There are times when the market chase the thrill of growth and times when they seek the refuge of quality. These themes often catch the fancy of investors and see huge amounts of money pouring into them, eventually reaching mainstream acceptance and becoming a self-fulfilling prophecy.
In today's piece, we try to classify the coronavirus across time and intensity, attempt to identify the key risks that will be top of mind for most investors and try to understand why longevity could be the theme for the next few months.
Classifying the coronavirus risk
While on the fringes, this could escalate into a global health crisis; relatively low mortality, vaccines in the queue, and potential negative effects of the summer heat on the virus seem to indicate that the world would hopefully have recovered from this in the next 3-6 months. In the meantime, however, stocks from select industries will take quite a beating, and markets, on the whole, will suffer.
If we were to classify the coronavirus, it would probably be fair to think of it as a short term, medium intensity problem. With that background, let's try to analyze the risks that investors might be thinking of right now.
Which risk factors are top of mind
In situations like these, it helps to put yourself in the feet of a portfolio manager looking at their stocks and thinking about how they could perform over the remainder of the year. Think of the stocks that are bound to give them the most pain and misery. The sectors worst hit - travel and tourism, sectors that involve large gatherings - theaters, malls, experience parks, as well as firms with supply chain exposure - auto and auto ancillary are probably ones that will be accounted for first.
Once the sector-specific risks have been managed, they would probably go back to the drawing board and see which of their other firms might be at risk. A company with a weak balance sheet, perhaps saddled with too much debt, might not be able to honour its obligations if it faces two to three-quarters of extreme hardship. These are probably names you would want out of your portfolio as well.
Longevity - the theme of the hour?
The value of a share is determined by calculating the present value of the future cash flows the firm will generate. Our classification of the coronavirus put it as a short term medium intensity risk factor, meaning cash flows for the next 2-3 quarters, and perhaps one more where the supply chains recover will be depressed, with the expectation that things will return to normal post that.
Firms that have very strong moats, and therefore higher longevity, generally derive a large amount of their value from the terminal value of the share. This makes it less susceptible to the impact of short term shocks. This is a fairly logical thing as well, even without the jargon. If there are two firms, one which is going to be around for the next 2 years, and one that is going to be around for the next 100, a shaky few quarters ahead will hurt the one with two years left a lot more than the one that has a hundred.
With fund managers reluctant to hold too much cash in their portfolios, if they access the virus the way we have, the most likely reaction, therefore, becomes stocking up on firms with extremely high longevity. With the tide taking down a lot of stocks down with it, they may actually present a good opportunity for them to enter quality names.
Which leads us to believe that the alpha for the next few months will come not from growth or quality, but longevity.