While this may (or may not) provide some useful insights into how events could unfold, the biggest and most difficult challenge in today’s situation is that – unlike previous crises – the “fix” is still unknown.
In the 2008-09 financial crisis, the solution seemed fairly clear – clean up the banks, let some shareholders lose their stakes, allow the bondholders to take over, and install new management to be better stewards of those assets.
Today, we are dealing with a medical problem that is causing a broad economic problem at the same time.
Furthermore, unlike many politicians, a virus is very patient and, depending on which country you reside in, a lack of strong, coordinated political leadership has been quite problematic in trying to get things under control. From the perspective of this author, sitting here in the US, Australia’s current situation is certainly one to envy!
But given the nature of the current crisis, we believe that the risk of a broad-based credit crisis is low given the relative health of balance sheets for both banks and consumers alike. That doesn’t mean we don’t think there may be pockets of issues, or that the price of bank equities won’t fall, but we do not believe that they are systemic as they were in 2008.
Silver linings
Overall, we don’t believe everything is all doom and gloom. Indeed there are areas of the market where we’re actually quite sanguine.
While we cannot predict the duration of the current environment, we believe it has created the opportunity to buy some fantastic companies that have come under pressure – a lot more than warranted. We are actively looking for attractive opportunities into which to upgrade.
For example, we feel that select technology stocks should be just fine and may get stronger given current circumstances. To the extent that social distancing remains in vogue, and companies adopt more “working-from-home” policies in the future, we will all need more bandwidth, more cloud capacity and faster processers to handle the increased data loads.
On the flip side, travel-related companies have been hit quite hard and may take a while to recover, given industry dynamics and potential behavioural changes by consumers.
From a country perspective, given both demographics and economic positioning, parts of Europe and emerging markets will most likely be hit the hardest, but longer-term we do believe these areas will ultimately bounce back.
There are very few obviously defensive areas to hide in, given that the current prices offered for “traditional” defence are not really selling at depressed levels. In fact, despite the sell-off, we may find ourselves in a situation where many defensive companies are still priced far too high.
Balance sheet strength
For investors, the key lesson by now is that balance sheet strength really, really matters.
Many people tend to look at quality on solely a backward-looking basis but we believe that some more traditional “Steady Eddie” companies may not be as strong as people think, and may expose investors to higher degrees of cyclicality than they would have experienced in the past.
For example, advertising spending has come down sharply across the globe, so some social media companies may turn out to be far more cyclical than previously appreciated given such a high reliance on advertising spend.
Additionally, some consumer staples companies, such as many in the alcohol business, may find that their over-indebtedness makes them far less stable during this cycle, decreasing their ability to effectively navigate a choppy environment.
Ultimately, for investors, we believe a focus on quality, combined with an adaptive process that avoids being too dogmatic about what has worked in the past, is the key to compounding capital over the long run. In our view, a focus on the forward nature of quality, purchased at suitable prices, is the best “defence” over the long run.
Rajiv Jain, chairman and chief investment officer, GQG Partners
