I have been absent from this column for the past two weeks as I concentrated on maximizing the best return possible from the volatility. In my last note on March 6th, I highlighted that I didn’t think valuations were back to cheap or attractive levels following on from my warning on equities in January (after clear alarm bells being rung in the bond market).
Maximizing the best return possible from the volatility is not only understanding (and reacting) to what is currently happening with headline news, but also formulating a view of what post-Covid-19 will look like and how to be best positioned for it.
Here are key takeaways of everything I see post-Covid-19.
1) I originally thought two weeks ago that much of the policies to be provided by Governments will be extremely stimulatory creating pent-up demand, but I have since concluded that the trillions of dollars being spent is largely not. It is largely being sent down a black hole to help people pay their bills while not at work. It replaces their normal income so it is not “additional” money being handed out like in 2009 to be spent on discretionary items.
Governments will then, to kickstart the economy, have no choice but to either a) write cheques for every individual or b) embark on massive fiscal infrastructure projects. B) is the only logical choice as it benefits multiple generations into the future. Think schools, bridges and roads to nowhere. Building is the only way Governments can get a direct economic return on their investments that benefits everybody – not just the rich. Clearly resource companies exposed to copper, nickel, iron ore and construction aggregates will stand to benefit most.
2) Investors will be jaded by the speed and violency of this sell off as well as the far reaching aspects of this crisis. It directly penetrated their daily lives and everyone’s homes. As a result, investors will be much more critical of businesses that are not well funded and positioned to outlast and withstand a future crisis. In fact I believe that these companies will actually trade on HIGHER multiples after COVID-19 because they are more valuable. They are heavily imbedded into the fabric of companies and society, huge cash positions and an ability to ride out virtually any storm. Who are they? Think the global tech mega-caps. Microsoft, Apple, Adobe, Google, Facebook, Disney etc. This is where the next bubble is likely to form. The rush to park money here will be on a gigantic scale and these stocks heavily influence the major indices.
3) Yield crunch. I talked about this for the past 18-months about the prices infrastructure/property trusts could trade at as central banks and bond yields approach zero. The current fallout has brought about a sharp drop in infrastructure/property stocks with long-term underlying hard asset valuations that are unlikely to change. Arguable with interests rates now imbedded closer to zero for longer as a result of the economic fallout, their relative valuations are ridiculously cheap vs their long-term cashflows. Spreads between 10-year bonds and dividend yields have shot out to twenty year highs, even accounting on my numbers a 30% ongoing long-term cut to dividend payouts (not my base case but possibly for one or two payments only). Infrastructure plays like Transurban and Sydney Airports will return to normal with time and so will their share prices. Many property trusts dropped from trading at large premiums to NTA to significant discounts. Ludicrous in my view, yet an enormous opportunity. Have a look at Bunnings Warehouse Property trust (BWP) and the sell off and subsequent rebound. Really would Bunnings stop paying rent?
4) Gold – Gold prices in a low interest rate environment will continue to boom. I have been a gold bull for a long-time and the circumstances underpinning gold only improve. This is a sector where you can afford to go out the risk spectrum and acquire several explorers along with large producers.
5) Small-Caps & Biotechs – this should be the smallest exposure as it could take years for some of these companies to recover. It is difficult to buy these stocks with any meaningful size and even more so to exit. 99% of small caps will end up forgotten by investors even if they were once upon a time high flyers. This region will be a minefield much like tech companies were post the tech-boom. 90% went broke. Attracting capital will be very difficult from both a balance sheet perspective and/or shareholder interest. Unless within 12 months the Company will be cashflow positive and scalable – forget it. And don’t listen to management forecasts – if you do – halve it. And then use those numbers as a realistic forecast.
6) Finally, avoid long-term loss making companies and sectors where the economic volatility can deliver havoc to earnings – discretionary retail, airlines, money managers, banks (can have a short term bounce but are at risk of bad debts rising).
Constructing or repositioning a portfolio that stands to benefit from the above thematics I think is the best way of looking and tackling life after Covid-19. The market sell off has presented opportunities to investors unlike that seen in a decade. But not all opportunities are equal and hopefully the above pointers can help navigate you through the current storm and the eventual calmer waters on the other side.
