The World Turned Upside Down

We live in unprecedented times. The ‘law of the jungle’ or survival of the fittest is very much in play as Covid-19 lockdowns leads to recession in many countries. In this environment, investors have had to completely re-think – what is a defensive business?

For example, in previous recessions pubs were relatively defensive as even though customers, with less money in their pockets might drink at home or order a takeaway meal they would still visit the pub but less frequently. However, we now have a situation where pubs and restaurants have been forced to close so they have no takings whatsoever!

Similarly, the food service sector has been viewed as relatively defensive -people have to eat. The problem with the Covid-19 lockdown is that with the pubs and leading takeaway outlets closed the food services sector has been adversely impacted. In turn, dairy farmers have been forced to pour milk down the drain as there has been a fall in demand for milk from pubs, restaurants, coffee shops and takeaways.

Talking of ‘law of the jungle’ we then have the new generation of internet business models such as Amazon. Last month it took on 100,00 extra US staff to fill priority online orders for food and medical equipment for existing customers. By comparison, in the UK, Next had to close its high street shops but also its online offering due to warehouse staff safety issues.

For ‘essential’ industries worker safety is paramount. Protesters in the US state of Michigan have demanded that businesses re-open to allow them to work. Meanwhile, workers in Mexico are protesting to shut factories due to the risk of their health. Clearly, there is heightened concern for workers across a number of ‘essential’ industries but this has to be balanced against the continued production of key products such as food and for economic activity to resume. The UK is even having to fly in crop pickers from Romania to help UK farmers who can’t find enough domestic workers.

So, the challenge for government, businesses and households is once we have passed the peak of Covid-19 just how do we return to normal? A vaccine and testing are key to avoid the risk of a resurgence in new infections. Furthermore, countries are also at different stages of the Covid-19 outbreak and everyone is currently watching those in Europe such as Italy and Spain for guidance as they tentatively ease restrictions.

Business sectors, also differ greatly in terms of the impact from Covid-19 with some deemed ‘critical’ (defence) or ‘essential’ (supermarkets/pharmacies) operating relatively normally compared to some which to conform with social distancing have had to shut completely (pubs). For the online retailers, such as Amazon, a return to normal may mean it can ease temporary curbs on non-essential third-party goods being sold on its platforms. By comparison, last week Next re-started its online service on a modest basis with low volumes that would only require a small number of warehouse staff. On its first day Next had to stop taking orders by 8.30am as demand exceeded capacity!

Even some ‘essential’ businesses such as small independent pharmacies are facing unexpected consequences of Covid-19. Longer hours and higher home deliveries have meant higher staff costs but more significantly the wholesale price of medicines has shot up. One small pharmacy operator in South Wales told the BBC his medicine bill in March had jumped by 50%!

For many businesses on the high street and those that rely on customer footfall just what the government now decides on lockdown and social distancing measures is not just about returning to normal but about survival. The government is doing its best to support as many UK businesses as possible but simply cannot support every single one.

We, are having to view investments in a ‘world that has turned upside down’. A defensive business in a previous recession may not be so now. Social distancing rules, are and will continue to affect businesses differently. We cannot say with any degree of certainty when life will return to normal. However, we do know one thing, no matter what the business – cash flow is king. Those businesses with robust Balance Sheets and cash flow are going to survive -those who haven’t will not. Flybe was an early business casualty of Covid-19 but it will sadly not be the last.

What have we been watching?

The global daily trend of Covid-19 cases appears to be plateauing as a number of countries are beginning to see lockdown and social distancing measures start to take effect. In Europe, Germany, Austria, Italy and Spain are tentatively starting to lift some restrictions as they have seen a clear down trend in new cases. Everyone will be watching the outcomes closely and governments will be looking to learn from the success or failure of others.

Caution is still required as, for example, Japan’s northern island of Hokkaido has re-declared a state of emergency having only recently lifted restrictions, although Japan’s version of lockdown is rather softer than those imposed elsewhere. China has also revised the Covid-19 death toll within Wuhan upwards by 50%! French president Emmanuel Macron has questioned China’s handling of the Covid-19 outbreak saying things ‘happened that we don’t know about’. A key risk remains the outbreak of a second wave of Covid-19 infections and the re-introduction of lockdown measures. Harbin, North East China’s second-largest city has been put under lockdown following a cluster of new infections although these are believed to have originated from imported infections from across the Russian-Chinese border.

