package, pledging to buy up to €750 in government and private sector bonds and commercial paper though year end.
While the central bank actions are welcomed, markets are now looking for individual governments to address how they are going to help individuals, companies and/or industries the pandemic has impacted.
German officials recently said something almost unheard of, that they would in essence break fiscal rules and would do anything it takes to try and protect their economy. Meanwhile, the United States government continues to debate a coronavirus relief bill. As investors, what we need to see is action for companies that are going to be massively impacted, particularly smaller businesses, and for workers that may not get paid for many months.
A Word on the UK Budget
The 11 March budget announcement by newly-appointed UK Chancellor of the Exchequer Rishi Sunak essentially included an open-ended promise to support the country’s National Health Service (NHS), provide “business interruption” loans of up to £1.2 million, and abolish business rates for retail, leisure and hospitality sectors with a rateable value below £51,000.
In our view, this is a large spending programme relative to history and recent years, and when we take into account the UK’s projected £2 trillion debt plan, the government’s spending proposal begins to resemble former Labour Prime Minister Gordon Brown’s. However, whether the budget has gone far enough or not yet is the debate.
We think this one-two punch of monetary and fiscal support provides a much-welcomed injection of liquidity and should help assure investors somewhat that policymakers are willing to take action. Let’s not forget the beginning of the 2007 Global Financial Crisis involved a severe shortage in liquidity in the UK market after the collapse of British bank Northern Rock, which had to be split up and nationalised. What we can see is a concerted effort by the UK government to avoid anything similar to the panic during those times.
Implications for Investors
In terms of the impact on companies, it’s been different from prior crisis periods. People were still traveling and going out during the financial crisis just over a decade ago (albeit maybe a bit less than usual), whereas today, people are shutting themselves in their homes. We could see a three- to six-month period where businesses involved in leisure activities or travel take in very little to no income but still have fixed payments, like rent, debt or salaries.
Certain companies or sectors such as health care, personal household goods and utilities look to fare better during this time of market turmoil, but indiscriminate selling sprees start to unlock values. From a valuation perspective, UK stocks are so lowly priced now that it won’t take much for share prices to go back up, should we see glimmers of positive news. If there is an improvement in the coronavirus situation, we’d expect at least a small uptick in consumer spending as pent up demand begins to be unwound.
We are looking at individual companies and sectors with quality management teams and solid business models, with a long-term lens. We all know in business it’s about cash flow. Of course, if there is no cash flow coming in at all for a reasonably long period of time, quickly there will be problems.
For example, we spoke to a pub company recently which was in very good financial health but have basically said they could probably survive three months of a closure without breaching any of the covenants. That’s quite a long time to be able to withstand no income at all. They are hopeful the banks will relax all of the covenants and the bondholders will relax all the covenants.
That’s really the type of thing we need to see next; we need to see a little bit more evidence of support from the government for these types of industries.
Similarly with UK house builders, if the situation is short-lived, we see companies that should be able to survive and thrive. Management at one company in the sector we recently spoke to said it is retaining cash on its balance sheet, rather than returning it to shareholders, to get through any negative demand shock related to coronavirus. And many stocks in the sector look very cheap to us right now.
While things do seem pretty bleak at the moment, our team feels pretty confident in conveying that the global economy and the markets will eventually recover from the coronavirus shock.
But at the same time, it’s very difficult to give absolute confidence in what’s going to happen over the next three to six months, because we’re in a situation where it’s so fast-moving and we’re really waiting to see how this develops. The market is worried that the West is going to struggle to be able to contain the virus as quickly as China—which has a totalitarian regime and more control over the economy.
Naturally, it’s hard to envisage what may lie ahead over the next six months, as it’s a fast-moving situation. As bottom-up investors, we’re alive to potential opportunities, yet are also cognisant of the challenges that UK stocks may face in the coming months.
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