Zehrid Osmani provides his view on current markets, potential opportunities in a post-pandemic world, and a summary of the in-depth research process.
- Five key aspects that will dictate the shape of the equity market recover
- The path from recession - V-shaped or gradual recovery?
- Risk – avoiding unintended exposures in portfolios
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We could therefore get to a point of ‘bottoming’ in earnings downgrades much more rapidly than in previous recessions
Our funds focus on quality growth companies with sustainable business models
Hello, it’s Zehrid Osmani, head of GLTU at Martin Currie and Portfolio Manager of martin Currie Global portfolio Trust - with a third update in our podcast series.
Before we start, we would like to again congratulate all the frontline workers throughout the world, for the courageous work that they are carrying to help everyone - putting their duties and care for others ahead of their own safety. Our admiration for your commitment is immense. Thank you.
Last weekend, I watched some of the ‘One World Together At Home’ concert and was touched at the show of global unity in what had become a growing world trend towards deglobalisation. I hope that this show of unity and solidarity, and this acknowledgment that everyone throughout the world is in this together will show us the way to a more co-ordinated approach towards a sustainable manner of generating growth and creating wealth in the world going forward.
We have structured this podcast into 3 parts as always: the first one being to give some thoughts on the market; the second part is to highlight our work on the portfolios and how we manage the potential opportunities in a post pandemic world, and; the third part is to continue to zoom in on our investment process. As a reminder, we manage high conviction best ideas funds on a long-term time frame, offering Global, International, European and US versions of the funds to our investors, depending on geographic preference.
Our funds focus on quality growth companies with sustainable business models, high pricing power and therefore high returns potential, attractive growth prospects and solid balance sheets, all of which typically makes our funds able to perform well through most market conditions, and notably have shown to be defensive in periods of market sell offs.
Let’s start with an update on our market thoughts, and it is important here to highlight again that we are long term investors, and therefore these market updates have to be taken in the context of that time horizon.
We wanted to channel our market focus today on reflections about the anatomy of the bottoming of equity markets. We are conscious that the bull-bear debate ongoing in the market is about whether the recent market rally is sustainable, or whether it is simply a bear market rally.
The market bounced sharply from the lows of 23rd March. We’ve had the best week since 1974 in equity markets a couple of weeks ago, as the market continued to cheer the growing magnitude of policy responses. In the space of a month and half, we’ve technically experienced a bear market at record speed, and a bull market at record speed. The speed and volatility of the moves is most likely related to the exogenous nature of the shock the global economy is experiencing. The magnitude of the recession will likely be unprecedented in our lifetime, because of the globally synchronised abrupt slow-down in both supply and demand as a result of the lockdown policies across economies.
As we flagged in our second podcast, the bears are still focusing on the short-term recession risks, the many profit warnings still to come and the magnitude of the downgrades to earnings that we still need to see in the market.
The bulls are focusing on the policy actions which are unprecedented in scale and simultaneous across most regions, and the hope that this will lead to a rapid recovery, as well as the hope of rapid medical breakthrough to fight the virus.
There will definitely be a recovery over the next few months and quarters, as economies gradually exit the lockdowns. We are already seeing some signs of stabilisation in the Chinese economy, and tentative signs of a pick-up in activity, which are encouraging, even if early days.
But what will be the shape of such recovery? The answer is highly uncertain, due to the lack of clarity on five aspects:
- Firstly, the length of lockdowns
- Secondly, What a post lockdown world will look like?It is unlikely that it will be a return to the ‘old normal’ both in terms of shape of demand and of supply given that social distancing will still be in place for some time.
- Thirdly, the speed of channelling policy stimuli into the economy will determine magnitude and pace of a recover.
- Fourthly, the potential downside impact of any negative feedback loop of weakening labour market on the demand outlook.
- And finally, pandemic relapse risk once lockdowns end which could also dictate how rapid a recovery could be.
What is the anatomy of a typical bottoming in equity market:
- It took the US Equity market on average 18 months to reach the lows in past recessions since WW2 - although the range is pretty wide, and each recession should be assessed on a case by case basis.
- Average earnings downgrades of >20% from peak to trough in previous recessions.
- Markets have tended to bottom as earnings downgrades momentum has been bottoming, and downgrades have been easing.
