277. Investing through the recession that hasn’t come… yet
We start our interview with Tom Lemaigre, co-manager of Janus Henderson European Selected...
A maligned market for more than a decade, some green shoots of hope appeared for Europe at the start of 2020, as accommodative monetary policy, calming political tensions and strong underlying fundamentals (such as low levels of unemployment) promised better times ahead.
But the major outbreak of coronavirus in Italy, and its subsequent spreading across the Continent and beyond, was a game changer. The discussion has now changed to what type of recession Europe will face.
Some of the preliminary data from the first quarter of 2020 is particularly concerning, as it showed economic growth contracted by 3.8% quarter-on-quarter in the eurozone. The flash composite purchasing managers’ index (PMI), which measures business activity, hit a new record low of 13.5 in April, down from 29.7 in March. To put this into context a reading above 50 suggest expansion in the manufacturing and service sectors and anything below suggests contraction*.
Policymakers in Europe have responded forcibly in both monetary and fiscal terms – such as packages to help those unable to work – in a bid to minimise the long-term damage. More than 40 million workers have been furloughed across Europe’s six largest economies (including the UK) during the shutdown**.
Bloomberg Economics estimates if all workers at risk were to become unemployed, the jobless rate could pass 50% in Italy and Spain at their peak, with France just behind at 46.6%**.
Schroder’s senior European economist and strategist Azad Zangana believes Italy, the EU’s third largest state, is in a particularly perilous situation, as it is one of the most heavily indebted.
Zangana says along with Spain and Greece, Italy is already finding it more expensive to borrow. He points to two key concerns. “Number one: how are they going to service that debt going forward. And number two: how are they going to refinance that debt on an ongoing basis?”
This will be a major concern when the European Central Banks decide to scale back their quantitative easing programme.
Janus Henderson European Focus and European Select Opportunities fund manager John Bennett believes depression rather than a mere recession is probably underway for some businesses and sectors, namely hospitality, travel and catering.
Hear John’s thoughts about the ‘Control-Alt-Delete recession’ and which companies he thinks will be the winners and the losers in this podcast.
PIMCO’s Nicola Mai believes the European economy will contract by around 10% this year, with risks skewed towards a larger contraction – citing “second-round effects on the economy from high unemployment, corporate bankruptcies, damaged animal spirits, and behavioural changes.” He adds that there is a need for fiscal support to be not just aggressive, but also long-lasting and broader, to help struggling sectors.
“Recent anecdotal evidence confirms that these risks are very much alive. One major airline announced that it may need to lay off around one-third of its staff, and reports suggest three-quarters of UK restaurant and bar operators risk going bankrupt. In Italy and Spain, tourism represents around 12% and 14% of respective GDP, according to the World Travel and Tourism Council, and it’s hard to see these activities coming back anytime soon.”
Although the outlook remains bleak at least in the short term, as always, there will be winners and losers – and therefore investment opportunities.
Marlborough European Multi-Cap fund managers David Walton and Will Searle say that while the next set of quarterly results (which includes most of the lockdown period) will be poor for many companies, management should begin to gain an understanding of the post-coronavirus demand profile. In the meantime, the pair say they can still find good quality companies with strong balance sheets that can expand their business in this difficult economic environment.
Recent acquisitions to their portfolio include Swedish telecom equipment and services provider Ericsson (strong balance sheet with net cash and well positioned to take advantage of shift to 5G) and Irish fruit and vegetable distributor Total Produce (defensive business with an attractive valuation)^.
T. Rowe Price Continental European Equity fund manager Dean Tenerelli says many companies’ valuations have compressed so dramatically that his team are now being presented with some real opportunities in the long-term. He says these opportunities are coming across many industries, ranging from luxury goods, industrials, selectively in energy and materials, and even in consumer staples after their derating. In total his team added 11 new company names to the portfolio during the first quarter, four of them in March
Jupiter European fund manager Mark Nichols says although the pandemic is likely to have damaging effects on previously resilient business models, it will also create new opportunities for some businesses, such as improvements in health (clinical diagnostics), the industrialisation of the food supply chain and an increasing move to a digital world.
He says: “The balance sheets of the private and public sectors are likely to become significantly more stretched. Confidence and capital investment will clearly suffer. But this is already old news. As long-term growth investors, what is of more interest to us is that consumer behaviour is likely to change.”
*Source: Schroders: Monthly markets review – April 2020
**Source: Bloomberg Economics – Europe’s Virus Furlough Programs Bail Out 40 Million Workers
^Source: fund factsheet. 30 April 2020