Today pain, tomorrow gain
The good news is that we
enter this period of macro
weakness with low inventory
levels and capex below trend
Using the NHS pandemic analysis papers, we see that a
virus spreads through a population until it reaches a 20 to
40% infection rate, peaking 7 weeks after the start and
falling to very low levels 7 weeks after that. It does not
disappear but by then the impact on a given community
of infection or immunity is clear.
This timeline appears broadly accurate when looking at the
statistics from China and in particular Wuhan and the
Hubei province. In Europe, there may well be containment,
but on a 7-week-to-peek basis our peek will be mid-April
and the all-clear in late May. As such, we need to discount
for a period of increasing uncertainty and lowered
business activity up until the end of May. The fact that the
peek period will now be over the Easter break is helpful for
manufacturing, as it’s a natural period of shut-down, and
conversely unhelpful for services as the holiday period
means enhanced consumer spending.
The reaction of corporates and fiscal authorities becomes
key. The impact of a quarter of ‘infected’ growth is likely to
produce some short, but ferocious, shut-downs.
Governments are showing that they are prepared to
quarantine towns and cities to prevent spread, but this is
likely to merely delay disruption by a few weeks. The
precipitous PMI drop in China is showing us the logical
progression, with that data being collected at the height of
disruption. As such, it is an indication of how bad it could
be, but not the shape of the recovery.
The shape of the recovery will depend on a number of
Capex and inventory levels into the downturn
The good news is that we enter this period of macro
weakness with low inventory levels and capex below trend
levels. Into the oil price induced global slowdown in 2015,
inventory levels were high whilst oil & mining industry
capex was huge therefore these were aggressively slashed.
The weak economies of Europe and China during 2019
coupled with weak raw material prices incentivised
businesses to delay inventory purchases. Currently we are
seeing companies report some lengthening of supply lines
whilst simultaneously consuming their limited inventories.
Based on this, once economies gain traction again, we
expect to see a rebuild in inventory of components and
working in progress. This points to an sharp V shaped
bounce towards the summer commencing in China.
Workers speed of return
The speed with which the labour force can return is vital.
Much will depend on the timing of the employer’s decision
to reopen and the power they have insist upon their
workforce’s return. It would be reasonable to suggest that
there would be a lag in the return to work in Europe,
where the Unions will be part of the decision-making
process. This would potentially delay any traction of a
recovery until June.
Consumers return to norms and pent-up demand
The consumer will likely resume normal purchasing when
confidence levels start to rise. Initially there may be a relief
surge with spending higher than normal. Cuts in taxes and
interest rates would be a significant help, but most
importantly the return to normality of the work and school
day is key. If a normalised summer holiday season occurs,
then after a quarter of lost earnings (especially for the
travel, hotel, luxury, fashion and entertainment industry) a
return to normal levels of demand will occur.
Will banks be sympathetic with impacted businesses
Even without the direction of local governments and
monetary authorities, banks are likely to act with kindness
and forbearance for now. Clearly the statements from the
Bank of Japan, the US FED and the Bank of England
support this. Banks may well see lower income for a couple
of quarters, and some customers closing. They will not be
allowed to exacerbate the downturn or hinder the
How large will monetary and fiscal action be
Fiscal action is yet to be seen. Post Brexit UK is already
planning a significant fiscal boost, and this may be
accelerated under the cover of a viral aid package.
Germany, and others, may then follow suit. It’s hard to
quantify, but measures announced in Italy already amount
to 0.2% of GDP. We could see overall fiscal boost to GDP
on average by 0.5% over the next 2 years.
What will the long-term impacts be
There will be a slightly higher level of goods and materials
held by industry and a significantly higher level by the
consumer, principally of essentials. There has already been
a significant shift to onshoring production, in particular by
the USA and this will accelerate. The drive for security of
supply by finding different geographic suppliers will
continue and some levels of extra investment will be
needed to achieve this.
The long-term impact on consumer confidence will be
interesting; stockpiling in the larder, nervousness of public
transport and travel in general will eventually fade. But
there will be a significant increase in awareness and
consumers will be quick to react negatively to any follow on infections or even rumours. A permanent revolution in
areas such as reducing business travel is unlikely, we have
seen travel bans imposed by businesses before during the
GFC or European financial crisis and they have had little
lasting impact. Politically any government that has been
seen to hide the truth will probably be punished. There will
clearly be a demand for higher levels of central health
spending and preparedness. The US elections, in particular,
will be a test case. Europe, except for Italy, with its quieter
political calendar in 2020 will be more stable.
What are we doing
We are focusing on the time-line of how this plays out
globally and how each industry is affected, it is longer than
most realise. The vigour of the recovery will be defined by
monetary and fiscal action, those that say Europe is
toothless are already being proved wrong.
Markets, valuations and prospects
Equity markets have moved to discount a significant cut to European earnings.
We have long argued that European
earnings see cuts of around 10% in a normal year. This year
will be far deeper, loaded to the first half. Markets will
increasingly begin to focus on the prospects for the
second half and 2021 as we approach the summer. As in
2016, at some point we expect to see strong
outperformance from cyclicals and value.
We are focusing on the time-line of how this plays out globally and how each industry
is affected, it is longer than most realise.
This information is issued and approved by Martin Currie
Investment Management Limited (‘MCIM’). It does not
constitute investment advice. Market and currency
movements may cause the capital value of shares, and the
income from them, to fall as well as rise and you may get
back less than you invested.
The information contained in this presentation has been
compiled with considerable care to ensure its accuracy. But
no representation or warranty, express or implied, is made
to its accuracy or completeness.
The views expressed are opinions of the portfolio managers
as of the date of this document and are subject to change
based on market and other conditions and may differ from
other portfolio managers or of the firm as a whole. These
opinions are not intended to be a forecast of future events, research, a guarantee of future results or investment advice.
The document does not
form the basis of, nor should it be relied upon in connection
with, any subsequent contract or agreement. It does not
constitute, and may not be used for the purpose of, an offer
or invitation to subscribe for or otherwise acquire shares in
any of the products mentioned.