10 March 2020
The breakdown of talks among OPEC+ members has sent oil prices plunging. Ripple effects are being felt across global markets, which are already pressured by the accelerating international spread of the coronavirus. We asked several of our investment managers for their views on this latest market episode and impacts for their respective asset classes.
Investment Director, Technology Equities
The coronavirus is, in our opinion, a catalyst for a possible slowdown in economic growth, rather than a major issue in itself at the moment. Social network globalisation allows for fear to reverberate around the world at an alarming pace, which exacerbates the potential self-feeding effect. The OPEC / Russia situation risks making matters worse and creates an obstacle for central banks and governments trying to find the tools to stimulate. The suspension of US futures at 5% limit down also adds to worries and will make the already nervous investor even more likely to panic sell.
Our base case is now that the world dips to either low growth or a recession. We have not yet seen company announcements on earnings that reflect that. That said, implicit interest rates are so low that a shallow economic effect could in fact drive a longer, larger final leg to the bull market. That is currently our base case.
For technology and disruptive growth stocks, overall the message is clear. If you are in the world’s supply chains then you are likely disrupted – this might apply to smartphones, semiconductors, cars, and so on. If you are virtual, things are more likely to be fine – this might apply to software, internet and in particular gaming and media.
One interesting case will be what happens to digital advertising, which is 25% of global advertising now and therefore has some level of maturity. If a downturn reduces ad growth then we suspect Facebook and Google will see measurable impacts to their growth rates. This has not been seen before because previous cycles were too early in digital ad evolution. We believe any significant pressure on these shares may yield an attractive opportunity. In our view, they are already cheap for regulatory reasons.
Investment Manager, Emerging Markets Equities
The twin effects of the virus outbreak and oil price crash have driven China and Japanese equity indices lower. For both the virus and events in the oil market there are contrasting drivers at play. Regarding the virus, while President Xi’s visit to Wuhan is intended to send a clear message that the worst is over and Korea and Iran are also seeing sharply declining new infections, Italy is now in full lock-down. While a lower oil price is a significant boost to most Asian economies who are predominantly net importers there is concern on the implications for the energy sector and related industries (banks, services, materials) with regard to the impact on broader growth, earnings and the fallout from negative credit events.
It appears that once national authorities elevate the outbreak to a suitably high alert level the infection rate starts to fall quite sharply over the next 30-60 days. However, clusters are likely to continue to emerge and some situations are likely to become critical (in a similar fashion to Italy) – the US is the key area to watch and where infection rates have been climbing. The economic impact of high alert levels involving closures and personal isolation are significant – the full impact globally cannot currently be estimated. China’s GDP over Q1 2020 it likely to be 0-2% year-on-year (versus Q4 2019 6%) driven by the impact of the domestic outbreak. If the external environment continues to deteriorate, this will put extra pressure on first half growth and the current consensus of a U shaped recovery into the second half of 2020, helping full year GDP at 5-5.5% year-on-year. Japan which had 2020 forecasts around the 0-0.2% level is now seeing forecasts as low as -1.7%.
China equity market returns may be constrained near term by international risk aversion however the decisive and comprehensive policy action of the China authorities re-affirms a key leg to our positive long-term China thesis. We see the equity market as offering premium growth, with the firepower to sustain that growth (as in this case), an improving quality of growth (which will be enhanced by this event as marginal industry players are sidelined) at reasonable valuations. The market offers only reasonable valuations despite recent events as the liquidity provided by the authorities has supported the market. However, we see attractive opportunities across consumer discretionary, technology, non-bank financials, renewables and healthcare.
While key near-term drivers in the form of the rate of the international spread of the virus and economic impact are difficult to predict, the sharp drop in new China infections and the robust policy responses including the US Federal Reserve rate cut are supportive. The sharp move lower in the US dollar, US rates and commodity prices are also positives while certain sectors and business models are less exposed (and in some cases beneficiaries) to this outbreak. Despite likely near term volatility we remain positive on regional consumer internet, technology, China non-bank financials and healthcare.
Investment Manager, Luxury Equities
The consumer discretionary sector – in particular cruise operators, hotels and gaming companies – has borne the brunt of the coronavirus-related travel restrictions.
We saw some indiscriminate selloffs in Italian-listed companies, such as Ferrari and Moncler, on 9 March – purely on a domicile basis, considering they are primarily exporters not especially exposed to the Italian economy (no more than peers – and in the case of Ferrari, very minimal revenue exposure given their largest market is the US). We note rising concerns around the Italian supply chain given the national lockdown in Italy. The majority of luxury manufacturing in Italy takes place in Tuscany, and to a lesser extent Campania / Sicily in the south. Apparel manufacturing does take place in the Lombardy region but is a lower profit driver for luxury brands than leather goods and accessories. The key issue for the sector presently however, is demand – not supply. Given a significant portion of the products destined for sale in China in February have gone unsold, and now product for Europe as the virus spreads in that region, there is ample inventory available to satisfy demand when it resumes. Much of luxury inventory is carryover rather than seasonal, unlike fast fashion, hence easing the impact of potential Italian supply bottlenecks that could emerge. Moreover, luxury brands have longer lead times and are currently preparing for Autumn / Winter 20 – with Spring / Summer inventory already in place and as such have room for catching up on any lost production in a short period of time.
