With China relaxing the ‘stay at home’ rules, diners and shoppers started to emerge from the month-long closure of public areas to contain the spread of the coronavirus. Many still wear masks, but this signals the beginning of a recovery for the world’s biggest consumer market.
Chinese consumers are not spending much: noodles, momos, or different recipes of egg fried rice in convenience restaurants are selling fast, however car showrooms and estate agents still struggle to find customers. What is clear is that the resumption of consumer spending is uneven and is unlikely to follow patterns set in the past.
There is many good news from other countries too. In Italy, the epidemic is slowing down. In Spain, the case load peaked last week. Professor Neil Ferguson from Imperial College expects the case load in the UK to peak next week to ten days. We should be able to start relaxing the measures from early May, and we may be able to be back to our offices, warehouses and factories by the end of May.
However, many scientists warn the novel virus could still be carried by asymptomatic people and a lot of testing would be needed. What is worrying are reports that 14% of patients who recovered in China’s Guangdong province were tested positive in late check-ups. Our forecast is that the number of weekly testing would need to be increased to even higher levels than planned now, and probably countries would institute interdictions over the summer to allow entrance for people who have a certificate they tested negative within an agreed timescale (which could be as short as 14 days).
Stock markets would continue to remain volatile as they try to price the news about the coronavirus. After Easter, we would start to get earnings reports for the first quarter, and we will start to understand the exact damage done to different types of companies and industries.
As shown by China, consumers are not keen to spend much apart on consumer staples, and some small indulgences like Nike shoes. People would first need reassurance this virus would not comeback, otherwise the recovery would be slow and painful. There are already a few companies who started to fill for bankruptcy. Many cyclical companies would need to borrow huge amounts of money, or they will need a rights issue and dilute existing investors, to be able to survive. This makes it very difficult for investors to price stocks correctly.
Investors discount free cashflow from the future. Companies would need first to repay these emergency loans, and repayments could take nearly 5 years, so investors are asked to discount free cashflows from 2026 onwards. This gives many investors a huge headache in trying to forecast earnings so far ahead, and the result they will increase the discount rate they use, reducing the prices they pay for cyclical stocks.
In conclusion, our asset allocation will remain defensive. Hygiene companies like Clorox would not only benefit on an immediate uplift in sales, but it will also benefit from a long-term increase in people anxiety around germs. We also look for companies which invest in what we name ‘postponed’ surgeries, as we expect that hip & knee surgeries to come back in high numbers in the second part of the year. Healthcare companies like Smith and Nephew and Stryker were beaten up in the indiscriminate sale and are good value.
Last thing, there are lots of articles out there in the UK press (and some in the international press too) about what is defined as ‘a dividend famine’ – companies cutting or suspending dividends. Using dividends to cover living expenses was never a good strategy. Retired people need to have cash reserves and short duration high quality bonds for at least 5 years’ worth of their expenditure. Chasing high dividend yields results in very poor equity selections, which will now have a dramatic effect, when some of the more extreme dividend payers like Mortgage REITs would fill for administration. – I will dedicate a separate blog to the ‘living on dividends’ subject.