Views on the global economy, driven as ever by those on the US economy, started with a potential “V” shaped recovery, moved through thoughts of a reverse “tick” and then onto a “U” shape with an extended bottom. The stock market, particularly the US, has pretty much missed out the tick and the U and has convinced itself that its own recovery will be V shaped. So is this possible? The short answer is yes. Is it probable? The answer just a bit less positive.
As in the financial crisis a decade ago central banks have been and are pumping billions into their economies. Pre-Covid there was already lots of cash swilling around in the system looking for something better than the meagre returns available from the banks and government debt. At least some of the billions currently being unleashed will have added to this wall of cash, whilst interest rates have been cut even further, exacerbating the search for meaningful returns. Of course, many companies have cut, cancelled or postponed dividends so immediate income returns from equities may not be there but the market seems prepared to gamble that many will rebuild their distributions fairly quickly once businesses are unlocked. That’s possible but not a certainty.
The market is also gambling that economies can be unlocked without causing a second spike in the infection rate. That is the biggest gamble of all since, if it fails and a second lockdown were to become necessary, the damage would be even more severe than from the first hit and recovery from that would, in all likelihood, take much longer. The market is gambling that, with the aid of testing, tracing and tracking, targeted quarantining, increasing technological and biotechnological support and the possibility (not probability) of an early vaccine breakthrough, that V shaped economic recovery will ensue. If we get away without another spike the gamble will pay off but, I think, only to a degree and this is where the economic and market recoveries might diverge.
The market knows that the second quarter’s economic data and, hence, company reports on this period, are going to be abysmal. It is prepared to look through that and concentrate on the verdant uplands beyond. However, at some point investors are going to want to see a resumption of growth, not just the recovery of lost ground. For the majority of companies the third quarter, if unlocking proceeds smoothly, should see a bounce-back from the truly awful second quarter and, if a rush of activity ensues (particularly in consumer focussed businesses) this could add to the stock market momentum. However, human behaviour being what it is, this relief rush of business will probably not be sustained and one has to ask what sort of prospective earnings multiples some of these companies will be on by then, bearing in mind that the businesses may be a lot smaller than pre-Covid. Autumn through to the end year could hold some major disappointments.
Putting all of this in perspective, the initial advice during the market collapse in March, to maintain the long-term view and hold on has, thus far, proven sensible as has our stance to retain reasonable levels of cash. This cash may seem an unnecessary hinderance when the market is pushing ahead but the dangers outlined above are still very real so a completely risk-off approach would be far too gung-ho, we feel.
One sector that does still seem overlooked, however, is the housebuilders so those with too much cash might consider these as a home for a little of it. Most have been working throughout the lockdown, albeit more slowly whilst obeying the social distancing rules, and anecdotal evidence from the estate agency industry suggests interest since their unlocking has been enormous. There is, of course, a long way to go from interest to completion but you won’t get the latter without the former. The housebuilders had very strong balance sheets coming into this problem and, although dividends were halted, their early resumption seems very likely if things go smoothly. Most were already on very low earnings multiples even before Covid and, on any reasonable recovery in business, they are likely to look very cheap.
We like the look of Vistry (formerly Bovis) which was strengthened by the merger with the housebuilding division of Galliford Try at the turn of the year, current price 770p, and Redrow, very conservatively managed and currently priced at 486p. Both are FTSE 250 constituents. Among the big boys, our choice would be Persimmon, which is trying hard to lose the stigma of its previous, fat cat CEO. It has a considerable land bank purchased mainly 6 to 8 years ago at advantageous prices. It has plenty of cash and has not used the government’s furlough scheme. The dividend was postponed rather than cancelled and the aim is to pay it later on. Current price is 2305p.
Russell Dobbs FCSI
Chartered Wealth Manager