Sooner or later markets are going to have to make their minds up who are likely to be the winners in the longer term and who are not. We should make it clear we are not recommending where to invest because the current valuation is a major input into the latter but not the former. Here’s our take on the first question, with a few lines on the latter.
Winners
It’s clear that any company whose business involves selling the tools we need to work, learn and play from home and online has been a major beneficiary from the COVID-19-inspired lockdown. That includes both software and hardware providers, though a few have found themselves uncomfortable under the spotlight. It’s hard to imagine that the new ‘normal’ when this is all over will resemble the old ‘normal’; many of us have found that greater use of the internet is more efficient, cheaper and opens new doors.
Businesses who have helped us keep alive and sane as we stay at home have also benefited. Obvious candidates are supermarkets and purveyors of physical objects such as gym equipment, paint brushes or alcohol. It is less obvious that there will be a long-term beneficial effect on these; much of this is surely consumption brought forward rather than a new trend.
What about the infrastructure we’ve been forced to rely on? Private delivery companies have had the convenience of their offering reinforced, but we’d argue that the value of other less well sung providers such as postmen, bin-men and, of course, the NHS is now much better appreciated. There will be less resistance to paying them well in the future.
And the solution providers for tomorrow? Top of our list is bio-tech, which has been starved of capital in recent years and are the storm-troopers in the coming conflicts. But we also think other businesses which [SW1] can provide medicine more cheaply, or more cost- effectively, will be winners. And what about companies focusing on bio-security, whether testing or protecting?
Finally we would add old-fashioned manufacturing, as there is clearly going to be an element of on-shoring and at least diversifying production rather than relying on China. Any who have managed to survive the last 20 years will surely be in a strong position, eg. the Scottish company which is the only on-shore supplier of NHS gown material.
And the losers?
We are not sure where to start. So much human activity has been shown up as either inadequate or unnecessary. That includes daily commuting, the distant supply lines which the world has relied on for the last generation, high street shopping, many in-person meetings and foreign holidays. This must have a negative impact on whole industries. We would list airlines, large office buildings, auto companies, foreign travel companies (tourists may well not be welcomed), shipping and many energy producers (including perhaps renewables) as a starting point.
We are not so sure about hotels and restaurants. They are clearly losers in the short-term but humans are social animals. Even if we find ourselves doing more virtually, we suspect there will still be the desire to meet – once the virus is under control – in person. Whether that takes place in hotels and restaurants or elsewhere - gyms and sporting arenas for example - is not clear.
In the financial world, we are tempted to add private markets to the list of losers. In an environment where transparency is going to be more highly valued and leverage is less desirable, private equity may not be well placed. However much public equity shareholders suffer from an - entirely appropriate, we would add – dilution on the focus on shareholder returns, surely private equity owners will be worse affected? And that is just the companies who survive; private equity own many businesses which were already fragile, and it is hard to see how they can bear the current levels of leverage. The other side of this coin is that there is something of the order of US$2 trillion of ‘dry powder’ which is in a good position to pick up bargains. We would expect returns to be of the order of 5 to 10% and the question is whether there is sufficient excess return over public markets to make it worth the extra costs of investing there.
At some point a pick-up in inflation seems unavoidable and it is likely that businesses with some protection will be beneficiaries: core infrastructure, particularly where the government is the counterparty, some areas of real estate and, though it pains us to say this, index-linked bonds. The capital increase from a real yield reduction from -2% to -3% is immense. Conversely, conventional bonds must surely be long-term losers.
Finally, the big ones. It seems to us that the biggest loser from COVID-19 is the United States and the biggest winner China. Not only has the West’s economy been trashed in the short-term but it has mortgaged its future. The United States’ dysfunctional health system and lack of co-ordinated leadership shows up badly against China, however much we may dislike the way in which the Chinese authorities operate. The impact on China will not all be positive, as it seems to us likely that the West will be more careful about doing business there, but in the long-term it has strengthened its hand in many parts of the world. We think that will be more than adequate compensation.
And Planet Earth? We think it could be the largest winner. Greater bio-diversity (nesting turtles and butterflies for example) has appeared within weeks of the dramatic reduction in human activity. It is too early to call the consequences of the pandemic a re-set but we sincerely hope it will make humanity think a great deal harder how it conducts its activities.