The final important component for a bottoming in equity markets is valuations.
Without knowing the shape of a recession, it is difficult to know the anatomy of a market bottoming. Will we have a gradual bottoming in economic activity as seen in the GFC Or a V-shaped recovery such as ones seen post some natural disasters? Or will it be something in between?
This recession is like no other, so the earnings downgrades is likely to be much more severe and much more rapid. We could therefore get to a point of bottoming in earnings downgrades much more rapidly than in previous recessions.
There is, of course, a risk of negative feedback loop from the sharp increase in unemployment and furlough so we will need to continue to assess the situation.
The final important component for a bottoming in equity markets is valuations. Currently equity market valuations are some way away from the lows seen in previous recessions. This is something we will spend more time focusing on in the next few podcasts
For us as long-term investors of course, focusing on the long-term picture makes it easier to navigate than trying to assess when are markets troughs being reached.
Onto our second part: work on portfolios, and thoughts on opportunities post this pandemic crisis.
We mentioned in the past the work we did on checking our holdings for balance sheet strength and supply chain dependency risk, and deploying our supply chain database to its full potential - we have written a report on this, available on our website, for those of our listeners who are interested in the detail around that work.
Last week, we also flagged that we think tax rates could be at risk of rising post this pandemic crisis as a way to fund the stimuli. We calculate that, to fund the stimuli, corporate tax rates might have to increase by 0.5-2.0 percentage points, which would pay for the stimuli over a 5-10 year period, depending on the country.
As a result of that reflection, we have taken the view to increase corporate tax rates assumptions by 2 percentage points across all the companies we hold in our portfolios, which has led to a small decline in our fair value estimates, and therefore price targets. Overall, this change in assumption is not changing our view on any of the stocks we hold. We have therefore made no change to our list of holdings from this point of view.
The other work we have spent the past four weeks on as been to update our forecasts, to capture the recessionary environment. We will use the next podcast to fully flesh out the details of our framework, which we have applied on our forecasts.
Onto the third part of our podcast, zooming-in on our investment process.
We zoomed-in on step one of our 3 steps investment process in the first podcast, namely how we screen for quality growth ideas. The second podcast focused on step 2, our in-depth structured fundamental research work we go through for any company we are looking to invest in.
Step 3 of our process is portfolio construction. It is just as important a step as steps one and two. In fact, many stock pickers seem to only seeing the job a stock picker as being about steps one and two, i.e. screening for ideas, researching them and then adding them to the funds.
This carries a high risk of exposing funds to unintended risks. We see step 3 as an important step because it permits us to build portfolios that are high conviction but diversified at the same time, with no unintended risk exposures.
We consider risk analysis as an important part of what we do as portfolio managers and can indeed talk about risk alone for a long time - something that some of our investors have praised us for.
We use many different tools to assess our risk exposures in funds. We use the traditional risk tools that many investors use - whether it is style analytics, factor exposures, macro-stress tests, or any other traditional volatility measures. But we also augment that traditional risk analysis with some innovative risk analytics tools, driven by our fundamental risk assessments that we carry during the in-depth fundamental research work.
We assess every stock we intend to buy across four risk assessments: industry risks, company risks, governance and sustainability risks, and portfolio risks that the stock would bring, if we purchase it. This already gives us a detailed and structured list of risk assessments that are fundamental in nature.
Furthermore, we assess our funds in terms of geographic exposures of revenues and profits from the stocks we hold, end-user market exposures, thematic exposures, industry life-cycle exposures, and in terms of classifications of companies across five different types of companies that we invest in.
This detailed risk analysis helps us ensure that we are fully aware of the risk profile of the portfolios, including the fundamental risk profiles, so that we can construct diversified portfolios despite running best ideas concentrated funds. This permits us to ensure that we do not have any unintended risk exposures in our portfolios.
In future podcasts, we will go in more detail on some of the risk analytics.
In our next podcast, we will spend more time assessing the earnings downside risks in the market and in our portfolios. We will also further soon in on our team processes and structure.
Thank you for listening. It’s Zehrid Osmani, head of GLTU and portfolio manager of Global Portfolio Trust at Martin Currie, Wishing you a good day and a good week ahead.