Beyond Bulls & Bears


Quick Thoughts: Living on “COVID” Time

The coronavirus has forced a number of behavior changes throughout societies across the globe, including how we work, shop and interact with others. Our Head of Equities Stephen Dover discusses how COVID-19 has impacted investor decisions, too.

We are all globally on “COVID time” now as we have never seen as swift a change in our society, culture and economy as that caused by the coronavirus. Here are some points for investors to ponder.

  • Investors are experiencing uncertainty more than risk in their portfolios: The markets have shown record daily volatility. At the same time, price movements in different asset classes (except US Treasuries) have been highly correlated  because the markets are dealing with uncertainty. Market volatility will likely abate once COVID-19’s length and magnitude are understood.
  • It’s bad, but not The Great Depression (TGD): During TGD, policymakers tightened monetary policy, misdirected fiscal aid, raised trade barriers, tried to reduce fiscal spending and increased the regulatory burden on banks and industry. Policymakers have learned from those mistakes; the current global response to the coronavirus is at least less likely to make matters worse.
  • Cash is king for companies and investors: Investments of all kinds are being indiscriminately sold to raise cash. Money-market fund assets and flows are at all-time highs. To survive the freefall in their incomes and cash flow, companies are strengthening their balance sheets. Companies will need stronger balance sheets and individual investors will need larger “rainy day” accounts.
  • Company earnings forecasting in the fog of war: Most companies cannot predict earnings in this volatile environment. Current earnings projections for a least the next two quarters are overstated and will be revised downward. Investors should look past this and base company valuations on a longer-term earnings outlook, balance sheet strength and cash flow quality.
  • Stock buybacks will slow in the United States: Buying back stock increases a company’s earnings-per-share (EPS), because there are fewer shares. So, we will likely see reduced EPS growth rates as well as flows into equity markets for the next few years; stock buybacks averaged about 40% of the flow into the US equity market in 2019. I anticipate there will also be a slowdown in dividend growth, and we will likely see cuts in some dividends.
  • Fiscal deficits as far as the eye can see. Globally, the COVID-19 serves as a catalyst for Modern Monetary Theory (MMT)-style policies that are not concerned about the size of fiscal deficits. The risk is that once these “temporary” policies are introduced, they may become permanent. When the economy starts to recover, there likely will be increases in taxes, including on capital gains. Investors should take into consideration the current low tax rates and likely future higher tax rates into their portfolio decisions.

In a world where bond yields are at or below zero and there is massive fiscal spending, equities should outperform dramatically in relative terms. The recent indiscriminate equity selloff has left pockets of relative value for investors.

Asian equities, especially Chinese equities, have outperformed many other markets this year, and the recent rise in the US dollar has also made foreign stocks relatively less expensive. Global technology companies and Chinese internet companies should see their competitive market position further strengthened by the current shutdown as the entire world learns to both work and live remotely.

What Are the Risks?

All investments involve risks, including possible loss of principal. Bond prices generally move in the opposite direction of interest rates. Thus, as the prices of bonds adjust to a rise in interest rates, the share price may decline. Interest rate movements may affect the share price and yield. Treasuries, if held to maturity, offer a fixed rate of return and fixed principal value; their interest payments and principal are guaranteed. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging market countries involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Such investments could experience significant price volatility in any given year.

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