How to position your portfolio for a post-COVID boom

The good news on COVID-19 vaccines strengthens the case for a global equities boom in 2021.  But where will the biggest gains be found?  In beaten-down cyclicals, ‘re-openers’ and other firms smashed by the temporary lockdowns? Or in the so-called ‘pandemic darling’ tech stocks?

We believe the emergence of several vaccines from successful trials will ultimately give governments and their constituents the confidence required to prepare for, and move towards, the normality of pre-COVID commercial and social activity. This we believe should be at the forefront of investors’ minds.

The combination of imminent vaccine distribution, immense conventional and unconventional monetary and fiscal stimulus settings, still distrustful portfolio positioning, pervasive northern hemisphere fear about the persistence of the virus and a proliferation of abandoned or beaten-up stocks and sectors is simultaneously a justification for optimism about 2021 and a recipe for meaningful returns.

Are we going to see a global recovery boom in 2021?

Some investors suggest the environment has set the most attractive scene for equities since the Global Financial Crisis. We would argue the significant gains since the March 2020 lows suggest the most attractive scene was, by definition, set in March. Irrespective however of whether one invested in March or at any time since, we believe the full benefits are yet to be fully realised as the COVID-19 vaccines have significantly strengthened the argument in favour of a global recovery boom in 2021.

The aforementioned ‘distrustful’ portfolio positioning is a function of the incumbent tension between largely good news on the vaccine front and the continuing challenges faced by our developed western cousins in the Northern Hemisphere. The virus’s spread is described as ‘out of control’ in the US, where daily infections have hit 200,000 and daily deaths exceed those killed in the Twin Towers tragedy. In Europe the virus’s spread has triggered renewed lockdowns. The distrust is perhaps still limiting the potential upside and this is the opportunity for Australian investors.

Here in Australia we can see daily the optimism that is ignited by a lifting of restrictions, blue skies, warm temperatures and the promise of a vaccine.  In the northern hemisphere, investors have the optimism about a vaccine but they are yet to experience the emergence from COVID fears.  A complete lifting of those fears has the potential to ignite further market gains and keep in mind the US market’s moves has a heavy influence on our own.

Unsurprisingly, a shift in the market’s leadership has commenced. While equity investors have looked through the bad news to register new market highs, with tech stocks also recovering, some analysts note that the “pandemic-darlings” are priced for a perfection that inheres too much risk for many investors.

Significant upside potential, with less risk, is arguably available in those stocks that were left behind during the COVID-19 crisis. Leaving high quality structural growth companies to one side, investors who ‘rotate’ away from the momentum of the ‘pandemic darlings’ may be enjoy better risk-adjusted rewards.

Tech stocks priced for perfection

Some technology stocks are priced for perfection that will only transpire if lockdowns were permanently in place. This is not our central thesis and so we believe there is some risk among those technology companies that are relying on a continuation of recent monthly and quarterly growth statistics, fuelled by customers being locked down and working from home. It is true many display compelling growth, solid free cash flows and attractive margins. It is also true that many enjoy long growth runways. But where growth may prove to be cyclical as well as structural, the reporting of slowing growth rates could see some technology companies take time to surmount recent highs.

Banks make money when rates are high, the yield curve is steep and credit conditions are loose. Recently, the opposite conditions have been entrenched. But improving credit conditions, increasing transaction volumes – not least thanks to the government’s moves to loosen the responsible lending framework – and a potentially steepening yield curve are all positive drivers for the banks. With adequate reserves Australian bank returns on equity may not decline any further and could improve. It also appears as though valuations, while not bargain basement, are fair rather than stretched.

Will cyclical stocks continue to benefit?

Cyclical or economically-sensitive stocks are enjoying a reopening-related momentum that could persist for the time being. Of course, the greatest jumps in sequential growth may have already occurred. In the case of the major materials companies, a continuation of rising iron ore prices should help short-term earnings per share and share price performance but investors need to consider the long term sustainability of those higher commodity prices.

Income producing companies, particularly those with boring annuity style income streams may be in hot demand post COVID. With central banks committing to low rates for the foreseeable future, global pension funds are on the hunt for attractive acquisitions. Their investors are receiving zero on cash so global pension funds may be willing to buy Australian annuity generators at capitalisation rates significantly lower than local investors may be prepared to pay. Merger and acquisition activity in 2021 could heat up.

A caveat

The further the market rallies on reopening and vaccine optimism, the more sensitive it becomes to risks such as delays to the vaccine’s rollout through disruptions to distribution and production.

The market is currently prepared to look beyond a return to lockdowns for many countries. Provided those lockdowns are as effective as Victoria’s, the optimism is probably justified. Any failure of the lockdowns to contain the virus however may result in the optimism being premature. Nevertheless, the rotation into cyclicals, ‘re-openers’ and into companies left behind by lockdown-fuelled momentum, is underway. Investors should seek advice about whether it is sensible and appropriate to consider listed companies and managed funds positioned favourably towards a rotation, and especially those with an eye on quality and value.


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