Investment Outlook - Market Update
The first quarter ended with financial markets in an extremely tough spot as the Corona-crisis rapidly became a global issue with nowhere to hide. A remarkable couple of weeks with markets at times in freefall and certainly in ‘yoyo mode’ with large falls followed by modest recoveries. The trend however is still very much downwards and little sense that we have yet reached the bottom. It’s hard to believe that it’s only a few short weeks ago since global markets were at record highs and global conditions seen as relatively perfect! Since then global equity markets have fallen sharply into bear market territory.
There is no debate but that the global economy will imminently enter into a sudden and deep recession, but our working assumption is that the crisis will be relatively short lived and we can look forward to a back-ended recovery during the second half of the year. Global earnings will drop sharply and an educated guess at this point suggests a 35% contraction for 2020.The good news is that the combined monetary and fiscal response by authorities has been unprecedented in scale and is likely to be the greatest in post-war history. Unprecedented policy response including fiscal spend to the tune of $4-5tn have been announced so far across the world. Monetary policy responses have been equally impressive to date. There is no doubt however that while all these combined measures will cushion the system and limit the damage, what is absolutely needed is clear evidence this ‘Covid-monster’ is being contained. Until there is strong confidence that global health authorities are on top of infection counts, the shape and speed of the economic recovery will remain unclear. On a more positive note, the clear evidence that the lockdown model that worked in China is also beginning to resonate in Europe over the first week of April with a significant slowdown in new infection counts to single percentage daily rises being now recorded in Italy for example. Much more to go obviously and the Americas will be the core focus through April.
We do expect that markets will calm down and a market bottom will be reached during the second quarter. As we await both the economic data and company profits to be released over the quarter we expect these will be relatively nasty and undoubtedly will contain surprises, both positive and negative. Having observed that investors have during the first quarter indiscriminately sold shares of smaller cap companies, more cyclical industries, value or yield income oriented companies while maintaining blind faith in larger cap companies, defensive sectors and growth stocks, we certainly believe the latter group are now particularly vulnerable and we expect a rotation or mean reversion across markets throughout the upcoming quarter. We also highlight that the valuation of the growth & defensive sectors is currently the most stretched versus value/cyclical sectors in history. Worth noting also that this extreme positioning is at a point where we look to a resumption on growth into 2021 aided by an unprecedented monetary and fiscal injection into the global economy. The economic expansion that commenced with the Global Financial Crisis during 2008 is now ending and we must now all focus on the new cycle and how it may be very different in character to the one of the past 12 or so years.
In the short-term we will focus on the success or otherwise of containment measures across Europe, North America and other regions, assessing whether these measures can be as effective as the measures that China took. The ultimate positive is a vaccine but that is expected to be 12-18 months away. The team at KBI continue to focus on the business models of our portfolio companies and constructing portfolios of high conviction stock positions as we look with optimistic expectation of what can be delivered by markets and our portfolios when we get to ‘the other side’.