"Great companies are improved by a crisis"
"Great companies are improved by a crisis"
Over the past six months, it has often felt as if stock market investors have been living on a different planet. The global economy experienced its deepest slump in decades – yet global equities quickly raced to new all-time highs, despite bad news about Covid-19 on a near-daily basis.
This swift recovery underscores the head-scratching unpredictability of modern-day market moves – and also the significant risk to investors who try to time the market.
Through all the noise, we have seen a wave of innovation and disruption across numerous industries, explaining much of the strength in equity markets and benefiting many of the businesses that we own. This includes cutting-edge industrial companies like Cognex, which is developing vision systems for use in autonomous factories, as well as consumer-facing businesses such as McDonald’s. The fast-food giant has invested heavily in technology, allowing it to adjust to the changing needs of its customers.
One industry where we have seen major innovation is healthcare. This has the potential to drive new opportunities for companies, reduce overall medical costs and, most importantly, improve lives. The race to develop a vaccine is an obvious area of progress – but advances go far beyond pharmaceuticals. Broader advances in technology, like greater connectivity and artificial intelligence, are helping to turbocharge the development of a whole host of therapies.
Thermo Fisher Scientific is a good example. It is a market-leading life sciences company, whose diagnostics tools help identify some of the world’s most infectious diseases. Yet the company also demonstrates how innovation in one area can “spill over” into others, helping to address further societal and environmental challenges. While healthcare is its main area of activity, Thermo Fisher has also developed tools and IT systems for use in agriculture, such as soil analysers that help produce healthier, safer crops.
Andy Groves, founder of Intel, famously said that great companies are improved by a crisis. We suspect that 2020 will turn out to have been an opportunity for great companies to accelerate their growth over the next decade. Take Nike. It is increasing its investment in online distribution to focus on direct-to-consumer sales. Less dependence on wholesale distributors means higher margins for Nike, higher stock turnover and improving shareholder returns. Another example is Disney, which is boosting its investment in streaming content to rival Netflix. The coronavirus has forced it to push back the release of more than a dozen major films and reroute others to streaming services. Watching a film at home may not be quite the experience of visiting a cinema, but like Nike cutting back on wholesale distribution, it will help to boost margins and returns.
Despite the innovation, 2021 remains clouded in uncertainty. The hope of a vaccine is offset by the logistical problems of producing enough doses to inject billions of people (twice!). There is also ongoing financial hardship as businesses struggle with lockdowns and unemployment remains high. History may offer useful guidance in terms of what to expect from stock markets. We need only to look back at 2010 – another year that followed a terrible recession, an aggressive policy response and a strong market recovery. Despite economic weakness and a growth scare early in the year, 2010 ultimately proved a solid, above-average year for returns as the global economy continued to recover.
We believe that the lesson of 2010 could also apply in 2021. Following a recession, cyclical tailwinds are powerful beasts. And in our experience, the cycle usually “wins out” in markets. We think investors care more about “rates of change” rather than “levels”. In other words, as long as economic growth is moving in the right direction, markets could continue to move higher – even if economic activity does not make up all the ground lost in the pandemic.
Rio Tinto is one stock we think will benefit from the economic cycle. As a global miner, it is a play on a global recovery. However, it also has attractive defensive characteristics, with a strong balance sheet and low production costs. With the majority of revenues coming from iron ore, it also stands to benefit from fiscal stimulus aimed at infrastructure. Rio is disciplined in its capital allocation and focuses on returning cash to shareholders, yielding 6%.
Other, more economically sensitive sectors such as the auto industry are also likely to benefit from a recovery. The average car in the US is now 12 years old – compared with nine years a decade ago. With governments bringing forward targets for phasing out internal combustion engines, it is likely that we will start to see a wave of new demand for electric vehicles. This should benefit auto component suppliers, such as 3M and Sensata.
Price of copper and iron ore, USD per metric tonne
Source: Refinitiv Datastream, Cazenove Capital
2021 should also see a pickup in both buybacks and dividends. Higher income payers fell heavily out of favour in 2020. Despite relatively robust balance sheets, management teams opted to preserve cash at all costs. This hit the UK particularly hard, with cancelled dividends totalling £36 billion as at the end of October.1 In the US, the aggregate dollar value of buybacks for 2020 is estimated to be at the lowest level since 2013 – just shy of $500 billion (£374 billion).2 We expect to see both dividends and buybacks recover in 2021.
The economic outlook is far from clear. However, our belief is that irrespective of what 2021 throws at us, there are plenty of opportunities. As stock pickers, we see plenty of good quality companies with robust balance sheets that should fare well in myriad economic environments.
1. Peel Hunt, 29 October 2020.
2. Strategas, 25 November 2020.
The securities referred to in this article are for illustrative purposes and are not to be considered a recommendation to buy or sell. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.