Did the global pandemic catch you off guard, Ms Taylor Jolidon?
Such a decline to the March trough was not expected at the beginning of 2020. However, we did make a cautious start to 2020, and expected economic growth to be weaker at a global level as compared to 2019. Consensus earnings expectations appeared too high, particularly in cyclical sectors such as energy, materials and capital-intensive industries. We noted subdued growth figures from China. As such, we were already defensively positioned before the global coronavirus crisis.
How did you react to the global pandemic?
Calculating what could be the magnitude of the effects on the global economy, led us to adjust the portfolios we manage to a more defensive tilt. We increased our exposure to companies that are better able to withstand the current downturn and are potentially able to benefit from some behavioural changes which may result from the pandemic. The Swiss stock market is well positioned on both these points.
The Swiss market tends to outperform other markets, on a relative base in crises, in particular, European markets. This is partly due to the well-observed defensive nature of the heavyweights, Nestlé, Roche and Novartis. Furthermore, investors appreciate the safe-haven status of the Swiss franc, which can be an added advantage.
That’s the generally accepted interpretation.
We prefer to look deeper and concentrate on the fact that the Swiss equity market offers particularly attractive high and stable levels of cash-flow return on investment (CFROI). Companies that are able to increase or maintain at a high level their CFROIs, are value creative. That value creation enables them to withstand crises with greater resilience and return to growth once the economy stabilises or grows again. The comparison is particularly marked with European stock markets, which have significantly failed to create value, or increase their CFROI beyond a breakeven level since the Great Financial Crisis. Indeed, the US market and Switzerland stand out with their strong and sustainable value creation.
How are these companies different?
These relatively crisis-proof businesses will tend to have strong balance sheets. They can continue to manufacture and sell their products and services, thanks to well-established networks of suppliers and customers. They can finance their business and they continue to generate cash flow. Furthermore, in current circumstances, if a company produces necessities, such as is the case for the aforementioned food company and pharmaceutical companies, they will see less cyclicality in their end demand. Indeed, they may even witness higher demand for their products.
Where would you see higher end demand?
Beyond some consumer staples and selected healthcare, there is a potential for stable or increased demand for IT and software companies, particularly those that are involved in the digitalisation of businesses, which has become even more important in this work-from-home setting. SoftwareONE, which provides software license management and advisory services plays into this indirectly; Temenos and Crealogix, which specialise in banking software; and Logitech, which produces computer peripherals would be selective examples of this.
However, this could also simply be a flash in the pan. Who is winning structurally?
Now that we have a heightened awareness of pathogens, private individuals and companies may also envisage renewing their infrastructures, for example by updating ventilation and air conditioning systems. Companies like Belimo, a leading provider in this area, could benefit.
Would the pharmaceutical and healthcare sector be the big winner now?
Caution is advised here. Many companies are currently researching vaccines or treatments for COVID-19. However, there is a valid opinion that for reasons of social responsibility, these may enter the market at major discounts, or even free of charge in some countries. Success in the fight against the virus will therefore not automatically translate into higher returns. In addition, the demand for some specialist drugs or materials has been disrupted by the pandemic.
But there must also be winners in these areas.
Yes, there are. One company that is benefitting during the pandemic, due to changes in regulation, is the online pharmacy “Zur Rose”. The German authorities have now not only allowed electronic prescriptions, but the legislature will actually make them mandatory from the beginning of 2022. This makes it relatively more attractive to order medication online than previously.
Contract and development manufacturing organisations (CMO/CDMOs) such as Lonza, Bachem, Siegfried, and maybe also Dottikon, stand to benefit from research into a vaccine or therapy for COVID-19 and higher sales of existing drugs used to treat the viral side effects of COVID-19. Furthermore, their long-term positive drivers have not been disrupted.
And which companies are you avoiding?
The exit from the crisis may be slower than initially thought. Millions of jobs have disappeared, at least temporarily, and the unemployment rate in the USA is around 15%. Consumption will only recover slowly, and this slow recovery may have negative repercussions on retailers in particular. Furthermore, it is unlikely that sales figures of car manufacturers will spring back to the already depressed pre-crisis levels. A large proportion of the population may be cautious about types of travel and leisure activity that involve large numbers of people in close proximity for extended periods. The aviation, travel, tourism and events industries may need more time to recover.
Which Swiss companies are affected?
One example is the exhibition provider MCH Group, which was already experiencing problems before the crisis. Duty free retailer Dufry will face half-empty airports for some time yet.
The market has rallied since the March trough. How sustainable will it be?
Markets may be underestimating the likelihood of a second wave of infection and another lockdown. Although profit expectations for this year have fallen sharply around the world, there may be further necessary downgrades. The publication of Q2 numbers may reveal more regarding the severity of the economic downturn caused by the pandemic.
How will things look after the crisis?
Both public and private debt will be higher. Balance sheets will be adversely affected – and possibly in particular those of consumers. Recovery may be slower than was initially assumed, an assumption that has led to the apparent optimism in the market at the moment. Hopefully that optimism is not misplaced. Nevertheless, further market corrections may well happen.
Many forecasters assume strong economic growth in 2021.
This is understandable. The crisis will peter out with our infrastructure intact. Many businesses will have their machinery up and running again at the flick of a switch. The question is how quickly consumption will return to its pre-crisis level. Governments and central banks are supporting the economy in general, including companies that were already in difficulties prior to the crisis.
What is wrong with that?
This comprehensive support scheme will also rescue businesses that would have gone bankrupt under normal circumstances. In the particular case of the financial sector, for example, the rules on capital adequacy are being temporarily relaxed, thereby supporting those institutions which have long ceased to be sustainably profitable; but at the same time everyone is virtually banned from paying dividends, which means that the strong cannot display their strengths. This is ultimately a missed opportunity for beneficial consolidation.
Are you sceptical of financial stocks?
There are no disturbingly weak or precarious listed banks, insurance companies or financial service providers in Switzerland. The major banks and financial services companies have actually profited from the high level of customer activity in Q1. However, it is questionable whether this will continue in Q2. The banking sector continues to face a long-term trend in terms of higher regulation and lower earnings opportunities which make it less value creative. Insurance is more preferable in that context.
What will be important in the coming months?
The success of exit strategies will be key. Second waves of infection such as experienced in Singapore would surely be a major setback.
Eleanor Taylor Jolidon
Co-Head of Swiss and Global Equity