The implications of a global pandemic are far reaching. What started as a virus outbreak and tragic loss of life quickly morphed into a Chinese supply shock, then rapidly became a global demand shock sharply impacting consumer spending habits. The flow on effect is now hitting businesses as they adjust to the ever fluid environment, and delay or postpone investment while looking to firm-up balance sheets. Actions taken by governments around the world aiming to slow the spread of the virus have led to an immediate decline in economic activity, and while emergency budgetary and monetary measures do little to offset the immediate decline, the actions will provide a springboard to growth once the pandemic is over.
Financial markets have suffered as a result, with investors weighing up the costs to businesses. Rapidly deteriorating investor sentiment and a high degree of uncertainty has seen volatility spike and share markets plunge into bear1 territory. From the recent peak (only four weeks ago) to Friday 20th March the S&P 500 Index is down 32%, while the S&P/NZX 50 Index has declined 24%. This was the quickest descent into a bear market in history.
While no financial market has been spared from the fallout of Covid-19, the domestic share market has so far declined by less than the global market. This is largely due to the performance of its three largest cap companies, Fisher & Paykel Healthcare, a2 Milk and Spark. Removing capitalisation from the equation, the average decline of the constituents of the S&P/NZX 50 Index since the market peaked is 31%. This is in-line with global market peers.
One flow-through effect of spiking global share market volatility has been an increase in trading volumes as retail and institutional investors scramble to reposition their portfolios. Liquidity is vital to maintaining a well-functioning stock market. However, with seemingly unconstrained selling, the counter to increased liquidity in this risk-off event has been a higher cost to execute trades, with bid-ask spreads widening. New Zealand is not immune to this, we have observed the same market forces at play domestically.
While equity managers reposition their portfolios for a probable recession, Salt Funds Management, who are the appointed manager of the AMP Capital New Zealand Shares Fund, have been largely positioned appropriately heading into the reversal, due to valuation measures prior to the outbreak. Salt’s portfolio has been underweight in the more richly valued stocks in the market for some time, proving beneficial since the February market peak. The portfolio has held underweight allocations to the majority of stocks most impacted by the pandemic, preferring more ‘defensive yielding’ names which coincide with companies where earnings are less exposed to the spreading macro weakness caused by the virus.
Salt’s portfolio has remained defensively positioned since the outbreak with key overweights in Spark and Contact Energy both outperforming the S&P/NZX 50 Index. Salt believes that the two stocks should continue to outperform given their defensive qualities and resilient earnings. It should be noted that while Salt are overweight Contact Energy, the portfolio remains neutral on the utilities sector as a whole, given the uncertainty that still exists around Rio Tinto’s plans for the Tiwai aluminium smelter.
Salt has positioned the portfolio to be overweight a2 Milk in the food & agriculture sector, which proved beneficial following a good result, positive earnings momentum and a confident outlook statement from management. The stock also has a potential positive outcome from Covid-19 as consumers change their purchasing behaviour towards quality consumer staple goods. Being in the healthcare sector and aided by a lower New Zealand dollar, the other domestic net beneficiary from Covid-19 has been Fisher & Paykel Healthcare. While its share price remains at a premium to Salt’s valuation, the fund manager has taken the opportunity of share price weakness to reduce its underweight allocation given the positive earnings risk in a sustained or escalating Covid-19 outbreak.
Salt believe that increasing media attention on Covid-19, including the spread of cases within New Zealand, is likely to drive a temporary change in consumer behaviour that may not have been evident to management in February when companies gave earnings guidance. Salt therefore sees negative earnings risk for companies in the tourism & leisure sector, specifically, for Tourism Holdings, Sky City and Air NZ, as well as the infrastructure sector, namely Port of Tauranga and Auckland Airport. Salt’s portfolio remains underweight all of these companies. Retirement villages also remain underweight given the potential business risk of an outbreak within a village, plus the sector’s debt-load sensitivity which could present a headwind in the current macro environment.
The listed property sector, which is positively leveraged to lower bond yields, remains underweight within Salt’s portfolio. In saying this, Salt are keeping a close eye on the sector as value starts to emerge. While Salt’s portfolio remains defensively positioned, they are keenly aware that increased volatility and rebased share prices present opportunities for active managers like themselves to increase exposure to the most oversold stocks when the appropriate time arises. However, at present there is far from sufficient clarity on the near- and medium-term impacts of the pandemic to aggressively seek out value in markets which are not pricing assets entirely rationally, due to fast-changing news flows and, at times, outsized swings in sentiment.
1 A bear market is defined as a fall of at least 20% from the most recent peak
2 Volatility is calculated using the daily closing level of the S&P/NZX 50 Index on rolling 20-day period
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This blog post has been prepared to provide general information and does not constitute financial advice in accordance with the Financial Markets Conduct Act 2013. An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, 'AMP') make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.