April 2020 Review
What a difference a month makes
The savage and rapid financial market falls that stunned investors in March gave way to a meaningful rebound as the rally that started in the final week of March continued through April only petering out in the final couple of days of April.
The market dislocations of mid-March that brought about central bank support effectively solved the illiquidity of March’s third week. Even more central bank action coupled with governmental financial support enabled financial markets to look through dire economic data in this quarter to anticipating a better economic outcome later in 2020 and into 2021. The sheer size of the US Federal Reserve’s portfolio of assets, as a percentage of GDP (Gross Domestic Product), acquired to support markets is unprecedented and will get even bigger according to economists’ forecasts.
As April progressed, the passing of peak Covid-19 infections and deaths in Europe plus a plateauing in the UK and parts of the US also improved investor sentiment from its prior-month lows. Risk assets such as equities and corporate bonds responded, rising strongly in price through the month.
Probably not! The most notable exception to rising prices in April occurred in the oil market or to be precise, the West Texas Intermediate (WTI) crude oil futures contract. WTI settles on physical delivery and with a glut of supply and limited demand, most storage facilities at the delivery point in Cushing, Oklahoma were already full of oil. To avoid taking delivery with nowhere to store oil, traders did whatever they could to avoid taking delivery with the result that the May futures contract price went negative to the tune of minus $37 per barrel!. Traders were paying people to buy oil from them and so avoid delivery. Brent crude, which demands a premium to its WTI counterpart, is considered the global benchmark for oil prices whereas WTI is viewed as the benchmark within North America. To be honest, oil has little influence on our investment policy as its use will only decline in the years to come at the expense of renewable energy. Oil companies do not feature in our funds. But, for those oil watchers out there, the futures contract to follow for a true reflection of the impact of over-supply and lack of demand is Brent crude. Here is the June futures performance for the past three months sourced from Investing.com:
Equity Income Investing
Another sector that hasn’t done well in April is the equity income sector, not least in the UK. As total return investors, we don’t go down the equity income route. We acknowledge there are plenty of savers and retirees that prefer to live off an income derived from dividends, keeping their pot of capital intact. However, we see and hear of stories of investors taking on extra risk to maintain a higher yield than the prevailing yield available. That doesn’t usually end well. Cancelled or significantly reduced dividends from companies previously thought of as safe and consistent dividend payers have stunned equity income investors. For example, Shell cut its dividend for the first time since World War II; its share price fell 7% in April. We hear of investors switching to corporate bonds to achieve their desired income levels. I hope that ends well but take on too much credit risk and capital can easily be eroded by ratings downgrades or possible defaults.
Value vs Growth
Yes, that old chestnut has surfaced again after good relative and absolute performance from a number of ‘growth’ companies this year and particularly since the end of March. Whatever your definition of ‘value’ and ‘growth’ is, we feel that spending too much time on some sort of demarcation between the two is about as much use as at looking p/e ratios at the moment.
Regular readers will be familiar with our thematic approach to investing which also has the benefit of exposing investors to the key long-term drivers of growth, themes that will be in demand for the foreseeable future. The current pandemic has given us the opportunity to sharpen our focus to the likely winning themes in a post-virus landscape. Rather than ‘value’ and ‘growth’, we would categorise companies differently, preferring to invest with those that differentiate businesses along these 3G lines:
Let me expand. The Growers are those businesses who will grow beyond their country’s GDP (Gross Domestic Product) and probably global GDP too. Their business models will not be labour intensive nor reliant on complicated global supply chains but will be technology advanced, generating significant free cash flow and not reliant on debt financing. While companies like Microsoft spring to mind, many of these companies will be small or mid-cap businesses, possibly in the UK.
The Grinders will be those companies that survive this economic downdraft and eke out an existence similar to their market’s GDP. They may have benefited from government support but will be reliant on debt financing to stay in the game and not
necessarily exposed to long term drivers of returns like artificial intelligence, healthcare, nutrition and sustainability.
The Good Riddance category is made up of businesses that are labour intensive, reliant on debt financing but structurally challenged and unfortunately may not survive. Retail high street shopping is an obvious collective that will struggle. Companies that have built their profitability by cramming more people into limited spaces whether that be on planes (double jeopardy) or offices are also unlikely to survive the new normal.
In summary, the digital economy boosted by onshoring wins as the globalisation trend continues to ebb and long-distanced supply chains, once founded on cheap labour, evaporate. Sustainability, healthcare and nutrition are also the likely winners going forward.
Obviously, we want to be exposed to the Growers and can increase our chances by investing in growth themes with like-minded investment firms who manage conviction portfolios, agnostic of market indices. Portfolio changes made in April have been executed to accentuate our focus on the Growers.