Originally coined by PIMCO boss Mohamed El-Erian, “the new normal” is a phrase we are hearing quite often in the investing world. This time around the term is referring to the new world order that investors are being forced to adopt post the COVID-19 crisis.
Many sectors have seen revenues collapse as a result of the lockdown. Reports of the millions of people around the world who have lost their jobs in just a few weeks certainly poses real questions: What will the new normal world look like? What level of earnings will return after the lockdown period? What shape will the recovery take? And what price should investors pay for such uncertainty?
There is no firm answer to these questions. No one sector will be affected in the same way and we are expecting extreme sectoral performance variation. Ultimately, investors will be willing to pay a premium for businesses that thrive and will punish those that lag.
As the world becomes awash with cheap liquidity, the gap between the good and bad performers will only become larger. Looking at what has happened at the sector level we can see where the opportunities are.
Sector performance converged during March except for healthcare, the meaningful outperformer. Discretionary, property trusts and infrastructure offered some of the worst returns.
One month on, with signs that lockdown will soon be lifted, investor rationality has returned. The previous underperformers were among some of the best stocks in April, despite most having withdrawn guidance and pointed to extreme uncertainty in the next three to six months.
If March was a panic selling month, then April was a panic buying month, as fear of missing out drove investors into anything that underperformed in March.
Of course, long-term returns will always be determined by the underlying fundamentals of a business. The earnings trajectory, strength of the business model, management execution track record and balance sheet capacity are some of the key determinants of a quality business.
Ultimately, we are in an unprecedented health crisis-induced global recession, and most businesses will be affected to some extent (even though some may not be as clear-cut at first glance). It’s crucial for management to respond quickly to manage costs and ensure ample liquidity.
Quality businesses that will thrive in this uncertain environment will be those that take advantage of the changing competitive dynamic.
V or U shaped?
We are expecting essential infrastructure-like sectors to experience more of a V-shaped recovery. Examples include Transurban, Atlas Arteria and Ramsay Health Care. Tollroad traffic will pick up as lockdown lifts, and Transurban has already commented on rising traffic in recent weeks. These companies will return to a more normalised earnings environment reasonably quickly.
The same can be said for Ramsay. The share price sharply underperformed from $80 to $50 on the government-mandated deferral in elective surgery, but the lifting of the restriction in the past few weeks will see earnings recover reasonably quickly and its raising has ensured ample balance sheet capacity to possibly take advantage of cheap global hospital assets.
Retailers should also see a quick earnings recovery after the consumer has been trapped indoors with limited options for entertainment. The opening of the shopping centres and retail stores will draw traffic, particularly with the government support and stimulus waiting to be spent.
There is, however, the risk that this pick-up in spending will be short-lived as rising unemployment is expected to hit consumer sentiment in three to six months.
In terms of a U-shaped recovery, the travel sector is a prime example, with most travel businesses in cash preservation mode and cash flow barely breaking even - even with balance sheet recapitalisations. Investors will have to put a lot of faith in management taking prudent measures with such uncertainty of demand.
Where to from here
Essentially, the new normal means lower interest rates for even longer, lower dividends and a tough earnings outlook for the near term, and perhaps dire macro data to hit the headlines.
But similar to what we demand of our portfolio companies, investors also need to adapt to this new world and be realistic about the treacherous path ahead, and be nimble in making investment decisions.
It’s important to remember that returns are made when others are fearful or greedy, and opportunities are in abundance for those that are looking. Do watch your step, however, in case a ditch is ahead.
Happy stock hunting.
Jun Bei Liu is the lead portfolio manager at Tribeca Investment Partners and a two-time conference manager.
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