The quickest, sharpest decline in history has been followed by the quickest, sharpest rebound, so the question now is: Where do we go from here? In this article we take a look back at the history books and call on some veterans of the industry to help understand what the road to recovery might look like.

Key Highlights:
  • Looking back, history suggests a V-shaped market recovery is rare. And recoveries take time.
  • Timing markets has proven almost impossible, and the ongoing uncertainty surrounding the current situation is unlikely to make this easier.
  • Nonetheless, we look to the future and start to build positions for the ‘after-corona’, gradually and with the patience to find attractive entry points, without trying to time the bottom.
  • Looking beyond the immediate recovery, we are likely to see some long-term legacy from this crisis as well.
  • In the current context, humility and risk management are key words.

It is impossible to predict events like 9/11 or COVID-19. The good news is you don’t have to actually predict these events to be prepared for them.

~ Aziz V. Hamzaogullari, CFA®
Chief Investment Officer and Portfolio Manager
Loomis, Sayles & Company


Featured Affiliate Contributions:


Equities

Growth: Aziz Hamzaogullari, Loomis, Sayles & Company

It is impossible to predict events such as 9/11 or COVID-19. And we believe that it is futile to try and estimate how long they will last and how deep the impact might be. The good news is however that you don’t have to predict these events to be prepared for them. There’s no such thing as a ‘risk on’ day or a ‘risk off’ day, as if investors allocate capital rationally one day and not the next.

The best preparation requires a disciplined approach to doing the right thing every day. If you look at any profession, those who are successful are both disciplined and consistent. At the top of a cycle people tend to think very long term. They start talking about ‘the next decade’. Conversely, at the bottom of the cycle they tend to focus on the next quarter and forget about the next 10 years.

We allocate capital every day in the way that, we believe, everyone should allocate capital–with an informed view of risk reward. If you truly understand the importance of this relationship, you should be prepared for whatever tomorrow may bring.

As a result, this environment has provided us with some tremendous investment opportunities. There has been more activity in the portfolio than there has been in a long while. Typically, we invest in one or two companies per year, but recently we have invested in five new businesses, which is a significant amount of activity for us.

And when we buy, we buy with the intention of being truly long-term investors. In fact, we have analysed the holding period of our portfolio companies in the past and it is longer than 98% of the peer group. These are the times that define portfolios for the next 10 years. Investors should take full advantage of them, but do so by acting rationally.

Value: Bill Nygren, Harris Associates

On average, the S&P 500 has taken 8 months to reach new 52-week highs after bottoming out. It’s not clear that we have seen the bottom yet in 2020, but it is clear that it will take time to get back to where we were. It is easy for investors to become obsessed by shortterm price movement, but the underlying value of a business does not move as swiftly as stock price or often with as much magnitude.

As we entered the shutdown, the S&P 500 traded at a 2020 Generally Accepted Accounting Principles (GAAP) Price-to-Earnings/E ratio of around 23x, which, converting earnings to cash flow, means the typical company was expected to generate 4%-5% of its market cap in 2020 cash. Mathematically, most of the total value of a growing company comes from the aggregate cash it will generate in the years 2023-2050 and beyond.

If cash flows dropped to $0 for the entirety of 2020, the aggregate value of market should fall by about 5%. We do not believe cash flows will completely fall to $0 for the year. However, we have seen the stock market drop far more dramatically than 5%.

The truth is that it is still too soon to know what will happen. Shutting down the economy will certainly cause a severe drop in GDP, but even draconian scenarios should not frighten long-term thinkers. These types of dislocations provide opportunity for strong performance for those who are patient to weather the storm.

It’s worth remembering that a litany of frightening events have occurred over the past three decades and yet the S&P 500 has increased 11-fold. The question investors should be asking themselves is ‘How much will this affect the long-term cash flows of businesses?’. Beware of extrapolating near-term costs into perpetuity.

ESG & Thematics: Jens Peers, Mirova US

During the crisis, we’ve seen that many ESG strategies have seen inflows while non-ESG strategies on average have experienced outflows1. By taking a longer term view and focusing on companies that are believed to help create a more sustainable future, most ESG strategies, including ourselves, have little to no investments in some sectors which have underperformed the most during the coronavirus crisis, such as fossil fuels, tourism, aviation and financials. On the other side, a preference for health care stocks and companies with on average lower levels of debt compared to the broad market, certainly helped as well2.

Looking ahead to any potential recovery or normalization, long-term trends–demographic, technological, environmental and governance-related transitions–will continue to drive performance. We’ll still need to adapt to urbanization and invest in solutions for climate change–even though we’ve seen that pollution and CO2 emissions have actually been lower during the crisis.

