As always in times of turbulence, there will be winners and losers in the economy and we’re already seeing this. However, there is no doubt that the world has already changed structurally because of covid-19 and it will continue to do so more and perhaps at a faster pace. We have for the time being reduced our equity allocations achieved primarily via an underweight of UK stocks. The pandemic has caused great disruption and short-term change to global activity. Some of this change will become embedded and more permanent and we are focusing on some of these themes. Within our US equity allocation, for example, we have increased our weighting to technology companies. As the world is experiencing more sustained remote working, it is ever more dependent on technology to operate and connect. We believe tech will continue to perform relatively well as companies rely on it to function and survive in the economic downturn, and that themes such these will be driving much of our new investment decisions.
A by-product of the covid-19 pandemic is that central banks are again called to the rescue to reassert themselves as both lenders and, this time, buyers of last resort. Bond markets’ addiction to low rates and quantitative easing programmes will not be left unsatisfied for the next 12 months (if not more). Lower rates in the US will soften debt servicing costs in emerging markets via a lower US dollar and will create policy space via real rate differentials. Additional easing will be required despite G10 yields sitting at historic lows as the economic costs of lockdowns become real and fiscal stimulus programmes seem unavoidable at this stage. The main consequence for bondholders is that yields will remain suppressed for most of the year, and buying opportunities in the credit world will be up for grabs for those funds that manage to navigate the lack of liquidity over the coming months or until some confidence that the virus can be suppressed gains traction. In this respect, we will continue to focus on the highest quality bonds in non-cyclical sectors, particularly in Europe because of the European Central Bank’s bond-buying programme, and stay away from travel and leisure names deeply impacted by the coronavirus pandemic.
For credit investors, this will not be like the aftermath of the global financial crisis where indiscriminate central bank buying lifted all bonds. Many bonds may look very cheap over the next few months but that does not necessarily make them a buy if their business stands to be disrupted by the lockdowns to the point that they suffer huge losses or will see their debt obligations balloon sending them into “junk” bond territory. As ever in credit investing, long-term value is created by avoiding the losers, rather than trying to pick a few heroic winners and in this new environment we will see investment grade downgrades.
We have been relatively defensive during this unprecedented disruption of global lockdowns and exogenous shocks to the markets. With that said, we have seen ‘stay at home’ stocks, such as Netflix, Zoom and Walmart, outperform and there have been some attractive valuations to take advantage of throughout the freefalls in non-cyclical sectors. In our view, as the increase in death rates moderates and the peak moves West, markets are likely to find lows and the extreme volatility will decline. Mass testing needs to take place to understand where we are, but we believe markets are likely to be significantly higher by 12 months’ time. However, we then must understand what the new world looks like: higher debt? higher inflation? lower valuations? future outbreaks? We are monitoring Asia’s recovery closely as a barometer in this regard.
UK Commercial Property
The property sectors most vulnerable to the covid-19 crisis are consumer-facing retail, leisure and services, in addition to flexible office/co-working operators because of their high volume of daily workers’ interactions and proximity to each other. Traditional UK office markets are also vulnerable, but less so. Most should recover from next year onwards although not all underlying businesses will survive. Supermarkets and distribution warehousing/logistics, while not immune and still subject to short-term disruption, will be more resilient over the longer term due to an increase in consumer demand for essential food and online goods, which require greater storage, faster delivery to the consumer and more modern, automated warehousing facilities. Against this backdrop property investment activity will remain quiet for the next three to six months, with investors focusing on resilient income strategies, e.g. supermarkets, primary healthcare and long-leased assets, while avoiding non-food retail and other consumer-facing sectors.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
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CLI01596 Expiry 31/03/2021