It is challenging... more than ever, to make predictions, but it is also important to try and have predictions...
It’s Zehrid Osmani, head of Global Long Term Unconstrained, and manager of Global Portfolio Trust at Martin Currie.
We would like to start this podcast with a word of support and hope. We want to send a message of support to those who have lost dear ones in this pandemic crisis that the world is facing. And a word of support for those who are facing economic harshness brought by this sudden deep recession the world is going through. But also a word of hope: Humanity generally has an optimistic nature, and an ability to rebound from crises, and it is in these periods of uncertainty that we are facing, that we must remember that humanity will get through this tough period, and we will again get back onto a growth path and recovery.
We wish everyone courage and strength whilst navigating through these difficult times.
We have structured this podcast on our traditional 3 parts -
- an update on our market thoughts - focusing on earnings risks on this occasion, and going through the anatomy of the earnings revisions
- an update on our portfolios - specifically what earnings risks we foresee for our holdings, and
- an update on our investment process - this time focusing on our team structure and conviction approach to investing
Starting with an update on our market thoughts: and to reiterate again, these market comments are aimed to give our listeners food for thoughts. We are long term investors, and therefore some of the market thoughts do not impact our long term thinking.
We are living in an uncertain world, with unprecedented lack of visibility on what the future might hold, be it in terms of magnitude of recession we are going through, shape of the world post lockdowns end, or shape of the economic recovery that will ensue. It is challenging, in this instance more than ever, to make predictions, but it is also important to try and have predictions, because they constitute the roadmap to assess where we might be going. And as my grandfather used to say, if we don’t know where we might be going, it makes it more difficult to know when we get there.
Let’s start with the economic forecasts - consensus GDP estimates for the US are predicting close to -5% decline this year with likely further downgrades to come - from close to +2.0% less than 2 months ago. For Europe, GDP estimates are for a more than -6% contraction - from just over +1.0% previously.
For China, forecasts are predicting 1.6% GDP growth - from close to +6% previously - a significantly lower figure in contrast to the years of significant growth we have seen in this country in the past decade.
For the world as a whole, we are looking for a decline of -3.0/-4.5% decline in GDP growth - this compares to a forecast of a c.+3% growth just a couple of months ago. It shows how much the outlook has deteriorated as a result of this global synchronised supply and demand shocks.
For the western world, Q2 is likely to be the significantly weak point in terms of GDP downgrades, given the lock downs impacting that quarter especially, -7.6% for the Eurozone, -7.0% for the US, -11% for the UK. China’s GDP growth for reference shrank by -9.8% in Q1.
As the market has been going through these economic downgrades, it will start to move more intensely onto the topic of shape of the upcoming recovery. We mentioned in the last podcast that there is uncertainty on what the shape of such recovery will be due to the lack of clarity on 5 aspects that we fleshed out: namely, length of lockdowns, different shape of demand and of supply post pandemic given that social distancing will still be in place for some time, thirdly, speed of channelling policy stimuli into the economy, fourthly the potential negative feedback loop of weakening labour market on the demand outlook, and finally, pandemic relapse risk once lockdowns end.
As far as Market earnings are concerned, downgrades have been coming down rapidly in the past month, as a result of most companies coming in with profit warnings, suspension of guidance for lack of visibility, and/or reduction or postponement of dividend payments.
Earnings downgrades from start of the year to now:
- in the US, for the S&P500 - -26% in earnings downgrades since January - now forecasting -17% YoY decline in earnings, +9% expected previously
- For Europe, the STOXX600 has seen -27% downgrades since January - now forecasting -18% decline in earnings - was +8% previously
- MSCI World -25% downgrades - now forecasting -15% YoY decline in earnings - was +9% previously
In our top down model, we forecast a c.-33% decline in earnings YoY at the Global level - so we believe that there are more downgrades still to come despite the magnitude of downgrades we have seen fo far. We base our forecast on an assumption of Chinese activity dropping to 50% of previous activity in Q1, recovering to 70% in Q2, 90% in Q3, and then 110% of previous estimated activity by Q4. For Europe, the US, and most of the rest of the world, we are assuming the same shape of activity as for China, with one quarter lag.
