A pandemic of the magnitude of COVID-19 presents a huge set of challenges for equity investors. Quite simply, the rules have changed.
Three factors are now critical: which sectors and types of companies to own, how many shares and what kind of defensive assets to hold.
Pandemic-agnostic companies include supermarket chains such as Coles and Woolworths.
It is the interplay that is most important.
You don’t want to be holding too many stocks that are highly leveraged to a quick economic recovery, leaving you exposed if everything doesn’t go exactly the way you expect.
Holding a small amount of high-risk shares and lots of defensive assets might deliver you the same outcome as owning lower-risk shares in a higher quantity.
We classify stocks into three categories:
Pandemic agnostic: These are relatively immune to the coronavirus. Think supermarkets, software companies and consumer staples, such as shampoo, cleaning etc.
Pandemic beneficiaries: These benefit from the pandemic. Think toilet paper, cleaning and hygiene goods. The benefits may fade quickly for some while last longer for others.
Pandemic losers: These are hurt the most. Examples are travel, leisure, oil and personal services.
The biggest issue is pricing. The pandemic-agnostic stocks and the beneficiaries look expensive. The losers are cheap, based on last year’s profit levels, but may not see a profit for a long time. And if they are carrying too much debt, some may become insolvent before they have a chance to recover.
So, what will the shape of the economic recovery look like and how will it likely impact the sharemarket? Will it be V-shaped, U , W or L? It’s highly relevant to share prices.
If you are in the V-shaped camp, the biggest problem is the market has mostly already priced that in. You have little upside if you are right and lots of downside if you are wrong.
To reduce risk, perhaps the best strategy is to hold a core of pandemic-agnostic stocks, then rotate out of the more expensive and into cheaper ones, as opportunities arise.
Pandemic-agnostic companies include supermarket chains such as Coles and Woolworths. In the US, technology giants Microsoft and eBay and pet food supplier JM Smucker fit the bill. A global target could include Dutch food retailer Ahold Delhaize.
There are also some pandemic beneficiaries, such as hygiene and cleaning manufacturers, that may see a number of years of increased demand before returning to growth trend.
Essity, a Swedish company that supplies hospitals globally with sanitiser and hygiene products, and Clorox, the leading producer of bleach and other cleaning products in the US, are likely to see strong, ongoing growth.
It’s best to avoid the pandemic losers for now. Some will recover quickly once lockdowns are eased, however, many will take years to return to trend growth.
If you do want to buy these stocks early, the ones most likely to bounce appear to be the banks, oil companies and airlines – if they don’t go broke first.
If effective treatments for COVID-19 or widespread successful exits from lockdowns appear likely, it might be time to switch out of pandemic-agnostic stocks and into some of the pandemic losers.
Damie Klassen is head of investment at Nucleus Wealth.