The impact of the coronavirus continues to damage economies, agitate markets and plunge oil prices below zero. In the midst of such uncertainty, Richard Dunbar, Head of Multi-Asset Research at Aberdeen Standard Investments, considers some of the questions at the forefront of investors' minds.
The unprecedented impact of the COVID-19 pandemic will push nearly every economy into a deep recession. And it will apply even more pressure to those companies and countries with existing problems, such as high debt levels, disruption to supply chains, or exposure to tourism and travel. As I mentioned last month, no companies will escape the economic effects of the virus. However, some will be better equipped to deal with the current pressures, as well as the new world of behaviours and consumerism that’s already emerging.
For investors, the key is to determine just how robust and resilient a company is. This type of analysis is already a core part of how investment managers decide what to invest in and whether to continue investing in it. But in the current environment, this granular analysis is now even more important to identify which companies will survive – and possibly thrive – and those which will not.
For instance, at Aberdeen Standard Investments, we’re focusing on companies with strong business models and finances from a broad mix of different industries and geographical locations. Our view is that the pandemic is likely to accelerate existing market trends, sadly further damaging sectors like retail, leisure and travel, which were already struggling. In many cases, the virus has brought forward what may have happened anyway.
So, while we’re investing carefully in a broad range of company shares, we’re balancing this with increased investment in higher quality government bonds and corporate bonds. At Aberdeen Standard Investments, we feel that good companies are still generating profits and cash – which will pay the coupon (the bond’s regular interest payment) on this debt.
We’ve also reduced our investment in global property. Attractive areas remain in this sector but it faces a couple of big problems in the current environment. Firstly, it’s impossible to get accurate valuations of the underlying physical properties. Secondly, it’s difficult to sell a property quickly if you want out of it. Again we prefer global investment in this area to increase diversification – the UK property market is more vulnerable to falling oil prices (see ‘How low will oil go?’ below) and problems in the financial sector.
There are several obvious factors which will determine how severe and prolonged recession and market volatility are: the path of the virus in each country, the length of lockdowns and the gradual return of people to work and leisure activities (in other words to consumer spending), and the implementation of antibody testing and vaccines.
But from an investment perspective, there are other signals worth watching. Policy making by governments and central banks is high on the list. The scale and duration of the economic shockwave is highly uncertain, dependent to a large extent on how governments and central banks intervene to help markets, companies and individuals. For instance, Europe has shown the limits of its policy-making when compared to the US and Asia.
So far in the UK, the response from authorities has been considerable and quick. However, we need to see how effective the various programmes of support are and also whether they’ll be sustained for long enough.
The direction of the US dollar remains an important barometer of economic health. Blockages in the “financial plumbing” were at the centre of the liquidity (the ease of buying, selling and borrowing) crisis in March. Central banks intervened to clear these blockages but it was the rising dollar that was the most direct sign of mounting problems in the system. We suspect that this will remain the case, so we’re paying close attention to the dollar.
Leverage, or the amount of borrowed money a company uses, is another key factor to watch. In some cases, a company may have more debt than equity. In other cases, central bank support may keep a company afloat but not make it profitable. And in addition, many companies, countries and individuals may not have the capacity for further borrowing, or the access to it.
These are just some of the triggers of economic and market health that we’re monitoring. It’s a fast-changing environment and we’ll keep you updated on our analysis.
With humanity in lockdown, much of the world’s transport off the roads and thousands of aircraft grounded, demand for oil has plummeted – and its price with it.
I write this on the day that the key benchmark oil price (West Texas Intermediate) has fallen in price to -$37 (yes, MINUS $37). The International Energy Agency has forecast that global oil demand will drop by almost a third in April relative to 2019 – to levels last seen a quarter of a century ago. Unsurprisingly, the oil industry has been unable to cope with the brakes being applied to demand with such speed or severity.
It means there’s too much oil in the system and not enough demand, storage or refinery capacity to cope with it. Therefore, if you own certain types of oil, you’re actually having to pay to get rid of them, hence the negative price.
Obviously, when we get through this, because oil producers won’t have been incentivised or financially able to produce oil at this price, there’s likely to be a shortage of oil. And usually when demand rises, prices do too.
While the pandemic’s impacts, known and potential, are understandably dominating headlines and minds, there are other drivers that investors should consider. For instance, 5G and cyber security threats, and long-standing demographic trends such as ageing populations in Europe and Japan.
As I noted above, we feel that the pandemic is likely to accelerate existing trends – hence climate change and environmental, social and governance (ESG) factors also remain a key focus for professional investors. How a company manages its ESG impacts is central in determining its overall quality and performance potential.
Meanwhile, those companies specialising in products or services that aim to directly tackle some of the many global sustainability threats (including climate change, education and healthcare provision) may be well positioned in a world where we’re all becoming more aware of ESG issues.
The information in this blog or any response to comments should not be regarded as financial advice. Please remember that the value of your clients’ investments can go down as well as up and may be worth less than was paid in. Information is based on Aberdeen Standard Investments’ understanding in April 2020.