Pre-Covid-19 / Post Covid-19 portfolios

Covid-19 damage has been done

2020 has seen an acceleration of changes in working practices and in everyone’s lives. Even if a vaccine is found tomorrow, the experience has been so monumental that whatever shape the recovery takes (U shaped, V shaped, W shaped, L shaped) is almost beside the point. Recent societal changes are possibly irreversible.

Prior to March 2020 :-

1. WFH (“working from home”) was an option that employers offered as a temporary alternative, for a short-term need. WFH was taken up mainly by women. This suggests men felt being at home for prolonged periods was too big a career risk. C-19 ended the gender gap levelling the playing field.
2. International travel was thought important for business development, corporate oversight, short breaks, junkets, adventurism and of course family holidays. Some people took their wanderlust to great lengths gallivanting off to far flung destinations at the drop of a hat, squeezing overseas trips into every possible long weekend or half-term, taking sabbaticals early in their careers.
3. Investors thought dividends were sustainable, they assumed they signaled corporate strength. They assumed low interest rates provided the means to fund almost any business model or M&A activity. Corporate largesse, massive share buybacks, extravagant bonus schemes and debt funded dividends were commonplace.

Post March 2020:- Everyone is adjusting to a new environment where the old context has gone. Is it permanent? Personally, I am sceptical that half the working population wants to stay at home forever, merging their work and private lives. There should be some drift back to the office. But I am not particularly confident in that forecast. Many are pocketing significant commute savings and adjusting budgets and way of life. I think aviation will be slow to recover, particularly long haul, industry sources are pointing to 2023. I think going forward consumer behavior will be far more prudent. Finally I expect dividend payouts will be slow to recover to 2019 levels.

Source; CSS Investments Ltd

Ultra-low interest rates, the permanent legacy of the 2008 crisis, is a medication that is now working in reverse. It was first intended to help deleveraging. But it is now encouraging debt accumulation in developed markets, emerging markets, frontier markets and households. Central banks have deployed their toolkit and going forward government support will be critical to the debt equation. According to the Global Debt Monitor – debt ratios will increase sharply in 2020 as debt rises but the GDP denominator declines (possibly by 5%)

At the start of 2008 US debt to GDP was c. 62%. I recall Ben Bernanke in Senate hearings remarking that this ‘leeway’ had allowed the central bank and US government flexibility during the 2008 crisis. As of June 2020, US govt debt to GDP is 136% ($26.5 trn/ $19.4 trn). The US leadership’s strategy, regardless of the occupant of the White House, has been to accumulate debt as the first response to every major problem since Clinton. To what extent is this sustainable, and when, not if, will it cause its own financial crisis? There is no precise answer to this. The US Congress is currently debating a further $3.5trn package, the biggest single spending initiative in history.

Bifurcation in financial markets, asset repatriation

C-19 has led to collective behavior (trend following) alongside a trauma response (panic type behavior). The capital markets appear bifurcated – with an immense divide between valuations not seen since the dotcom era.

US ‘tech’ a ubiquitous term describing the disperse grouping of Alphabet, Amazon, Apple, Microsoft, Facebook, Netflix and recently Tesla Motors now deliver the bulk of US equity market returns, a situation that experience suggests is anomalous, but nevertheless has persisted for over five years.

Good evidence of the bifurcation is the decline in oil majors/ E&P/ oil services/ offshore oil companies. This group now appears as a rather sad footnote in US indices. Last May the oil & gas sector accounted for 5% of the US S&P 500 index – a level I thought was too low- today it is c. 3% approx. 20% of its 2010 level.

Part of the resilience of US indices is due to asset repatriation, declining confidence in non-US assets. C-19 has shredded the thin veneer of reputation maintained by the Chinese government pre-crisis. The reality of its repression was a truth sidelined by endless propaganda, GDP growth statistics and the like designed to boost confidence and hence acceptance of its nefarious activities. C-19 exposed its incompetence in allowing the virus spread, its repressive moves towards internal C-19 whistleblowers and now extended to punitive measures in Hong Kong. A Sino-US confrontation is possible, but more likely is a global effort to contain China. The C-19 crisis is too big for this issue to be ignored, too may have died. Investors are less willing to buy overseas in this environment particularly places most at risk from a China reversal i.e. Hong Kong, Taiwan and Australia.

The pre Covid-19, post Covid-19 portfolios and cash

Its worth considering how C-19 might impact both in the short and long term.

Who gains permanently from C-19?

1. Software & computer services/ IT- increase in hosting / cloud demand
2. Delivery/ Logistics companies- increase in fast moving consumer goods deliveries
3. Subscription TV/ streaming video/ online, computer gaming
4. Online businesses – gains in market share from retailers

Who gains temporarily from C-19?

1. Biotechnology – increased R&D / investor willingness to fund biotech initiatives
2. WFH related technologies/ cloud applications/ Zoom/ computer peripherals
3. Household goods, particularly domestic cleaning, personal healthcare, DIY
4. Gold/ precious metals

Who is most hurt longer-term by C-19?

1. Exhibitions- large event closures has accelerated the move to online variants
2. Public transport- C-19 has hit commuter mobility, the legal landscape now supports WFH rights to employees and hence achieves commute savings
3. Commercial landlords / Catering suppliers/ Office Equipment
4. Aviation services / engineering

Who is hurt short-term by C-19?

1. Oil & Gas- lower demand from aviation, consumer, transport
2. Retail- social distancing, lower mobility damages the shopping ambience, less demand for formal wear (a weaker trend has been in place for the last decade)
3. Airlines/ Restaurants / Tourism- impacted by social distancing
4. Banks:-exposed to rising credit losses – impacted by rising unemployment/ higher default rates

In my view it is wise to review investment portfolios in the light of C-19 implications.

Pre-C-19 portfolios are likely to have k) Commercial Landlords m) Oil & Gas o) Airlines p) Banks. My view is a portfolio should not have too much exposure, and holders should look to reduce investments in these sectors.

I am more careful of e) Biotechnology and h) Gold/ precious metals as recent gains I expect will be reversed.

C-19 has strengthened the case for index based investment portfolios where ETF index trackers / investment trusts represent significant exposure. They have weakened the case for stock picking/ income based strategies due to the considerably higher risk at stock specific level.

Portfolio cash levels, the balancing item is frequently an investor’s bone of contention. Going into C-19 there was a major clue about investor aversion going into the new decade. Warren Buffet’s Berkshire Hathaway often cited as the world’s greatest investor was holding $125bn in cash / liquid assets or c. 25% of the Berkshire portfolio, a record level.  At the end of June 2020 Berkshire cash holdings were up to $146.6bn. Furthermore a 2019 Cap Gemini World Wealth Report cited cash holdings at 28% for people with over $1m of investable assets. In our view the current environment merits higher cash holdings up to c. 10%-20% of portfolio assets.