Navigating new waters… what lies ahead
Markets are reflecting a V-Shape recovery, but the underlying global economy is reflecting U-Shape recovery.
“We believe economies will re-open in a gradual, staged way or phase. GDP recovery, pre-covid levels, to pre-covid levels, should be to towards the end of 2021, beginning 2022. In terms of a vaccine, we believe a vaccine will be available sometime in the first quarter of next year. That is what informs us that a U-Shape recovery is most likely,” said Joe McDonnell, Managing Director and Head of Portfolio Solutions EMEA at Neuberger Berman Group, during the Momentum Global Investment Management Think-Tank Conference 2020.
Three distinct phases
“There have been three distinct phases in this crisis. The first was the indiscriminate sell off of risk assets, which we saw in March. The second was the policy response… both the fiscal and monetary policy response we saw across developed markets,” said McDonnell.
“Risk assets respond to policy responses, and today, we find ourselves in phase three where we feel the low hanging fruit is not there anymore and it is challenging from an asset allocation perspective for investors over the next six to 12 months,” added McDonnell.
Where the focus should be
“In the short-term investors are focused on two critical issues. The first is the path of the Coronavirus… conditions are easing in Europe and Asia, while the growth of US Covid-19 cases remains stubbornly persistent. Economic activity has improved significantly, across major economies treatments have also improved and the mortality rate has dropped. However, there are limitations. Markets will focus on whether a vaccine can be developed in short order,” he continued.
“Investors should pay attention to China for two reasons. The first is that it is more advanced in terms of Covid-19 recovery… it is at least three to four months ahead of Europe, and six months ahead of the US in terms of Covid-19 recovery. Secondly, the importance of China to global growth cannot be understated,” he said.
India and Brazil, according to McDonnell, have big issues around Covid-19 and this has a big impact on how investors view that market. If we have a constructive growth environment in 2021, this could be supportive for emerging markets.
Key investment themes
“The effects from this unprecedented economic shock will impact risk assets for an extended period; it is important to be flexible in our approaches and seek opportunities to benefit from volatility,” added McDonnell.
There are four key themes McDonnell shared:
- Durable income and yield - Resilient strategies for income and yield as dividends fall, defaults rise, and negative yielding sovereign debt continues to grow. The rapid recovery in risk premiums and ultra-low rates create a challenging setup: sector and issuer selection is critical;
- Regime shift in equities; strategies with potential to outperform - Low interest rates will likely drive investors to seek out higher risk premium; favorable for quality companies with staying power. With lack of earnings visibility, focus on quality, income and monetizing volatility. Also consider structural thematic investing;
- Dislocation play through private equity and private credit- Access to new capital via private markets will likely play a central role in supporting companies affected by the COVID crisis. Identifying quality, mispriced assets created by recent events; and
- Idiosyncratic ideas - Opportunities for diversification. Strategies that aim to deliver returns uncorrelated to overall market directionality.
“The ever-increasing debt load in a regime of secular reduction in growth paves the way for inflation down the road. Commodities respond positively to money growth and may prosper when USD weakens. Long-term recoveries tend to have ups and downs roughly every three months. This time, swings could be larger and more frequent, given the nature of uncertainties and concentration of market leadership in a few mega-cap stocks. Benefit from volatility to implement portfolio moves gradually and opportunistically,” added McDonnell.
Sustainable growth in emerging markets
“Growth investing is about predicting the future, but the world is an unpredictable place. We believe that some things, however, are predictable over time. Earnings growth tends to drive long-term stock returns… (returns are correlated with earnings growth over time) and a select few companies tend to create most of the value,” said Brian Christiansen, Research Associate at Sands Capital Management.
“So, what’s the playbook? Our investment philosophy is that over time, common stock prices will reflect the earnings power and growth of the underlying businesses. To be successful we must identify the few truly exceptional businesses with sustainable above-average growth, construct a concentrated, conviction-weighted portfolio and accept short-term market volatility in exchange for long-term wealth creation,” added Christiansen.
“Buy the few but seek to buy the very best. The cornerstone of our investment strategy is our proprietary global research: fundamental, bottom-up, and business-focused. We seek to identify leading growth businesses that meet the following criteria: sustainable above-average earnings growth, leadership position in a promising business space, significant competitive advantage/unique business franchise, clear mission and value-added focus, financial strength and rational valuation relative to the market and business prospects,” he said.
“Different views produce different results. Our three decades of growth investing experience can help us appreciate what the market often discounts. There are a few of the areas where we see significant growth opportunities in EM. China’s biotech industry, for example, is rapidly moving up the innovation curve to address massive unmet needs. We prefer both innovative drug companies (with differentiated assets, multinational validation, and world-class management teams) as well as businesses providing the “picks and shovels” to the industry. Also, Ecommerce adoption is in early stages and accelerating in large consumer markets, such as ASEAN and Latin America. Cloud computing is modernizing developed-market businesses but remains early in EM. Approximately a third of the world’s adult population remains unbanked, and nearly all of them live in emerging markets. New technologies are also enabling access to basic financial products and services,” continued Christiansen.
“Going where the growth is… our domain experience gives us confidence in our ability to identify tomorrow’s winners. This is where the potential opportunities for capturing long-term sustainable growth are,” concluded Christiansen.
Writer’s Thoughts:
Although economic activity has improved and the mortality rate has dropped, we continue to hear of ‘second waves’ of Covid-19 hitting countries, which has resulted in the reintroduction of harsh lockdown tactics, and in some instances, market drops. Do you believe GDP recovery and global economic activity, pre-covid, will be towards the end of 2021, beginning 2022, or could things take longer? If you have any questions please comment below, interact with us on Twitter at @fanews_online or email me - [email protected]
