Before we get into the body of this newsletter, may I convey our hopes that all our investors, contacts and their families have stayed safe and relatively unaffected over these extraordinary two months. If that has not been the case for you, then our thoughts are very much with you in these difficult times. If members of your wider family have been part of the front-line effort through this crisis, we send them our sincere thanks.
Across the world, this crisis is challenging conventional wisdom and changing (what had perhaps become lazy) perceptions of government, society and of ourselves. In many instances we have seen the best of humanity in the surge in volunteering, the appreciation of small acts of kindness and fortitude, the willingness to make individual sacrifice for the greater good. Against that, certain governments have been shown to be sclerotic in their response, largely weighed down by historic layers of inefficiency rather than any wilful abdication of responsibility or lack of compassion. It is not our place to make public any judgement on the response to minimise the human cost of this tragedy, and even if it was, it is too early to pass such a judgement. Over time we are seeing that the phenomenal success in creating NHS capacity to treat covid-19 victims came at a dreadful cost to some of those in care homes. There will be further reappraisals of all elements of the crisis when the data required is more complete. We are likely to find things that could have been done better; we will also surprise ourselves by what was achieved so quickly in some areas.
On a lighter note, amongst the surprises is likely to be the extent that technophobes have had to pick up new communication tricks. Our Marketing Director is a good case study. Very much an “old school” communicator (and no, that doesn’t mean he only works in pubs and on golf courses), he is now becoming a dab hand at Zoom and Microsoft Teams. Across our whole business we have been surprised by the success of video-conferencing in ensuring that what would have necessitated face to face meetings and physical journeys only a few weeks ago can be done from the supposed comfort of our kitchens and spare bedrooms. Indeed, due to the lack of requirement for physical attendance, our communications with our “Wise Men” advisors – Bob Semple and Adrian Cunningham – has been more frequent than in more normal times.
We have had two meetings in the last four weeks; both of them incredibly useful as sounding boards – brain storming and “wargaming” future scenarios have dominated the discussions. Conclusions have been less obvious. Many times over the last decade and more we have used the word “unprecedented” – sometimes with real justification – but nothing in the recent past comes close to replicating the sheer breadth of the uncertainty facing investors at this time. The nature of the collapse in economic activity and the scale of monetary and fiscal response has not been seen in our lifetimes.
In many ways, this environment should play to the strengths of fundamental investors. Today’s questions are not abstract discussions on the intricacies of economic theory and philosophy. There is no vast pool of similar historic data that highlights the arbitrage opportunities that might arise. In the short term, at least, valuation drivers will play second fiddle to working out just what shape companies are going to be in by the time any sort of “normal” takes hold.
What exactly will constitute “normal” in a year or two years’ time will largely depend on pharmaceutical advances. Without a cure or vaccine, an uncomfortable equilibrium will need to be reached between the level of sustainable government support that can be offered and society’s tolerance for excess death. Economic deprivation causes excess death as surely as covid-19. Society will have to work out how to manage that macabre equation. If a vaccine is discovered in the near term, as many (if different) questions will still need to be answered. What happens to travel and holiday industries? Will people be afraid to step on planes or ships, or will there be an explosion of repressed wanderlust as travellers redouble efforts to tick off bucket list destinations whilst they can? Will office space become redundant as some of the stigma associated with “working from home” is removed and its productivity benefits are appreciated, or will an extended period of remote working highlight the “soft” benefits of face to face communication and team building? Will competition and efficiency increase as companies are forced to find new and better ways of producing goods and services, or will competition decrease and innovation stagnate because only the largest and best-financed companies made it through the crisis intact? Will central banks struggle to fight the threat of deflation as consumer demand and business investment is hollowed out, or will inflation surge in an environment where the money supply has exploded and productive capacity is curtailed?
Right now, we don’t know.
However, we need to try and make some sense of it, and chart a plan to best protect investor interests in the short term and position our portfolios when recovery comes; as it will. In the short term, we are unapologetically cautious. Economic commentators and modellers have almost exclusively delivered a series of ever worse forecasts for global growth through the course of the last three months. We do not believe that trend is yet in a position to be broken. Few quoted companies are offering financial guidance; in that vacuum we see hope rather than expectation being the factor driving equity valuations. Even with a v-shaped recovery profile, we are still so early into the process that believing that markets can simply look through the destruction of profits and accumulation of debt that will hit equity markets in the interim results reporting season (in August and September) is bestowing a measure of composure on markets that I have yet to see in my career. This is even more pertinent when one considers that over that period the most generous of government support mechanisms will start to roll off, and companies will be forced to foot the bill themselves or countenance deeper restructuring.
Thereafter, things should get better. The power of business to survive, adapt and then thrive should not be underestimated. Necessity may well be the mother of invention. We are likely to see many changes to working practices that we would not have imagined a few short months ago.
I raised the question earlier about the impact the coronavirus crisis will have on competition and efficiency. Will it play into the hands of nimble disruptors, or consolidate the dominance of the economy’s current titans? My guess is that both will play out to some extent. However, in public markets, those with financial strength are likely to be the ones that can capitalise on the opportunities that present themselves; those who have accumulated debts in government support programmes will find themselves constrained in their flexibility until balance sheets are restored through future cash generation or new equity from shareholders. So far, investors have been very supportive of those companies seeking to get ahead of the game in this regard. Rights issues and equity placings have been a near daily occurrence in recent times. However, if these sums prove to be insufficient, management teams might find coming to the well a second time is a much more uncomfortable experience. We can’t rule out any of our current portfolio holdings tapping its shareholders for new funds, but we would much prefer that they come once when it is clear just how much equity is required.
In the coming weeks and months, we will spend many hours contemplating these issues and more. To coin a phrase that we used in a factsheet during the time of the financial crisis, we might be entering uncharted waters – but that does not mean that they are un-navigable. We will share our deliberations with our investors as we work through this historic period.
In the meantime, we hope everyone stays safe and enjoys the impending long weekend, making the most of what ever freedoms they have.