12 Jun 2020
Active Minds 3 June 2020
Head of Strategy, Absolute Return
James Clunie, Head of Strategy, Absolute Return, discussed the two conflicting themes that seem to be driving markets today. He asked which of these investors should focus on – is it on stocks that benefit from Covid-19 lockdowns relative to others, or on recovery stocks that should benefit from relaxing lockdown measures?
James used two companies in the digital and internet data space (one in the US, one in Japan) as examples of stocks that are being driven by ‘hot themes’ that have benefited from global lockdowns. Both stocks are trading on very high valuations, combined with lowered guidance and earnings downgrades by brokers. When modelled on a reverse discounted cashflow (DCF) basis, James said they are trading on as much as three times fair value. But these companies’ share prices are still going up, despite earnings downgrades and lowered guidance.
James said it’s also interesting to see that recovery stocks, which were particularly hard hit by lockdowns and have been facing well-known problems, are also rising, albeit from a low base. He used a shipping company and a UK retailer as examples – both stocks slumped in March but have rebounded since then. On a reverse DCF model, James said their share prices still have much further to go before they reach fair value. Brokers have significantly upgraded earnings for these companies.
So overall, James said it seems strange that both themes are working – the stocks that benefited from lockdown are outperforming, but so are those ‘recovery’ stocks that are set to benefit from lockdown easing. There are many other examples of this market bifurcation – physical gyms and companies providing online workouts are performing well; companies with physical car salesrooms and online second-hand car sales websites are both rising; the list goes on. Likewise, those companies that are trading on very high multiples but with earnings downgrades have been performing well since March’s selloff, but so have very cheap stocks with earnings upgrades. James said he’s keen to see what happens next!
Assistant Fund Manager, Emerging Markets
Neither Brazil nor Mexico appear to be handling the coronavirus outbreak well, as their leaders have adopted a Trump-like approach and a health crisis merges with a political crisis, said Matthew Pigott, Assistant Fund Manager, Emerging Markets.
In particular, President Bolsonaro in Brazil – Latin America’s hotspot for the pandemic – has told citizens to get on with their lives and openly clashed with local governors who insist on lockdown measures. Despite much justified criticism, Matthew reminded us that – even by emerging market standards – both countries have large informal economies. With over 50% of Mexicans living hand to mouth, full lockdown would swiftly lead to people being unable to pay rent, obtain medicines and food. In such economies, full lockdown has potentially even more serious health risks than the virus, so we should be careful not to judge them from a western European/Asian viewpoint.
Brazil is a market that can quickly flip from euphoria to hysteria, as it did during the first quarter, Matthew says and the team are now taking advantage of more attractively priced opportunities. Matthew reminded us that GDP growth and stock market performance are not the same thing. Thus, even though the doom mongers are predicting a huge contraction in economic growth this year for Latin America, this doesn’t mean we should expect something similar for the stock market. For example, in 2016, the Brazilian economy contracted for the second year running but its stock market rose 70% in dollar terms. While Matthew doesn’t expect a repeat of that he points out that company shares now trade at the valuations last seen in 2016, so it is important for investors not to be too swayed by gloomy economic forecasts.
Fund Manager, Global
Mitesh Patel, Fund Manager, highlighted one of the key questions that have come up in every recent client interaction: where are the opportunities in this market? Mitesh commented that, following the sell-off earlier in the year, the Japanese equity market continues to focus on a narrow group of companies regardless of valuation, and that makes life very difficult for any investors whose approach includes some sort of valuation boundary.
In Mitesh’s view, valuations matter because they tell investors something, they frame what a company needs to deliver and puts in context the risks inherent in deciding whether to invest in the stock or not. With that in mind, Mitesh has been looking at initiating new positions in companies on attractive valuations that are currently out of favour in Japan. These include the premium-yielding stock of a mortgage provider, that is targeting increased market share and is a company Mitesh believes to be well managed. In addition, he sees an opportunity in a manufacturer of dental tools, which he sees as representing the best of Japanese precision manufacturing. The business is high margin and with net cash on its balance sheet, but Mitesh feels it is under covered by analysts and the sell-off represents an opportunity.
Please note: Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. The views expressed are those of the individuals mentioned at the time of writing, are not necessarily those of Jupiter as a whole, and may be subject to change. This is particularly true during periods of rapidly changing market circumstances.
Important Information: This content is intended for investment professionals and is not for the use or benefit of other persons, including retail investors, except in Hong Kong. It is for informational purposes only and is not investment advice. Every effort is made to ensure the accuracy of the information, but no assurance or warranties are given. Holding examples are for illustrative purposes only and are not a recommendation to buy or sell. Issued by Jupiter Asset Management Limited which is authorised and regulated by the Financial Conduct Authority, registered address is The Zig Zag Building, 70 Victoria Street, London, SW1E 6SQ. For investors in Hong Kong: Issued by Jupiter Asset Management (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission. No part of this content may be reproduced in any manner without the prior permission of Jupiter Asset Management Limited.