2Q 2020 International Equity Outlook: As risks recede, fundamentals will come back into focus

As risks recede, fundamentals will come back into focus

David Souccar discusses a focus on quality in times of turmoil, the importance of a strong balance sheet and opportunities to upgrade portfolios.

Quality stocks outperformed during the first two months of the quarter as typical in a down market. Since March, sell-offs have been indiscriminate as the coronavirus expanded outside China. We expect fundamentals will start to become important again in determining stock movements.

As in 2009, markets panicked and there was a severe hit to global growth in a short period of time. But unlike the financial crisis, the financial system is in better shape and large corporations are stronger. In addition, both federal governments and central banks are pumping large amounts of money into the economy. We expect to see 20 to 30% downside to earnings this year, but a quicker recovery than in 2009. Investors should concentrate on quality stocks that can defend and perform well whatever the circumstances.

Investors should have a disciplined approach and not make decisions based on fear. Quality companies that have strong balance sheets should have the strength to survive a long period of distress as we don’t know how long or how deep the coronavirus impact will be.

Companies that survive the crisis may be in a stronger position to gain market share afterwards. We take a conservative view that businesses need enough cash flow to cover fixed costs and pay down debt in the short term. By running this analysis, we see that sometimes the market overreacts and creates an opportunity. For example, Ashtead is a US market leader in construction equipment rentals and is a cyclical business. But it also has a strong balance sheet and is trading at a historically low valuation. Understanding quality enables investors to capitalize on opportunities.

It is always difficult to make investment decisions based on macro forecasts, and since January macro forecasts have become completely obsolete. While we believe the best approach is to analyze businesses individually, in aggregate some sectors are more attractive, such as consumer staples, health care, technology in the software space and service-oriented industrials segments.

Investors take calculated risks about the future based on what they can reasonably predict, while speculators take risks they cannot quantify. For example, Nestle’s products are important for consumers day-to-day, and the company has a long track record that can be a reference for forecasts. In contrast, in the energy sector, there are so many variables weighing on the oil price that it is impossible to make a consistent forecast. Rather than predicting when the market might turn, we think investors should focus on great businesses.

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