Markets change, but human nature does not. This year's pandemic-induced swings in sentiment have created opportunities to buy best-in-class cyclical businesses in unloved industries.
There has been no industry more severely impacted than airlines, with aircraft grounded and passenger volumes taking an unprecedented hit.
In Europe, the pandemic is likely to turbocharge a supply-side capital cycle that was already well underway, with many airlines teetering on the brink of bankruptcy and reducing route capacity in 2019. However, there are winners and losers in every crisis, and players with scale at the bottom of the cost curve that have strong balance sheets and operational flexibility to weather the storm will likely emerge stronger.
The longer-term implications may lead to a reduction in competitive intensity, improved pricing, and opportunities to expand into profitable new routes. Environmental risks and strained labour relations are material risks, but even after accounting for a shift in some short-haul routes to other modes of transport and increasing labour costs, leading airlines Ryanair and IAG represent attractive value opportunities, in our view.
Following the Global Financial Crisis, Europe's slower monetary response, additional debt crisis and persistent political fractures meant its recovery lagged behind the US. However, during that tough period, many corporations cleaned up their balance sheets, preparing for the worst and are now in better shape.
There are also signs that Europe is pulling together a co-ordinated pandemic response, which sits in stark contrast to the US. With lockdown measures varying by state, civil unrest on the streets, and a contentious presidential election in November, the relative risks appear to be rising.
This combined with pockets of excessive leverage and elevated starting valuations may suggest the asymmetry is skewed towards some of Europe's attractively valued businesses.
The market environment is likely to remain challenging over the coming months, as visibility on the global reopening remains low. Regardless of the market volatility, we would suggest investors remain grounded in bottom-up fundamentals, investing only when a suitable margin of safety exists; as all else being equal, the lower the price paid, the less certain you have to be about future prospects.
• Swings in pandemic-induced sentiment create value opportunities for the contrarian investor rooted in fundamental analysis and with a probabilistic approach to valuation.
• Europe has lagged behind the US in recent years; however, its pandemic response and signs of political and fiscal unity may mean Europe's moment in the sun is approaching.
• Going from a shutdown of the global economy to a reopening will unlikely be smooth, given the risk of a second wave and further shutdowns.
• Unforeseen second-order effects have yet to materialise, and risk is elevated heading into a contentious US presidential election.
Anne-Christine Farstad is portfolio manager of the MFS Meridian Funds Contrarian Value fund at MFS Investment Management.