Should investors be positioning for recovery?

Vaccine progress has markets excited, but many are still warning of economic weakness ahead. Is it too soon to contemplate recovery?

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Despite the recent excitement on vaccines, many have suggested it is premature to talk of recovery. The virus shows no immediate sign of disappearing or its virulence diminishing. While there is good progress on vaccines, they will take time to roll out and, in the meantime, countries are facing renewed lockdowns and economic disruption. There is no ‘business as usual’, at least in the short term.

However, this gloomy synopsis neglects some key points. Countries are learning to manage round the virus, finding a balance between keeping the economy open and protecting their citizens. The second round of lockdowns, while tough, have generally left schools open, enabling more of the workforce to function at full capacity and limiting the economic damage to a few hard-hit sectors – leisure, the arts, travel.

Governments have been careful to manage expectations on a vaccine, but data now shows good efficacy for the three leaders in the vaccine race. Certainly, vaccines need to be deployed with considerable speed to allow citizens to move freely again, but governments are already preparing mass roll-out programmes.

At the same time, some stability appears to have been restored to US politics. In spite of ongoing lawsuits, Joe Biden appears to have secured a convincing win in the US presidential election. His presidency could bring smoother international relations and a larger fiscal stimulus package than might have been expected under a Republican administration. Both of these elements may oil the wheels of the recovery.

Economic recovery

In the meantime, economic numbers are more encouraging. Recent data for the third quarter showed the US economy recovering rapidly, bouncing by 7.4% quarter on quarter (or 33% annualised)1. This means it has recovered the lion’s share of its losses in the second quarter (though it remains 3.5% below its level at the start of the year)1.

We have seen a similar picture across the rest of the world. In the Eurozone, GDP rose 12.7% quarter on quarter after declining 11.8% in the second quarter1. This was notably better than expected with the French, Italian and Spanish economies showing particular strength. The BlackRock Investment Institute maintains that the cumulative GDP shortfall – the key for asset prices – from the COVID-19 shock is likely to be significantly smaller than in the aftermath of the global financial crisis.

Fiscal and monetary stimulus is an important factor here. Interest rates remain at record lows and in many countries have further fiscal support is in the pipeline. Central banks have taken a more relaxed stance on inflation on the basis that economies need to be given space to recover sustainably before raising rates.

“To our mind, this is not a time to be too exposed to cyclical areas that may not recover, or to expensive growth areas.”

Positioning for better times

With this in mind, it is worth contemplating a recovery strategy in a portfolio. After all, stock markets won’t wait until everything is back to normal before rising higher. However, this may not be a ‘normal’ recovery.

Normally, a recovering economy would favour more economically sensitive areas – banks, airlines, consumer discretionary companies. However, while those areas have seen share prices drop significantly and now look very cheap compared to ‘growth’ companies, there is still real uncertainty on the outlook. Is it possible to say, for example, whether airlines can recover to their previous level of earnings?

Even where companies recover, it is not clear that they will return to sustainable growth. Will under-pressure sectors return to business as usual or a new normal? Even though share prices are cheap, at a time of major structural change, there is a risk in being in sectors that are on the wrong side of that change.

Embracing cyclical companies?

The key, in our view, is to focus on those cyclical areas with a clearer path to growth as the economy improves. We believe there are real opportunities in the mining sector today, for example, with companies showing strong balance sheets. They are also geared into long-term trends such as the energy transition. This is the right balance of cyclical exposure and growth potential.

At the other end of the spectrum are the high growth companies. These companies are likely to see earnings continue to grow, particularly where they are plugged into long-term trends such as cloud computing or digitalisation. However, valuations in some of these stocks have moved a long way in the past 12 months and significant growth expectations are already built into share prices. Should earnings wobble for any reason, these areas may look just as vulnerable.

It is possible, however, to find growth at reasonable valuations if, as we do at BlackRock, investors have the resources and analytical capability to find it. In recent months, investors have assumed that growth is only to be found in high profile technology names. Yet it is also found in frontier markets, in UK smaller companies, and in out-of-favour European markets.

As with many aspects of the coronavirus, the recovery will be unpredictable.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of December 2020 and may change as subsequent conditions vary.

1. Fitch Ratings, October 2020