David Prosser highlights where investors should look for opportunities as the two-speed Covid-19 recovery plays out.
Economists use a technical term to describe shocks to the environment felt by all such as the Covid-19 crisis: they call them symmetric. And they also have a rule of thumb for these shocks: their impacts are almost always asymmetric – that is, not everyone is affected in the same way.
So it has proved with the pandemic. The Covid-19 virus may not respect geography or character, but the economic impact of this crisis has not been uniform. The International Monetary Fund (IMF) estimates advanced Western economies shrank by 5.8% last year as the pandemic forced them into lockdown; in the developing economies of Asia, whose experience of the Sars virus left them better prepared to confront the threat of Covid-19, the decline was only 1.7% - China even managed to grow. Closer to home, non-food retail sales in the UK fell 5% in 2020, but online retail sales were up a whopping 36%.
This asymmetry will be just as marked on the way out of Covid. “Economic recoveries are diverging across countries and sectors, reflecting variation in pandemic-induced disruptions and the extent of policy support,” warned the IMF in its April World Economic Outlook report. “The outlook depends not just on the outcome of the battle between the virus and vaccines - it also hinges on how effectively economic policies deployed under high uncertainty can limit lasting damage from this unprecedented crisis.”
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Countries that win vaccine race will bounce back more quickly
We are, in other words, heading for a two-speed recovery from the pandemic. At a macro level, countries that are moving quickly to vaccinate their populations – and are therefore in a stronger position to reopen their economies – will bounce back more quickly. Equally, industries and companies that now able to trade freely will recover more rapidly than those still subject to restrictions.
The detail of this big picture, of course, is more nuanced. “We see a multi-speed recovery as likely – country by country and region by region,” says interactive investor’s head of fund research Dzmitry Lipski, who warns of further unpredictability ahead. “There have been so many twists and turns during this pandemic and there could well be more to come.”
Fund managers agree, pointing out that global stock markets are doing their best to pick likely winners and losers in an uncertain landscape. “It is fair to say that the reopening and reflation trade is aligned with the relative success or otherwise of the vaccine roll-out, or the containment of Covid in various countries,” says Stuart Clark, a portfolio manager at Quilter Investors. “China recovered sooner, then the US and the UK, and more recently Europe is catching up, whereas some emerging markets are still very much struggling to contain the virus.”
UK looks good value and is still unloved
Where, then, do investors look for opportunities as this two-speed – or multi-speed – recovery continues?
At an asset allocation level, the challenge is to work out to what extent markets have priced in recovery in vaccine-advanced economies. “For several months now, we have seen China-focused investment funds and investment trusts rising up the best-buy charts, as many investors believe that China has dealt with the pandemic better,” says Lipski. “We still think the UK looks good value versus the US and Europe – it is still relatively unloved.”
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Stock markets, remember, tend to run ahead of economic performance. The strong gains seen in Western markets, including the US and the UK, in recent months reflects the expectation of a Roaring Twenties-style recovery that will arrive in these countries first. This is why Lipski adds: “Emerging markets could represent good value for contrarian investors.”
At Royal London Asset Management, meanwhile, senior economist Melanie Baker picks out the EU and Japan as contenders for attention. “A first-quarter Covid wave and slow vaccine roll-out have held back the euro area recovery, but recent data has been more robust and with the vaccine programme having sped up, prospects are good for a strong second half,” she argues. “A slow vaccine roll-out continues to threaten the pace of recovery in Japan.”
Share winners and losers
Moving from asset allocation into sector- and stock specific selections is potentially challenging adds Quilter’s Stuart Clark. “A lot has been said of the trends that have accelerated as a result of the pandemic - most notably the uptake of digital transformation - but these trends extend beyond sectors and, in fact, there have been winners and losers within,” he argues. “The broad recovery, including in leisure and retail, has helped most names but from here investors will need to think about active stock selection.”
The retail sector is a good example. The pandemic looks to have stepped up the move to online shopping, rather prompted a one-off move that will now reverse, so those businesses that are purely bricks-and-mortar based may be left behind, even though they are now able to reopen again. By contrast, businesses able to serve a multi-channel audience – Next (LSE:NXT) is winning plaudits for its recent investments in e-commerce, for example – are in a strong position.
“Another area for investors to pay close attention to is homebuilders and home improvement retailers,” suggests Clark. “As people spend more time at home, they might look to improve their home environment, particularly for home-working going forward,” Clark adds.
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By contrast, in hospitality, where serving customers online is less realistic, the winners from recovery may be more conventional. “Stocks such as Diageo (LSE:DGE) are likely to benefit, as could pub operators such as JD Wetherspoon (LSE:JDW), or hoteliers such as Whitbread (LSE:WTB) and InterContinental Hotels (LSE:IHG),” argues Richard Hunter, head of markets at interactive investor.
Elsewhere, look for first- and second-tier beneficiaries, Hunter adds. “Tourism remains a murky area given the ongoing travel restrictions, but the likes of International Consolidated Airlines (LSE:IAG) and easyJet (LSE:EZJ) stand poised to benefit,” he says. “And should frequent flights resume in the skies, this would also be a fillip for Rolls-Royce (LSE:RR.), which is paid on hours flown; Burberry (LSE:BRBY) is another stock which has suffered throughout lockdown, particularly with regard to the lack of Asian tourism in Europe.”
Cyclical stocks are poised to benefit
Nor should investors overlook sectors in a position to benefit from cyclical drivers as growth everywhere picks up, albeit at different speeds. Recent research from HSBC picks out oil and gas, infrastructure, metals and mining, and power and utilities as the four sectors where companies are currently most likely to describe themselves as thriving. At the other extreme, the arts, media, tourism and parts of manufacturing are still in the doldrums.
“The profile of profitability reveals a lengthy recovery for many sectors,” warns HSBC’s research. “Half of firms globally expect to return to pre-Covid levels of profits in 2021 [but] for nine in 20 firms, pre-pandemic profitability is not expected to return until 2022 or later.”
Translating that research into ideas for the UK, there are several potential opportunities, points out Hunter. “The FTSE 100 Index, for example, contains some of these sectors in the form of the oils, where Royal Dutch Shell (LSE:RDSB) is currently the market’s preferred play, and the miners, such as BHP Group (LSE:BHP).” Banks such as Barclays (LSE:BARC) might also fall into the category of businesses set for a boost from cyclical factors.
All this, it should be said, comes with some heavy caveats. If we have learned one thing about the Covid-19 virus, it is that the course of the crisis is unpredictable. In the UK, the debate continues over whether new variants could blow the easing of lockdown off course; setbacks would naturally disappoint investors in businesses set to benefit from the end of restriction.
Similar debates, moreover, are taking place in every country in the world. Singapore and Taiwan, both praised for exemplary responses to Covid-19, have both been forced to implement new lockdown restrictions in recent weeks. Brazil and India are wondering whether their virulent outbreaks have eased. The US feels as if it is on top of infections, although plenty of hotspots remain.
Proceed with care, in other words. Investors determined to embrace certain markets, sectors or stocks with gleeful abandon may yet discover that further social distancing would have been a more prudent policy.
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