Charles Morris
Charles Morris

Market Commentary – Never bet against mankind

March 2020

There are no precedents for this crisis, just as there never are for any crisis. If there were, there wouldn’t be a crisis because we would have a grasp of what to expect. It is the uncertainty that strikes fear into the market. We have become used to recessions and financial panics, but this time the economic problem is self-imposed to save lives. We understand that and support it. But we have no idea what the long-term damage to the economy will be.

The German Government have been telling companies to slash dividends in order to fight the virus and it won’t be long before all European banks slash their dividends to zero. Staggering though it may seem, FTSE 100 dividend futures have fallen by 45% this year, EuroStoxx by 57% and the S&P 500 by 33%. This puts forecast dividend yields at 3.2%, 1.9% and 1.6% respectively, despite a crash in prices. You have to go back two decades, to the dotcom bubble, to see the last time the market yield was this low.

It is beginning to look as if government bonds were right after all. In the post war period, gilts paid a higher income than the equities until around 2010. This was recognized by George Ross-Goobey, who persuaded the Imperial Tobacco Pension Fund to invest in equities as the yield was higher. At the time, pension funds stuck with bonds, but Ross-Goobey was right because the economy was growing. Over the past decade, gilt yields have been falling, and while many have questioned the resilience of dividend income, it wasn’t deemed likely to evaporate as it just has.

Income investors are generally seen to be risk averse and they will be sorely disappointed by dividend cuts. But the light at the end of the tunnel is that this is will be temporary. We frequently see a company’s share price collapse following a dividend cut, even during bull markets. They say that bad news comes in threes. It starts with a profit warning, then another, followed by a dividend cut. The share price reaction can be brutal under such circumstances; often seeing falls between 50% and 90%.

Value investors often say that they are being paid to wait. Not this time. Income stocks are currently faring worse than the market. In some cases, that is materially so, but in others, the weakness is deemed to be temporary. This is because the market knows that this storm will pass, and many dividends will be reinstated.

To the market, a company is merely a long-term string of cashflows, rather like a bond. If a 30 year bond pays £2 per year and returns £100 in 2050, the most important thing is the £100 rather than the £2. Stockmarkets are much wiser than many give them credit for, and to skip a dividend or two won’t matter much if it helps to keep the business intact.

Seeking survivors is the key. In part that means strong balances sheets, but more importantly, balance sheets that won’t deteriorate in this environment. Even if the lockdown ends earlier than we expect, having no customers gets expensive, and quickly. Government support with wages is helpful, but the domino effect is the real problem.

Retailers have collectively decided not to pay their rent and face the consequences later. Safety in numbers is a good strategy and we’ll have to decide who comes out stronger, the retailer or the landlord. With high street retail in decline anyway, perhaps both come out of this badly. Yet in other industries such as energy, mining, recruitment, support services, leisure and transport, they’ll be plenty of lasting change, but they will thrive again. For example, we may see a lasting decline in long haul travel, but short haul will pick up where it left off once this virus is able to be monitored.

At some point, we’ll return to work. Seeing colleagues again will feel like a school reunion. It’ll be straight to the pub at the first opportunity, which will be packed and soon run out of beer. Just as the food and beer (and loo roll) was in the wrong place when this lockdown began, it will be in the wrong place again. We suddenly found ourselves eating 21 meals per week at home, when normally it’s less than 10. Little wonder the supermarkets are packed.

The supermarkets are a good case study. They have done a remarkable job in restocking the shelves and demonstrate how adaptable systems can be. Amazon too, the way they have stepped up to the mark is impressive. While the pub might struggle to cope the day we go back to work, they’ll be plenty to go around once things fall back into place. When allowed to do so, businesses will be back up and running in no time.

Better still, not only will the immediate threat of the virus eventually pass, but new systems and treatments will come to light. The market saw this as a shock, because it hasn’t seen a virus shutdown before. With the lessons learned, the next pandemic will be a calmer affair. We might have to go home for a few days but will be better prepared. There will be more markets shocks in the future but won’t come from viruses.  And before you know it, dividends will be reinstated. The traffic jams will return, and the planes will fly. Oil demand will surge, and dividends will be reinstated; faster that at any time in history. There will be a boom in value stocks that will make 2003 or 2009 look pedestrian in comparison. The virus has changed the world forever. More people will work from home, and the high street will shrink. We’ll travel less and make more friends closer to home. But these changes aren’t necessarily good or bad, there’re simply changes. We’ll adapt to it in no time. Never bet against mankind.