PETER BROOKE: How should we invest in a post-Covid world?
To avoid distraction when it comes to our investment approach, our team takes time out from the noise of the markets and focuses on the longer-term trends on a biannual basis through the identification of a set of themes.
As part of this process, a year ago we took a view that the important part of Covid-19 was the “V”, as in the V-shaped recovery. Our “global wave” theme was based on a view that the unprecedented monetary and fiscal stimulus would result in a strong recovery in economies and markets.
On the back of this we had bought equity in our funds, preferred cyclical shares over defensive shares and increased our overweight to cheaper or value shares. This strategy proved successful, propelling our funds into top-quartile performers over the past 12 months.
However, we needed a comprehensive review, as no-one wants to overstay their welcome. When it comes to investing, Covid-19 is 2020’s story and investors need to move beyond the short-term opportunities created by the pandemic to focus instead on the longer-term outlook.
While Covid-19 is still a problem, with the Delta variant adding to the suffering and extent of our third wave, the point of our theme’s process is to look forward. Therefore, a focus for us lies in the post-Covid world. What will that world look like and where will the investment opportunities arise?
To assess this, we identified a few emerging trends. Looking at the property sector, we know SA retail and office properties will be negatively affected by internet shopping and “work from home”. Local disruption will be less severe than in the developed world as we have less capacity for both these shifts. Warehouses, on the other hand, are a beneficiary of these developments and we have a large position here.
Looking at the bottom-up effect on local company balance sheets, the surprising outcome is that Covid-19 has caused stronger corporate balance sheets, as capital expenditure was curtailed and cash management was tightened up. This gives us more confidence in the mid- and small-capitalisation shares we own in our funds. The pent-up capital expenditure also bodes well for our investments in Raubex and Wilson Bayley Holmes.
Our work on digitalisation and disruption highlighted the importance of differentiating between winning and losing management teams. Our view that environmental, social & governance (ESG) issues are a huge theme remains unchanged and continues to feed into our stock-specific analysis.
The one short-term opportunity that still exists as a result of Covid-19 is Asean trade. Early in the outbreak we pivoted some of our offshore assets into north Asia as its management of the virus was superior to that of the West. We faded this trade as vaccines were developed and the US and Europe got on top of their vaccine rollouts. However, access to vaccines is still unequal and there are some clear losers.
We dislike the broad categorisation of emerging markets as they are different countries — China, for example, was first into the crisis and first out. Asean countries like Malaysia, Philippines and Thailand stand out as big losers, particularly due to the effect on tourism. We were underweight Thailand in 2020, but are now looking for opportunities in the region.
In many ways Covid-19 simply added to existing global trends — whether accelerating the take-up of e-commerce or worsening income inequality. The effect of this will be felt for decades into the future, in particular as it brings forward our theme of “big government”.
There is a clear generational shift, with younger people expecting governments to solve their problems. Gen Z (those under 25 years old) rank nearly twice as high in this area as the silent generation (75+-year-olds). As voting profiles change, we should expect a more socialist stance from the developed world.
This will be a great environment for regulations and a tough environment for profits. We don’t know how governments will afford this, but taxes on super profits in the technology space should be expected. While we still expect excellent earnings from global equities in the next couple of years, it is difficult to see where returns will come from, feeding into the theme of a “low-return world”.
A big uncertainty flowing from our analysis is how governments will react to rising inflation. Will they tighten policy, pushing growth down, or will they allow inflation to run a little bit hotter with easy monetary policy? With the extra debt laid in from supporting households during the pandemic, our view is that governments would like to keep real rates negative for as long as possible. This is essentially taxing savers, and is why we have such low real returns from global cash and bonds. A regime change in inflation would be a market-defining event for the next decade. We think this is a real risk and prefer equity over interest-bearing assets for our offshore assets.
Though we discovered great opportunities in our analysis, we walked away from the process holding our views a little lighter. The V-shaped recovery has happened and though we still expect better global growth, the base is higher and the pace will be slower. Negative real rates mean “cash is trash”, but the next move for rates will be higher. We think higher inflation is good for “rotation” from growth to value, but we also think global price earnings ratios are high — meaning returns have to come from earnings instead of multiples.
SA stands a little taller in this environment. We are behind the curve on vaccines, meaning 2022 will have some easy base effects. We have done some reforms and the improvement in electricity will be a big positive theme over the next three to five years. While we don’t expect wholesale reform, most South Africans should be pleased with progress in 2021, which creates an upside risk. And in a lower return world, our assets still offer value.
• Brooke is portfolio manager at Old Mutual Investment Group.
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