Morphic’s Slater was bearish. But how much rally is too much to bear?
Sit in cash and suffer portfolio drag? Or go “all in” and risk testing the bottom with no bullets to spare? That’s the single most important question on the minds of investors right now.
As the ASX extends its largest monthly gain on record, up 25.4% from the March lows, sentiment is heavily divided. Many are in the camp of Chris Watling, who expects a retest of those lows. Others like Simon Shields are bullish and argue we don’t need the crisis to be resolved, we just need to be able to see when the worst will be behind us.
“At what point do you just accept this market is going up again? If you look back at the GFC, a lot of the people who did very well by carrying a lot of cash gave away all that performance by sitting on it all the way though 2010, 2011 and 2012. They continued to deny that the bull market had actually begun.”
Image: Chad Slater, Co-Founder, Morphic Asset Management
Portfolio drag is the negative impact on returns from holding cash as markets rise. Morphic’s funds have outperformed the benchmark by over 4% this year from holding relatively high cash levels, now at 14-17% across its strategies. But Chad recognises that cash is a double-edged sword and he’s “becoming less confident” that the market will plunge back into deep.
Hence why the Morphic team have a plan. Chad's base case is that the market will sell-off again as horrendous data makes it difficult for the rally to continue. That’s when more cash can be deployed. However, if the rally persists to the point where confidence is cemented, then it’s time become fully invested.
"If the market, for example, trades above February before we knew all this… we may argue with that. But it could be the case that a million people’s minds believe that this is a one-quarter event and they’re willing to look through it."
So far, sentiment seems to be returning to the bulls’ court, he suggests, as economies are steadily unshackled themselves from government decrees to control COVID-19.
4 portfolio themes for the other side
Regardless of the market’s short-term ups and downs, Chad believes portfolio positioning will need to change to avoid losers and catch winners on the other side.
1 - Underweight the US
While the U.S. has led the charge among major equity market returns following the GFC, don’t expect this to continue in the period ahead for two reasons: 1) U.S. stocks were overvalued coming into the COIVD-19 crisis, and 2) The world’s biggest economy has also been the hardest hit from the pandemic, so its recovery will be long and hard.
2 - Overweight Asia and Europe
Meanwhile, it's the opposite story in Asia. Countries including China, Vietnam and Taiwan appeared to have stopped the virus in its tracks early while stocks across the region entered the crisis at cheap valuations. In this region, Chad especially likes businesses enabling other companies to upgrade their technology systems.
While Europe has unfortunately not dealt with COVID-19 well, valuations are still more attractive than the U.S.
3 – Disruption of globalisation
One of the early, big lessons for governments in dealing with COVID-19 has been the over-reliance on global supply chains and offshore manufacturers to produce critical equipment.
Chad reckons COVID-19 will disrupt globalisation and governments may mandate companies to insource production. That could benefit certain businesses who win lucrative domestic contracts, but hit those who had outsourced capabilities offshore.
"You may be mandated to manufacture certain things now and that will lower shareholder returns. I’m not sure who it will happen to, but this will not as good for equity investors as the boom period we lived through."
4 - Be careful of travel and tourism stocks
One may need to think again about whether consumers will jump back on planes and jet set around the world like no tomorrow, Chad suggests.
Early indications from a post-lockdown world in China, for example, show that domestic air travel remains 50% below what it was before the pandemic, yet road travel has surged 15% and train travel is up 5%, according to Morphic’s analysis.
If this trend becomes enduring, then the knock-on effects will be huge. A consequence would be less Chinese visitors, the biggest source of inbound arrivals and spending from an Australian tourism context. And that would be a bad outcome for many tourist-focused industries such as airlines etc. "If travel behaviour does change permanently then that’s going to lead to structurally high unemployment in Australia," he says.
But there’s one thing can almost be guaranteed to stay the same: our national affinity for beer.
"Let’s see how many people go back the pub when pubs re-open. I suspect Australians will."
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