Clients have asked us about the difference between the global financial crisis (GFC) and the situation we face today. During the GFC, control of the recovery was largely in the hands of governments bailing out troubled companies and providing liquidity to the system. Today, the recovery depends on the containment of Covid-19; demand cannot improve until consumer spending and capital expenditures return. This is the difficulty.
Behind the volatility
Two key elements led to the stock market behaving as it did: firstly, the disruption of supply logistics because of China’s lockdown; and secondly, the decline in demand as the virus spread globally, effectively stalling growth.
These dynamics continue to lead to a more important driver of the volatility: the unpredictability of earnings. This causes uncertainty and investors don’t like uncertainty. Unfortunately, earnings remain unpredictable.
What do we do in this situation? As stewards of our clients’ money, we do the same as in bull or bear markets: we focus on the fundamentals of those companies that will survive the crisis and gain market share. We look for opportunities when markets panic and sell-off weak companies as well as the financially strong.
Pinpointing new opportunities
While we do not know when the recovery will happen, if past pandemics are any guide, a recovery will come eventually. Therefore, the more important question to ask ourselves is: which companies that were expensive before, now look cheap in value terms and are available at prices close to where we want to buy them? Further, if we look forward three years, will these companies trade at today’s prices?
Consider one example of a company we have invested in recently. We have been searching for a company that can benefit from cloud usage, and have been looking at a certain software design company that monetises the cloud platform on which engineers host and share design files. The company’s share price fell significantly over the last three months, and we believe it is an opportune time to start accumulating such companies that should benefit from the rise of industrial electronic applications, automobile data centres, internet of things (IoT) and other advancements. We believe this company will gain market dominance and leadership through industry transformation.
In short, it is the time to look for great companies and invest for the long term.
In China, although supply is returning, demand is still fragile. However, inter-city travel is returning; one domestic travel company we spoke to reported that 90% of business travel is resuming. Leisure travel is still slow but is starting to pick up. Therefore, we look for companies that are benefiting from this resumption in consumer spending.
We continually analyse companies that are gaining market share, keeping their costs down and increasing investments in research and development.
Another important consideration arising from the lockdowns is what might become a permanent change in the behaviour of individuals. It’s not only the young who are using online shopping platforms now; the older generations, too, have been forced by lockdowns to buy online rather than in physical stores.
Further, once the lockdowns are over, we believe the swing in pent-up demand will be extremely strong. This brings us to the question of inflation, but we believe this is further down the line. Until then, governments in Asia will be intent on stimulating weak economies. It takes time, and it will only work when demand returns.
In the meantime, it is a unique time to select good quality companies. The beauty of volatility is that it gives us opportunity; it’s never a dull day for a portfolio manager.
Visit our Coronavirus in Context page for more of our latest perspectives on the impact of Covid-19 on economies and asset classes.
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Last updated 31 March 2020.