Laura Foll, UK equities portfolio manager, provides an update on the market amid the coronavirus outbreak and oil supply price war, as well as what may be instore for UK income investors.
There are now two concerns for global equity markets – a potential global COVID-19 coronavirus epidemic causing a simultaneous demand and supply shock, and an oil price supply shock. This is causing heightened volatility in share prices as the market attempts to quantify multiple moving parts – does a company have supply chain exposure (either theirs or third party) in, for example, China and/or Northern Italy that is being disrupted? Will demand be severely impacted (for example is it a travel and leisure company? Is it substantially reliant on tourist demand)? Does it have any material exposure to oil & gas (either in its own operations, or if it is a financial company, does it have any material lending exposure to oil & gas?). All of these questions are complex and the market’s response for now is sell first, work out the reality later.
Possibility of a demand-led recovery in UK equities?
We do not know how long the impact of the COVID-19 coronavirus will last, or how widespread it will become geographically. Nor do we know how long the oil price will stay at these levels. However, monetary policy is already very loose, fiscal policy may be about to become looser (the UK Budget is just around the corner at the time of writing) and we now have a very low oil price. All of these factors put together could, when the virus is seen to be easing, result in a substantial demand-led recovery. This could come at a time when many industrial companies, because of the fall in manufacturing activity last year, have already had to substantially reduce costs. Therefore the drop through from sales to earnings when a demand recovery happens could be substantial.
Corporate debt levels across the majority of companies in our portfolios have remained conservative – lessons have been learned since the Global Financial Crisis and many management teams have continued to be cautious of taking on too much debt. Capital spending has been kept low and the focus has been on cash generation.
Our response is to do little in the current volatility, but to add in small size to those companies that we know well, have been following for a long time, and where we think the share price reaction looks extreme (recognising that there may well be earnings downgrades but we are investing on a multi-year view).
Sustainability of dividends via diversification
From the perspective of managing income funds, the other question in the coming weeks will be around the sustainability of dividends. We think the best approach in this environment is to diversify among income payers. There will naturally be questions about the sustainability of dividends within oil & gas companies (Royal Dutch Shell and BP, for example). However, there are sectors that may benefit in this type of event such as pharmaceuticals, utilities and non-life insurers.
Across all of the portfolios that we manage we are materially less reliant than the benchmark (the FTSE All-Share Index) on the dividends of major oil & gas companies. This may prove beneficial against dividend cuts in this uncertain environment.