Weekly Digest | 8 June 2020 | In terms of data, the latest batch of purchasing manager surveys (PMI) unequivocally shows that the worst of the storm has passed. For example, the UK Composite PMI rose from a trough in March of 13.8 John Wyn-Evans to 30.0 in April. Yes, that still suggests that overall Head of Investment Strategy activity was lower than in the previous month, with 50 being the demarcation line between expansion To V Or Not To V and contraction, but the rate of deterioration is much lower, and that is what markets tend to With apologies to the Bard, this is the question most trade off. Even more bullishly, last Friday’s monthly exercising the minds of investors currently. The “V” employment report in the United States saw private refers to the shape of the economic recovery. You payrolls increase by more than three million in May, will recall that various letters of the alphabet, mainly when the consensus forecast was for a further 6.75 “V”, “U”, “W” and “L” have been used to illustrate million job losses. The unemployment rate dropped how activity might bounce (or not), alongside a few from 14.7% to 13.3%, when expectations were other shapes including the Nike “Swoosh”, a hockey for a rise to 19%. Even allowing for some potential stick, a tick, a reverse square root and a barbed fish glitches in the gathering of data and the fact that hook, just to mention a few I have seen. While none some of this hiring is only in anticipation of a future are particularly scientific, all answer the basic human recovery in activity, the number was extraordinary. need for an illustrated narrative, especially at points Indeed, it completely bypassed the “second of maximum uncertainty. Where does the evidence derivative” phase of slower deterioration, going currently point? straight into full-on recovery. Hence an unequivocally “risk-on” market response. If one looks at markets, they are definitely swinging towards “V”. This has been more notably the case in As wonderful as all of this might sound, it presents the last couple of weeks when leadership changed something of a problem for investors, at least many from Growth/Defensive sectors to Value/Cyclicals. professional ones. The performance of most of the It is worth reiterating the point that the initial bounce investment industry is measured not in absolute in markets from the end-March lows was highly terms, but in relative. How has your fund fared anomalous, as it was led by the sectors that had relative to, for example, its own asset allocation been the winners beforehand. It was inevitable that benchmark, industry peers or a specific index? While the baton would be passed at some point, and that conservative managers, or those highly committed has occurred as economic activity has passed the to technology innovators and disruptors, might have trough while sentiment is bolstered by a steady flow “had a good crisis” so far, the resurgence of Value/ of positive news on the relaxation of lockdowns Cyclical sectors is eating into those relative gains. across most of the world. That’s not to say that those managers are not making positive absolute returns, but “fear of missing companies today on recovered earnings, it doesn’t out” can induce uncharacteristic behavior. The leave much cushion for anything to go wrong in the squeeze is exacerbated by what still appear to be interim. high average cash levels across the industry. As we have often repeated, the achievement of herd I have to admit that we find periods such as this immunity either through vaccination or the majority of a bit uncomfortable. Our long-term preference the population being infected is the only viable way is for higher quality companies, defined by good to return to what we think of as normal. Until then, management, a robust business model, sustainably there will be a sufficient percentage of the population high cash flow returns on investment and, perhaps that will remain risk-averse and will spend well most crucially, strong balance sheets. That is to say below their potential. The flip-side of this argument we tend not to get involved with companies that is that savings accumulated during lockdown will might just as easily go bust as prosper. While that be unleashed into the economy at some point, but approach has stood us in good stead since the the nineteenth century economist David Ricardo outbreak of Covid-19, we will, in all probability, lag countered this idea with his theory of Ricardian the market a bit if the rally continues in the same Equivalence. This postulates that individuals fashion. As I have written about on several occasions calibrate their consumption according to the life-time in the past few years, Value/Cyclical rallies since present value of their after-tax income. Thus they the financial crisis have tended to be short-lived, won’t see one-off hand-outs from government as and that does not suit a wholesale tactical rotation recurring gifts. More pertinently, if they perceive that of portfolios. We would want to see far greater government debts will have to be balanced at some evidence of a prolonged period of higher sustainable point by increased taxation, they will increase current growth and potentially also higher inflation to make savings to account for that. Recent polls have shown that call. Of course, we do own more cyclical stocks, support for higher taxes, notably on companies that but they will generally be the higher quality situations have benefitted from the Covid crisis (and I don’t within their sectors. During this crisis we have also refer to “price gouging” here, just having the right attempted to identify some companies where the business model for the times) and also individuals market is, in our opinion, mispricing the probability with “wealth” greater than £750,000. Add to that the of survival (that is pricing in a possible bankruptcy fact that both the household and corporate sectors or hugely dilutive capital raise which we do not view might well feel that recent events have highlighted as probable) and suggested that managers might the need for more of a financial cushion, then, bar consider “renting” these for the recovery phase. perhaps an initial relief splurge, there is plenty of reason to be cautious about future spending. Returning to the economy, is this “V”-shaped recovery as probable as the market is suggesting? Much as I think we would all like it to be from the perspective of getting our lives back to normal, there is still plenty to worry about, and thus more good reason for us not to want to make a big bet on Value/Cyclicals. First of all it looks clear that all sorts of physical constraints are going to remain with us for a while yet, and so it will be very difficult for many service industries to return to previous levels of profitability, especially given the increased costs required to fulfil new safety requirements. The only way they might achieve it is through shedding staff and renegotiating rents, but that only passes the buck. Most economists do not see overall levels of activity returning to previous peaks until late 2021 or 2022, and while it is perfectly acceptable for the market to look through that period and value Last week’s Economic Highlights Last Week’s Economic Highlights FTSE 100 Weekly Winners FTSE 100 Weekly Losers FTSE 100 Weekly Winners FTSE 100 Weekly Losers IAG 43.3% Hargreaves Lansdown -11.2% Carnival 35.4% Fresnillo -8.8% IAG 43.3% Hargreaves Lansdown -11.2% Carnival easyJet 35.4% Fresnillo 31.1% -8.8%Reckitt Benckiser -4.8% easyJet Rolls-Royce31.1% Reckitt Benckiser 31.0% -4.8%Ocado Group -3.1% Rolls-Royce 31.0% Ocado Group -3.1% Melrose Industries 15.9% Rentokil Initial -2.7% Melrose Industries 15.9% Rentokil Initial -2.7% John Wood Group John Wood 27.2%Group GlaxoSmithKline 27.2% -2.0%GlaxoSmithKline -2.0% Micro Focus InternationalMicro Focus26.7% International AstraZeneca 26.7% -1.8%AstraZeneca -1.8% FTSE 100 FTSEIndex, 100 PastIndex, Past12 Months 12 Months Source:FactSet The information in this document is for private circulation and is believed to be correct but cannot be guaranteed. 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