The coronavirus situation is developing rapidly. Italy is in lockdown, confirmed cases are rising across the rest of Europe and the US, and there is a huge global effort to contain the virus. On Thursday last week, European shares suffered their biggest one-day plunge since 1987. Panic appears to have gripped markets.
However, as with any market scenario, we are focused on the drivers of long-term growth and we block out short-term ‘noise’. When we do, we are starting to see opportunities to judiciously put our money to work in several high-quality European businesses.
How do we make sense of events?
There’s no doubt that we are experiencing a significant demand-shock across Western and emerging market economies. At the same time, we have seen significant supply chain disruption. This, in turn, is putting pressure on financing and the banking system – adding credit risk to an already challenging environment. Unhelpfully, the Saudis and Russia have embarked on an oil price war. Prices have plunged, putting further pressure on credit markets.
One interesting factor has been US dollar weakness versus the euro. In times of crisis, the greenback usually rallies as investors seek what they perceive to be ‘safe havens’. Not so this time. Ultimately, this dynamic could put pressure on European corporates. A weak dollar is unhelpful for exporters and could damage the earnings power of European businesses. Of course, this could simply be the unwinding of leverage carry trades and the end of investors exiting cheap euro-denominated funding. It’s too early to say at this point, although it’s certainly worth keeping an eye on.
As an investor, it’s important not to get lost in the big macro events. We need to go back to the basics and focus on company fundamentals.
So, there’s much to consider. But as an investor, it’s important not to get lost in the big macro events. We need to go back to the basics and focus on company fundamentals. After all, that’s what should get us through the next three, six, or 12 months. That’s why we invest in high-quality businesses. At the end of the day, it’s going to be earnings power, cash generation and balance sheet strength that will drive earnings. Good management of ESG (environmental, social and governance) risks and sustainable business models will also lend earnings resilience and downside protection. These are desirable characteristics in today’s uncertain markets.
In our view, a long-term investment horizon is also vital. We might not know what the 2020 corporate environment will look like. But by investing in companies whose structural attractions are unchanged by the virus, we have a better idea what 2022/2023 numbers could look like. The recent share price falls could create buying opportunities in these businesses.
Lessons from abroad
That’s not to say we’re at the bottom of the market. The situation in Italy could spread to other countries. We also haven’t seen the full effects of the virus on corporate earnings. The next two quarterly reporting seasons could be sobering experiences. That said, the 25%+ corrections in european equity markets are already pricing much of this in.
Meanwhile, central bankers, from the US Federal Reserve to the Bank of England, have aggressively cut interest rates. Markets are hoping large-scale fiscal responses will follow. We will have to wait to quantify the ultimate impact of such moves.
As we try to take stock, we should also look to Asia, the epicentre of the virus. We are starting to see a stabilisation in the number of cases in China, Japan and Korea. This could foretell how events unfold in the West.
The current pressures are likely to continue for the foreseeable future. Caution is therefore warranted. However, by focusing on quality franchises and taking a longer-term view, we believe there might be opportunities to take on risk through good businesses that the market has oversold.