GAM Investments: Six sectors returning to growth post-Covid-19

You have to be an optimist to work in emerging market (EM) debt. In terms of the impact of the continued impact of the coronavirus itself on EM populations, EMs tend to have a much lower infection rate than the rest of the world, which may be partially due to climate and demographic factors. 

The populations tend to be younger, meaning individuals may not experience the harsher effects of the virus. As a result, emerging markets are in a reasonably strong position. 

This environment allows for the maximum possible differentiation between the winners and losers. 

Certain sectors and companies have experienced positive effects from the crisis, such as technology companies like Hello Fresh and in healthcare, but many have been hit by both cyclical and structural issues. 

The average European company is anticipated to report a 40% earnings decline according to analysts, with impacts particularly acute for hotel operators, food caterers and office real estate companies, all of which will likely recover slowly. 

We believe this is a similar situation to what occurred at the end of the last two crises. At the end of the tech bubble in 2000, the tech sector missed the rally and structurally underperformed for the following five years. 

This was also true after the Global Financial Crisis, when banks and financials strongly underperformed, missing an important bull market over the ensuing years.

This may happen again now to the areas which are the most negatively affected by the crisis. 

Importantly, differentiation between the stocks with healthy earnings characteristics and those with potentially permanent problems is creating wide-ranging opportunities for long/short investment strategies.

This is a very powerful opportunity for the disruptive growth asset class. Out of all the areas within equities, disruptive growth has seen the most significant acceleration. 

Working from home requirements and the move online to acquire goods and services to run our personal lives has led to a massive acceleration in the adoption of e-commerce and associated online tools.

Anything related to the cloud is seeing a huge take-up and I expect this to continue as most companies operating within the disruptive growth space will not see any deterioration in their growth prospects. 

It will also mean that we will see some of the structural losers, i.e. incumbent companies, already losing market share which had been losing their market share slowly, begin to lose their market share more rapidly. 

The polarisation between winners and losers – those who adopt disruptive technologies against those who do not – is greater than ever, which makes this area of the market extremely interesting at the moment.

We believe the luxury sector is in an interesting place coming out of this crisis. Multiple trends that were simmering in the backdrop pre-Covid-19 have been accelerated by the crisis. 

Sustainable consumption is very much at the forefront of people's lives, and luxury's ethos of 'buy less, buy better' plays into this theme. 

Another interesting aspect of Covid-19 has been the trust that consumers have placed in brands over other bodies and authorities, at times even their own governments. 

Companies have told us that trusted brands, where consumers have faith in their authenticity and value proposition , are winning at the expense of those that seem less reliable. 

We believe the luxury and premium brands sector, which revolves around trusted brands with heritage and authority, is likely to benefit as a result of this crisis.  

Those companies will have experienced a significant drop in their revenues and profits between March and May, but dependent on the scope of any further lockdowns, they should experience a strong rise in pent-up demand followed by a sustained recovery into this year and next. 

In terms of earnings, we would hope for some of these companies that 2021 will not be much lower than was originally forecast. 

We remain more cautious on travel, although leisure is having the chance to rebound somewhat over the summer. 

We have also seen a greater switch from cash into card and online payments. We believe the area of digitalisation and the need for companies to operate remotely will continue to expand, which will benefit many software and hardware IT companies. 

Finally, the 'greening' of the economy, a core aim of Europe’s policy response, should continue to benefit the drive to make buildings more thermally efficient and the electrification of cars. 

These segments will see structural accelerations as a result of continued government fiscal support.  

If we take a step back and consider what has happened in the UK equity market, it is very interesting to look at gilt yields. 

The 10-year gilt yield has fallen from 1.5 to 0.12 since the end of 2018 and what that has done is really propel a certain part of the market. 

In the UK market, it is not uncommon for typical large-cap names to trade on 40x earnings. While we are not expecting a V-shaped recovery, we are now seeing incremental improvements. 

Talking to management teams, they are seeing month-on-month improvements and we want to see that translate to both quarter-on-quarter and year-on-year.

With that, we can take a step back and get some perspective on valuations, and assess the market on a two-year time frame. 

Stocks that have retained pre-Covid-19 earnings levels tend to trade on five to seven times earnings and those with good balance sheets that are looking to return to the dividend register are really interesting for us. 

Covid-19 has meant that the UK market has suffered some severe dividend cuts, with aggregate dividends falling in the region of 50%. 

We are now speaking to company management teams as they discuss whether they can return to the dividend register. 

As is often the case with small and mid-cap firms, founders may be invested in the company and the management team have shares, meaning that their interests are aligned with shareholders in their bid to return to paying dividends.