The key for the sector is the Chinese consumer – who drives 35% of demand and 90% of sector growth. There are signs that – following the reopening of workplaces, public transport and shops in China – traffic to stores is starting to return, albeit very slowly. On an underlying basis, the consumer appears to have been very strong until the end of January, based on company reports, and sales could recover quite sharply once the situation further normalises, likely by the end of Q2.
We expect heightened volatility to eventually provide attractive buying opportunities in many stocks given we believe the structural investment case for the luxury sector – the rise of emerging market (EM) middle class consumption – remains intact. The luxury sector benefits from high margins, strong cash generation and underleveraged balance sheets – providing further impetus for value-adding consolidation should this situation persist, forcing the hand of many hitherto reluctant family owners of coveted brands. While we acknowledge earnings estimates are likely to suffer further cuts, the sector is not in any cash flow / liquidity crisis whatsoever and shows a strong latent ability to bounce back once market conditions return close to something resembling normality.
Investment Manager, Emerging Markets Fixed Income
Emerging market (EM) bonds are going through an adjustment of global growth expectations due to the spreading of the coronavirus across the developed world and an oil price collapse due to the breakdown of the so-called OPEC+ discussions on 6 March. Since the beginning of the year, we have become increasingly cautious on the global economic outlook due to the coronavirus.
Both the coronavirus and oil-related market disruptions could be transitory in nature. We are already witnessing a decreasing number of new infections in China and also in South Korea. In Europe and the US we can expect a worsening of the present situation. The oil price shock was deliberately triggered by oil producing nations, as they could not agree on an extension and deeper cuts to oil production. At the current level of oil around USD 30 a barrel, oil exporting countries will face worsening fiscal balances and pressures on their pegged currencies to devalue, while oil importing countries will improve their external balances. The current status of no agreement inflicts economic harm on all of the OPEC+ countries. If common sense prevails, we may expect a recovery in the oil price from current depressed levels.
Investment Manager, Asian Fixed Income
It feels like risk assets, including Asian credit markets, are spinning into a bidless, bottomless, downward spiral. The market witnessed violent spread widening, steepening and decompression. Credit default swaps (CDS) and liquid high beta energy names underperformed; on the other hand Chinese bank AT1s and senior corporate perpetual bonds outperformed. The Chinese high yield sector also outperformed its Indonesian and Indian counterparts. Although a significant drop in oil the price may persist, there are many encouraging signs that China is recovering from the coronavirus impact. On the ground observations continue to point to a steady resumption of production towards 90% by the end of March.
Some interesting anomalies:
- Malaysian CDS widened 50 bps to 120 bps, while Malay August 2046 bonds widened 3 bps to +115 bps (z-spread), implying an inverted curve between five-year CDS and 26-year bonds.
- Medco Energi’s 2027 bond dropped 20 points, whereas its share price dropped 19%. Admittedly being an Indonesian single B rated oil and gas name, it is hard to argue the company is facing a bright earnings outlook. However, considering the company’s recent proactive refinancing to extend maturity profile and its earnings visibility from having a third of its revenue from fixed-price gas contracts, there is a basis to think the 20% drop in bond price is excessive.
- Seazen Group Ltd (formerly Future Land Property, ticker FTLNHD) is a BB rated property developer in China. The company recently issued a five-year CNY bond at par with a coupon of 5.1% which translates to a z-spread of 281 bps, equivalent of z-spread of 336 bps if swapped to USD. This is an interesting contrast to the US dollar bond (FTLNHD 6.8 2023) at Z+ 684 bps. With Beijing’s proactive measures to encourage corporates to issue in the domestic market, we expect this type of anomaly to support the offshore hard currency credit market prices.
Investment Director, Swiss Equities
Towards the end of February, Swiss small & mid-cap stocks sold off in line with the global stock market as the coronavirus increasingly spread outside of China. The sell off was broad. However, there were exceptions where corrections were only minimal or, as in the case of Allreal, the stock even gained in value. Valuations of real estate stocks had also reached very high levels, as they serve as bond proxies.
As far as the longer-term valuations are concerned, we expect that coronavirus effects will have almost no impact. The main risks for investors over the longer-term involve companies in a very weak market position and / or those with highly leveraged balance sheets. This can lead to forced capital increases at very unfavorable terms. As interest rates are low, high growth companies should be in demand and do well. In our view, general manufacturing started to show signs of improvement just before the coronavirus impact arrived. We believe the coronavirus outbreak has likely postponed the start of an upturn and maintain our long held belief that a focus on high value generating companies that can grow out of their valuations over time will be key in an environment of elevated stock market valuation multiples.
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. Reference to a security is not a recommendation to buy or sell that security. The companies listed were selected from the universe of companies covered by the portfolio managers to assist the reader in better understanding the themes presented. The companies included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers.