With cases of Covid-19 on the rise in some states in the USA, and the development of hotspots in Australia, fears about a second wave of infections have been heightened. Virologists and other medical experts have always warned to expect a second wave or even a third wave, so for many investors, this should not come as too much of a surprise.
However, given that the stock market has recovered so quickly, the question remains as to whether it has really factored in the possibility of a second wave. After hitting a low of 4546 on March 23, the S&P/ASX 200 rose a massive 35.2% to peak at 6148 on June 10. In the USA, the bounce has been even bigger, particularly with the tech heavy NASDAQ index.
So, if there is a second wave, how do you position to invest?
Before we get to that, we should ask “a second wave – where?”, because if it is just a second wave in Europe and not in the USA, I don’t think it will have a material impact on the Aussie market. The USA is the key, as is any local outbreak that results in lockdowns like we saw in March and early April.
The starting point is to consider what happened during the first wave for clues as to the market’s likely behaviour. I don’t expect a carbon copy, but I do think some of the actions will be the same.
Key takes from the first wave
The table below shows a selection of leading stocks (arranged by sector) and their price on February 20, March 23 and June 10. The S&P/ASX 200 peaked on February 20 at 7163, fell 36.5% to hit a pandemic low of 4546 on March 23, and then rose to peak again on 10 June. For each stock, the table shows the percentage drop from February 20 to March 23, and the percentage increase from March 23 to June 10.
Selected stocks during pandemic – peak to low and back to peak
Importantly, the stocks did not in every case peak on February 20 or hit a bottom on March 23, but it was pretty close. The percentages have also been adjusted for dividends declared over this period.
These are some key takes:
- No surprise that the stocks most directly affected by the lock-down and facing an immediate (and indeterminate) drop in revenue performed worst. This includes the travel companies such as Flight Centre and Qantas. What has been somewhat surprising is that their bounce back (in percentage terms) has been almost as strong – although if you drop by 75%, the rise has to be 400% to get back to square;
- The best companies (that is, companies that everyone recognizes as a “company to hold for the next decade” due to consistent growth, market dominance or balance sheet) held up best. This includes names such as CSL, Xero and even Commonwealth Bank – the latter only falling 38% whereas its three major competitors suffered falls between 45% and 49%;
- Consumer staples such as Woolworths and Coles fared well on the way down as sales surged, but got left behind as the market recovered and buyers looked for “alpha” elsewhere, and remembered that the supermarkets were incurring considerable additional costs to generate those sales;
- In a panic, everything can go to mustard and this is probably the only way to explain the short-term damage that was wreaked on highflyers Afterpay and Zip Money. But they absolutely roared back, delivering gains of over 450%;
- Property was one of the worst performing sectors, with shopping centre property trusts being hit harder than office building trusts. Industrial property held up well;
- Defensives such as Telstra, Medicare and APA traded like defensives – not as much on the way down, somewhat left behind on the way up;
- The resource companies (BHP, Rio) fared better than might have otherwise been expected due to a special factor relating to competitor disruption. Oil stocks were hit with the double whammy of the virus and a fallout between Saudi Arabia and Russia over supply.
What to expect in a second wave
During the first wave, Governments and Central Banks threw so much support to cushion the economic shock that the recovery in stock markets was rapid. The “don’t fight the Fed” maxim sung loudly. We had a ‘V’ shaped stock market recovery and although the jury is still out, the idea of a ‘V’ shaped economic recovery hasn’t been dismissed.
If a second wave occurs, I think that Governments and Central Banks will throw even more money to limit the economic damage. This means two things. Firstly, the market trough won’t be as deep as there will be too much cash around looking for a home, and secondly, the stock market recovery won’t be as strong as their actions will confirm that the economic recovery will be more ‘W’ or ‘U’ shaped. The outlook for many companies will be problematic – and there will be casualties.
So, how to play?
Firstly, stick to the strength. This will be the opportunity to buy “the companies for the next decade”, potentially CSL, Resmed, Xero, BHP and Macquarie to name a few. Offshore, look at Amazon, Microsoft and Apple.
On the tech side, the market will have noted that these stocks recovered fastest during the first wave. Although the Afterpay’s and Zip Money’s of the world are over-valued, they are also beneficiaries of a tailwind as purchasing behaviour changes and at the right price, the market will line up to buy.
Woolworths and Coles will again do well and because the idea of a ‘V’ shaped economic recovery has been dismissed, may actually enjoy more support as defensive stocks become fashionable.
The banks will go down hard with the market. They will be good value in the long term below book value (which is around $17.00 for the ANZ, NAB and Westpac), but recovery in the short term may be tepid as the economic toll mounts.
What not to buy? I think travel companies that depend on overseas travel could really struggle as international borders remain closed for longer, so I won’t be buying Flight Centre or Webjet. Also, if lockdowns develop, the “work from home” momentum could seriously pose a threat to the demand for office space, leading to substantial write-downs for some of the office REITs. Retailers who have strong online channels should be ok, but “bricks and mortar” fashion retailers could be in for a really hard time.
The resource companies may be more challenged if a second wave occurs, as declining economic activity leads to a gloomier outlook for demand and commodity prices.
Finally, if Australia avoids a second wave and continues to outperform in relation to its handling of the virus, the Aussie dollar will remain well bid. This gives support to the notion of currency hedging offshore positions, and could put a dampener on the gains of our leading companies that earn most of their revenue offshore, such as CSL, Amcor, Brambles and James Hardie.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.