Coronavirus Bargains

Today’s post is my first attempt to make sense of the market chaos wreaked by the coronavirus.

Ground rules

Let’s start with a few points to place this discussion in the appropriate context:

1. I don’t think we are at the bottom yet
   • There’s not much good news or even the prospect of good news over the next week or two
2. I don’t expect to find screaming bargains
   • Markets don’t usually work like that, and any projections beyond next week feel like speculation
3. I won’t be tipping which stocks to buy, or when
   • I’ll simply use firms as examples of sectors which present opportunities (or not)
4. In the short-term, lots of firms face an existential crisis
   •  Firms go bust when they run out of cash, and many are about to see their revenues come to a complete stop
   • What would you spend your cash on in the coming months, other than food, loo roll, booze, heat and online?
   • Any company that can cope with zero revenues for many months probably wasn’t being run in the most efficient way before the virus
5. Government aid at the moment amounts to loans with unspecified repayment terms
   • This might not be enough for low margin businesses
   • Even if firms survive, recapitalisation (and hence dilution of existing equity) is likely
6. In the medium-term, we need to predict how long it will take for certain aspects of life to get back to normal
   • This won’t be easy – airlines and cruise ships, anyone?
7. Long-term, we need to work out which aspects of life have changed forever and will never get back to normal.
   • But we’ll assume for now that our old way of life will eventually return and that most firms which don’t go bust and aren’t nationalised/bailed out will still have customers.

I’m going to spend most of my time talking about (UK) stocks, but I will touch briefly on other asset classes.

• As expected, correlations tend towards one during a global crisis, so at this point, it looks as though diversification across geographies and asset classes hasn’t achieved much.

In the long run, it’s a different story, however – you will end up with lower volatility and hence a better Sharpe ratio.

• You’ll also find it easier to stick to a larger equity allocation, which should lead to higher growth.

Stocks

Let’s start with some first-level thoughts on which sectors might do well or badly out of this.

1. Travel = bad
   • Airlines, hotels, holidays, cruises, rail and coach
   • Theme parks and experiential attractions (bowling, escape rooms)
   • Conference venues and organisers
2. Leisure = bad
   • Pubs, and restaurants, fast food
   • Cinema and theatre
   • Sports
   • Gyms
   • Retail and property related to retail
3. Insurers = bad
   • There will be lots of claims ahead
4. Staples = good
   • Supermarkets
   • Online (Amazon and Ocado?) and deliveries
   • Drinks firms?
   • Healthcare (over the counter –
5. Other online retail = bad
   • Do you need new clothes if you never go out?
6. Online entertainment and connectivity = good
   • Netflix, Spotify, Apple?
   • Zoom
7. Gambling and gaming sites = mixed
   • Loss of revenue from sports betting, more revenue from casino betting by people in lockdown?
8. Vaccine firms and medical suppliers (tests, masks, ventilators) = good
9. Spread bet firms, who should benefit from volatility = good
10. Online education – who knows?
    • With schools closed, will they bodge together their own offering?

Approaches

Amongst private investors, there are four popular approaches to playing a crash like this:

1. Quality
   • Stocks with good returns that will continue to grow, and which are currently trading at a discount
   • Strong balance sheets and free cash flows
   • A competitive moat
2. Value
   • Cheap stocks which are largely priced to go bust, but which we hope will recover
   • Some overlap with Quality, since even Quality stocks should be cheap by now
   • Riskier than Quality since more danger that the firm actually does go bust
3. Dividend
   • Even riskier than Value in the current circumstances, since a lot of dividends will be cut in the next few months (and this process has already begun)
4. Insider trades (by which I mean Directors, not criminals)
   • If a firm has a serious risk of bankruptcy, and the Directors are buying heavily, perhaps they think that it won’t go bust

My personal preference is for a combination of Quality and Value.

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I will probably switch my active UK portfolios over to Quality as the crisis progresses

• And then access Value firms (and any with clear Director signals) via leverage (spread bets) once I think there is a low risk of bankruptcy
• I’ll also add some spread bets on the major indices.

I’m not a fan of the dividend approach at the best of times, and this seems far from the best of times for this technique.

UK stocks watchlist

At this stage of the crisis, this section is largely an aide memoir for me – don’t expect much in the way of analysis today.

1. Restaurants and food service – RTN, TAST, CPG, FUL
2. Pubs and bars – JDW, MARS, MAB, YNGA, RBG
3. Cinemas – CINE, EMAN
4. Gyms – GYM
5. Experiential entertainment – BOWL, ESC, TMO, RNK (also online)
6. Airlines – IAG, EZJ, RYA, WIZZ, DTG
7. Holidays – OTB, TUI
8. Cruises – CCL
9. Hotels – IHG, PPH, HSW
10. Travel – GOG, SGC, FGP, NEX, SSP, SMWH
11. Insurers – LGEN, AV., PHNX, PRU
12. Supermarkets – OCDO, SBRY, MRW, TSCO, MKS, ABF
13. Drinks – DGE, FEVR
14. Retailers (broadly defined) – FRAS, NXT, JOUL, SCS, DNLM, BRBY, CARD, SDY, KGF (and not ALY)
15. Online retail – BOO, SOS
16. Online gambling and gaming – PTEC, 888, FLTR, GVC, WMH, BOTB, CDM, TM17
17. Leveraged brokers – IGG, CMCX, PLUS
18. Online education – WEY, LTG
19. Medical stocks – NCYT, ORPH (both testing), SNG (drug), BYOT, TSTL (both infection control), MGP (remote radiology), LID (monitoring)
20. Quality at a reasonable price (QARP) – GRG, ABDP, BVXP, SOM, SPSY, JDG, ULVR, GAW, YOU, PMP

That should do for now.

Funds

There are a couple of ways to use funds in a crisis like this:

1. Buy theme funds that you think might benefit
   • Cloud Computing (FSKY) and VIdeo Gaming & eSports (ESGB) might fit the bill
2. Pick up investment trusts on larger than usual discounts (or smaller than usual premia) eg. JARA
   • But as above, be wary of dividend-focused ITs

Bonds

I’m no bond expert, but interest rates won’t be rising for years after this, so sovereign bonds at least look reasonably safe.

• The problem is that they don’t yield much, so private investors might be better off keeping their powder dry as cash in instant access accounts and Premium Bonds.

Corporate bonds, junk bonds and EM bonds have been behaving more like equities through the crisis, and I would avoid them for now.

Commodities

Oil has obviously been crushed by the combination of COVID-19 and the breakdown of negotiations between Russia and Saudi Arabia on restricting supply.

• You might expect a rebound when the global economy recovers.

The same can be expected of industrial commodities like copper.

Gold should do well before that.

• The price has been underperforming recently, probably because there has been liquidity-driven selling.

But it should do well as the crisis drags on.

• The same goes for the other precious metals – silver, platinum and palladium.

FX

It took a while to get going, but the dollar is now king, rising against all other currencies.

• You can expect this dominance to unwind as the crisis is resolved (as with oil and copper).

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That’s it for today.

• I’ll probably do a follow up in a week or two when the situation has evolved somewhat.

Until next time.