As the books close on an eventful first quarter – the Dow Jones recorded the worst first three months of the year on record – markets seem to be showing some vague signs of consolidation (or at least are trying to).
In the past week, shutdown measures and pledges of economic assistance have spread throughout the world, including in developing nations. While numbers on testing are not standardised, there seems to be a growing global consensus that the situation is extremely serious and there is a need to flatten the curve so that the medical response can ramp up.
Equities: markets on a rollercoaster ride
Within equity markets, the swings in performance have persisted. Much of this has been driven by sharp volatility in the oil price, which has frequently moved by 10% on a daily basis.
The dispersion in analyst price targets for S&P stocks is at a 20-year high, which suggests there is a lack of consensus around the shape and length of the recession that now seems likely. It also points to the persistent uncertainty around corporate earnings, as well as the unwillingness of markets to give up on some of the growth narratives that shaped the last decade.
Some of our Equities teams observe that growth stocks and value stocks continue to diverge even when the market is correcting. While deep value stocks have fallen precipitously – they now trade at price ratios close to those seen during the financial crisis – growth stocks have been far slower to reprice and remain at levels closer to those seen during cyclical market pullbacks during the past decade.
The unique nature of the current crisis has essentially frozen both supply and demand, meaning that cyclicals have seen a particularly sharp correction. Liquidity does not seem to be an issue in equity markets – which is a positive sign – and the sporadic rallies in markets suggest that there is still pent-up demand as investors seek appealing entry points.
Dry powder: companies draw on their reserves
At this critical juncture, it is not just investors who value any reserves that have been kept on hand. Our Credit team notes that many of the companies in their universe have drawn their revolving credit facilities to shore up cash as they enter a period of deep uncertainty.
In the UK, the Prudential Regulation Authority has asked banks to restrict both dividend and bonus payments in order to galvanise their cash reserves. This indicates the increased regulatory oversight that is likely to characterise the financial sector at least for the duration of this crisis. There is evidence that private credit and equity managers are keen to draw on the ‘dry powder’ in their limited partner base so they can move swiftly to pick up new investment ideas.
Credit: defaults on the horizon?
On the whole, there has been more of a focus on liquidity within credit than in equity markets. There continues to be a divergence between the liquidity of ‘quality’ BB or BBB-rated companies and those with lower ratings, while the recent uptick in buying has also compressed pricing in some of the more desirable names.
Much of this wariness on the demand side stems from the expectation that there will be more defaults. Bankruptcies in the the retail and service industries are likely, while we saw the first major Chapter 11 filing in the energy sector this week – and expect a further wave to follow.
Property: retail funds under pressure
Our Real Estate team notes that some of the public real estate investment trusts (REITs) have recorded precipitous moves in their discounts to net asset value. Some retail-focused REITS are trading at discounts of more than 60%, which suggests a dividend yield of over 20% – although the income component is certainly not assured at this point. By contrast, industrial and data centre REITs have held up well. However, all real-estate valuations remain severely challenged.
Impact: is the crisis hastening trends already underway?
One of our Impact Opportunities team’s key theses is that governments will increasingly transfer funds to the private sector in order to address pressing environmental and societal challenges that they lack the capacity or expertise to tackle.
During this crisis, we have already seen the private sector come to the aid of governments in areas like healthcare equipment (particularly ventilators and personal protective equipment), testing, hospital construction and other logistics solutions. This reinforces our belief that impactful private companies are an essential mechanism through which to service the unmet needs of society.