However, we’re also going to see an acceleration of the digitalization of our economy. Many people are now used to doing video conferences, working from home and ordering things online, but many businesses are starting to think about that a lot more too.

Supply chain management will also be increasingly important. We’ve seen that Wuhan is probably the global production center for many different industries, including many basic components for pharmaceuticals and the car manufacturing industry. Centralizing all your production centers in one specific city can lead to significant disruptions in your supply chain management, so companies that have a wider distribution or sourcing network will continue to benefit in the future.

I think it’s really important to construct your portfolios around the things that you’ll believe will create a sustainable, long term future. That’s why we only invest in the companies we like–and we like them because they have the right products to benefit from these important long-term trends, they are well managed and they don’t take irresponsible risks.

Fixed Income

US: Dan Fuss, Loomis, Sayles & Company

By background and by habit I like to buy into severe market declines. This is unlikely to be a smooth recovery and there will be substantial bumps along the way.

I would say our official outlook is certainly to be hoped for. That is that the recovery will not be V-shaped, but a very big U i.e. we go down very, very sharply. And then, as the impact of the virus starts to pass and activity gradually returns, we start the upswing. There’s not an immediate rebound, but a gradual uptrend in the economy.

As such, I can understand people buying equities right now. I can even see the attraction of investment grade if you feel the Fed is going to keep buying for a long time. But, I think we have to be particularly careful on credit. A lot of the earnings models will need to be changed. Many cost structures are not flexible enough for significant reductions in revenues; especially when revenues fall faster than costs can be adjusted. From a cashflow standpoint, once you go negative, that’s a real headache.

Mentally, I’m preparing for inflation because I think there’s a real risk that it will return. Do we have the tools to fight it? Yes. Would we be willing to slow the economy again in order to stem it? The answer there is less clear cut, especially when total revenues are far short of expenses. I expect inflation to be comparable to the ‘50s and ‘60s, where it crept in at first and then at a point, started to accelerate. I don’t anticipate a return of the conditions experienced in the late ‘70s, at least not in the U.S. But then again, it is very hard to isolate ourselves from the rest of the world.

European: Philippe Berthelot, Ostrum Asset Management

Nearing the end of April, one can notice that the bulk of risky assets has recovered more than half of the slaughter in prices that occurred since mid-March 2020. Investment Grade and High Yield corporate bonds are still lagging in this respect. But one could wonder whether or not credit as a whole is the right place to be in such turmoil as the global economy is entering into its largest contraction wince WWII! Let’s not hide the fact that credit will be featured with further waves of downgrades ($€550 bn to $€850 bn for Euro denominated€ Investment Grade) including several fallen angels but as we can see, a lot of it is already priced in at current levels. On top of it, we do not foresee default rates skyrocketing in Europe like in the US but rather a rise to 7.5% by year-end at worst (much above 10% for the US default rate because of the Shale oil sector massacre to come).

This is a crucial moment when active investments can make the difference vs passive investments: active sector allocation and active issuer picking will be key in the end: some issuers will suffer like hell or eventually vanish in the case of bankruptcy. Even if we’re still navigating into uncharted territory, with some genuine uncertainty about the letter defining the recovery to come (U, V, L or W shape?), we are constructive on credit at current levels for both IG and HY in Europe (1.5% yield in IG vs -0.5% for the 5 y German Sovereign bond).

What’s next? This all-time unknown pandemic crisis, will have structural consequences comprising a shift from global to local supply chains: the «just in time» rule with zero inventories will soon be replaced by the « Just in case » one. Let’s forget about the double digit ROE obsession for CEOs or CFOS! The short-term earnings focus will morph into longer one, combining a robust and quality focus for employees, clients or providers including much more green consumerism, i.e. a ‘sustainable’ Capitalism: welcome to Capitalism 2.0!
1 Source: Morningstar; H. Bioy, Investors Back ESG in the Crisis, 12.05.2020

2 There is no guarantee that investing in ESG strategies will result in a profit or limit loss in declining markets.

GAAP (generally accepted accounting principles) is a collection of commonly-followed accounting rules and standards for financial reporting.

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings

Investing involves risk, including the risk of loss. There is risk in equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.

Sustainable investing focuses on investments in companies that relate to certain sustainable development themes and demonstrate adherence to environmental, social and governance (ESG) practices; therefore the universe of investments may be limited and investors may not be able to take advantage of the same opportunities or market trends as investors that do not use such criteria. This could have a negative impact on an investor's overall performance depending on whether such investments are in or out of favor.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions are those of the respective authors and may not represent the views of Natixis or any of its other affiliates. The views may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.

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