In the US, President Trump said the US has ‘passed the peak’ and given local governors guidance on re-opening state economies, with phase one being the lifting of non-essential travel with large venues such as restaurants and places of worship to be allowed to re-open under strict physical distancing protocols. This does seem somewhat premature to us! He has also suspended funding for the World Health Organisation, accusing it of severely mismanaging the Covid-19 pandemic -clearly an attempt to deflect from his own ineptitude. Meanwhile markets continue to watch for any progress on a vaccine or treatment for Covid-19. In the US, there was some encouraging news with Gilead Science’s drug Remdesivir reported to be producing a rapid recovery in Covid-19 patients in a Chicago hospital. In addition Roche announced it has developed a new Covid-19 test able to detect anti-bodies and whether a person has become immune.

In the UK, the government announced a three-week extension to the lockdown but the Chief Medical Officer said the outbreak is slowing. However, there is no lockdown exit strategy as yet.

Evidence would tend to suggest that in the absence of a vaccine, that testing and tracing are key to any lockdown exit strategy and that countries will need sufficient testing capacity.

The IMF attempted to assess the ‘Covid-19 hangover’. It forecasts that the global economy will contract by 3% in 2020 making it the worst decline since the Great depression of the 1930’s. However, the organisation praised the ‘swift and sizeable’ response from a number of governments and central banks. Providing Covid-19 is contained in the second half of 2020, the IMF is forecasting a recovery in global economic growth to 5.8% in 2021. ‘A partial recovery is projected for 2021 but growth will remain below the pre-virus trend, with considerable uncertainty about the strength of the re-bound.

The Economist Intelligence Unit warned of a possibly much worse downturn, driven by a debt crisis from governments with weak fiscal positions such as Italy which are currently borrowing heavily to fund Covid-19 lockdown support packages.

In the UK, the government gave formal approval for the HS2 project to begin the construction phase once the Covid-19 lockdown has been lifted. Meanwhile, the Office of Budget Responsibility predicted the UK economy could shrink by up to 35% between April and June in a worse case lockdown scenario. This assumes a three-month lockdown and gradual re-opening which seems more pessimistic than many UK fund managers are expecting.

In Europe, French President Emmanuel Macron warned the EU could unravel unless the bloc embraces financial solidarity.

In the US, retail sales fell by almost 9% in March with car sales down by 27%. Manufacturing activity declined by over 6% in March, the biggest monthly fall since the end of World war II. Weekly unemployment reached 5.25milion in the week ending 11^th April taking the four-week total to over 22million. No wonder President Trump is keen to re-open the US economy, with the clock counting down to the presidential election!

China’s economy has contracted for the first time in decades due to Covid-19. The economy contracted 6.8% in the first quarter. However, the monthly activity readings for March were more encouraging, especially industrial production. The People’s Bank of China cut its benchmark interest rate for the second time in 2020 from 4.05% to 3.85%. China, is clearly stepping up stimulus measures as the country emerges from lockdown. House prices edged up slightly in March while new apartment sales in major Chinese cities trebled in March from February on pent-up demand.

Brent oil drifted back to $27 and close to an 18-year low. Concern grew that the recent OPEC+ output cuts will not be sufficient to offset the Covid-19 driven global slump in demand. Meanwhile, West Texas crude plummeted to under $15 a barrel as traders became concerned that storage facilities are reaching their limit. The market appears awash with oil.

Finally, yet another unexpected casualty of Covid-19 – the Dutch flower industry. The Covid-19 lockdown has resulted in the closure of flower shops and garden centres across Europe meaning that an estimated 400million flowers and 140million tulip stems have had to be sent for composting by Dutch growers. (The last famous tulip bulb crash happened in 1637 and was one of the first recorded investor ‘speculative bubbles’)

Read Last Week’s Alpha Bites – Testing Times

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The World Turned Upside Down

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