19 March 2020
The coronavirus sell off has impacted UK equities and stock markets globally. GAM Investments’ Adrian Gosden and Chris Morrison share their views on the current market volatility and why their investment philosophy has not changed.
The coronavirus and oil price shock has led to an indiscriminate equity market sell off in the UK and indeed globally. While the current period is particularly severe, we have seen aggressive pullbacks in the past. It is important to apply experience in these difficult market scenarios and stick to principles. Fundamentally, we believe dividends are the most important driver of total equity returns over the long term; this is due to the powerful effect of compounding on reinvested income. Therefore, in our view, continuing to focus on identifying stable, cash-generative companies in the UK capable of paying a strong, progressive dividend is a solid way to navigate this steep market correction.
We are likely to see sharp revenue shocks from a wide range of businesses in 2020 due to the coronavirus, although, for the most part, we do not expect such shocks to extend into 2021. In our view, while we understand discussions about not growing dividends this year may occur, investors should be on high alert for companies using the coronavirus as an excuse to abandon dividend payments altogether. We would class this as a red flag. Good businesses should be able to react by adjusting capital expenditures / changing share-buybacks / initiating divestments in order to maintain substantial dividends, even if temporarily reduced.
In our view, focusing on a broad range of cash generative companies is crucial in this environment. So far, this market has been an amazing ‘leveller’. All sectors are suffering. Only a handful of select utility and pharmaceutical names have held up. Airlines and leisure stocks have borne the brunt of the sell off. Even highly regarded businesses – including firms not substantially impacted by the coronavirus, with strong brands trading on as much as 40x earnings – are also coming down in price. It is hard to stay safe. That said, this does present buying opportunities and brings a great number of businesses onto investors’ watch lists. In some cases, management are buying substantial amounts of company shares with the belief that the market is treating their business harshly.
One consideration to bear in mind is a potential second phase of the sell off. Investors are not only worried about earnings, but are anxious on how the coronavirus trickles down to leverage and debt payments. In a specific downside scenario, with widespread site closures and film launches being scheduled later into 2020, Cineworld has said it would lose the equivalent of between two and three months’ total revenue across its entire estate, leading to a risk of the company breaching its financial covenants. We believe certain companies (leisure in particular) may breach covenants on the back of this period, but banks are more likely to extend agreements, rather than foreclose and the UK government has initiated support structures. As a result, we expect lower default rates compared to those seen in a genuine economic downturn.
The emergency rate cut by the Bank of England (BoE) on 11 March, combined with the loosening of the so-called ‘countercyclical capital buffer’ – a cushion that banks must hold in extra capital to absorb potential losses – is a boost for the financial sector. In addition, the massive spending increase by the UK government should bode well for other areas of the market, notably the construction sector. Thankfully, the relationship between the BoE and the government appears to be in a good place.
Overall, we are sticking with our principles. We believe an understanding of the cash generative nature of companies and their ability to pay dividends enables investors to remain long-term in their convictions, yet agile enough to react to present challenges and those that may lie ahead.
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.