All that work has been done at record pace by our team...
Linking this to our portfolios and moving to the second section of our podcast, to discuss our portfolios and earnings downgrades we foresee. As a reminder, we manage high conviction best ideas portfolios focusing on long term sustainable quality growth stocks, which have low disruption risk, high barriers to entry, strong pricing power, attractive growth and returns profiles, good ESG profile and attractive valuations. We offer our investors Global, European, International and US versions of our Long Term Unconstrained funds, as well as Global Portfolio Trust being one of our Global offerings.
We have updated our forecasts on all holdings across our portfolios, taking the assumptions above as a basis, and adjusting them on a case by case basis for each company, based on their cyclicality profile, their sensitivity to this specific economic recession, and their geographic exposures, as well as their degree of fixed costs and therefore negative operational leverage brought by the sales declines we foresee. In our tried and tested approach of assessing earnings risks, we have classified each company from low risk of downgrades to high risks, through our 1 to 5 ratings that is customary across the various fundamental and portfolio risk areas that we assess, as explained in our previous podcasts.
This intensive work to update our forecasts on all companies that we are invested in, and all of our bench candidates, reflects our approach of keeping our internal proprietary financial forecasts live and up-to-date at all time. This gives us a better ability to assess our portfolio profiles with up-to-date forecasts, and therefore be able to make any investment decision that needs to be made on a more accurate basis. It is one of the essence of good portfolio management and efficient portfolio construction in our view.
As part of that work, we have been able to pinpoint the companies that are at most risk, and do the necessary work on those to stress-test balance sheet strength, and assess debt repayment schedules and liquidity risks. We also highlighted in previous podcasts how we also checked all holdings for the supply disruption risks from this pandemic, assessing suppliers and customers to all companies we are exposed to, and checking inventory levels, receivables risks, and any liquidity risks that might spillover into our holdings.
All that work has been done at record pace by our team, because the risk assessments have been done in a structured and systematic way prior to investing in the companies we hold. That systematic risk assessment that we have detailed in previous podcasts is what has made us ready to be able to assess risks in periods of crisis such as this one in an efficient and accurate manner.
This is a good Segway into the third part of our podcast - focusing on our team. We have a team of 9 persons with a diverse range of experiences, with intellectual, generational, cultural, cognitive and gender diversity which enhances our team culture. We are organised by sector of responsibilities, with 2 analysts per broad sector vertical, which permits us to be productive, and have a good coverage across the areas we focus on. The team culture is based on excellence in everything we do - this drives us to constantly learn and seek improvements across our investment process and how the team functions, which in turns fuels our innovation spirit - and we have put in a place a long array of innovative proprietary tools to help us in terms of portfolio risk assessments and therefore portfolio construction.
Each team member wears two hats - an analyst hat, where she or he is tasked with finding the best long term ideas in her or his respective sector of coverage; and a portfolio manager hat all the way down to the most junior member, which she or he puts on whenever we discuss a stock idea in our research meetings. The strength of such culture and approach is that we push everyone in the team to think like a portfolio manager, and to have a view on all stocks in the portfolio. Over and above all, the team culture is one focused on passion to deliver strong performance for our investors, which is an important component of what drives us to find undervalued quality growth ideas throughout the world.
Optimising our investment decision making is an important part of what we focus on, something that we will detail in future podcasts.
In the next podcast, we will focus on market valuations, which we didn’t get the chance to discuss given the importance of tackling the earnings downgrades in this podcast. We will also focus on how we manage conviction through our portfolios. And finally, we will zoom in on our ESG risk assessments as part of our investment process.
We would like to finish this podcast by going back on the uncertain climate we are going through and which we described throughout our podcasts. Given such uncertain world, today, more than ever, we need to continue to invest to improve lives. As Robert Burns once said: There is no such uncertainty as a sure thing.
Wishing our listeners a good day.
Stay safe, keep the spirits up and stay optimistic.