Positioning for the rebound?

Have we seen the bottom in Asian stock markets? How is the Asian strategy positioned in these uncertain and volatile times? Is the strategy  positioned for a rebound? What can we learn from the Asian experience of the virus in terms of how this might play out in other markets?

Before I answer these specific questions, let me first say that these are the sorts of times we live for as fund managers. Volatility provides opportunity, uncertainty leads to mis-pricing. Work we have done over several years can now be brought into use: we have already run the ruler over many businesses which used to trade at fair values but which now trade at bizarrely cheap valuations.

Decisions we make in these weeks of high-intensity can be crucial for performance both in absolute and relative terms. And our team’s experience of previous situations of similar intensity (1998, 2001, 2003, 2008/09, 2015/16) helps inform these crucial decisions. While I am deeply unhappy with the performance of our investment strategy this year, I believe there are now many buying opportunities out there.

 Have we seen the bottom in Asian markets?

• As a team we have been actively discussing this for several days. Clearly the bottom in markets will be linked to the data on virus infections and deaths, because the sooner those numbers peak out, the quicker the lockdowns can be removed, and the quicker we can return to a more normal economy.
• But to a large extent we have agreed that the question is somewhat irrelevant and distracting. That’s because some stocks may have already bottomed, while some others have not yet bottomed. We may do better just to focus on the stocks.
• We are also aware that we cannot get much of an edge by trying to be ahead of the market on the true extent of the virus spread and other such questions, but maybe we can get an edge by keeping a cool head, by maintaining a longer term horizon and by focusing on what specific stocks are pricing in.
• So without directly answering the question, I would take a lot of confidence from the fact that the P/B of the Asian market is more or less in line with the trough seen in the GFC. And we should remember the trough valuations of the GFC did not last for very long at all – 2009 was a very strong year for markets. Whether we have seen the bottom or not, I would say the risk-reward is highly skewed to the upside.

How are we positioning the Asian equity strategy in these uncertain and volatile times? Is the strategy positioned for a rebound?

• We feel that the vast majority of stocks we look at today are clear Buys, the only question being whether one stock is more of a Buy than another, and how the portfolio should weight the different opportunities.
• We are not doing huge amounts of trades simply because we feel all the stocks we own are trading below our estimate of fair value, and in many cases very significantly below that estimate.
• The opportunities we like best are those with strong balance sheets where management teams are not having to firefight in order to save the business, but where they can survey the damage and deploy their balance sheet to strengthen the business either organically or through M&A.
• A great example came out of two different conference calls we had last week with company management teams, both based in Hong Kong. One of these companies owns some hotels, and they said that they were using the high vacancy rates as an opportunity to accelerate renovation of the hotels; the other company owns some retail stores and said that it had halted all new store openings and all renovation projects in order to conserve cash in these difficult times. Both managements are doing the right thing given their situation, in our view. But the difference is that one company has a very strong balance sheet and the other has a weak balance sheet. The former company’s share price has fallen substantially this year (despite its strong balance sheet) and we have been adding to it quite aggressively.
• The exposure to companies with super-strong balance sheets (which is already very high) is increasing as a result of purchases such as this, but I wouldn’t say that is reducing our sensitivity to a market rebound.

What can we learn from the Asian experience of the virus in terms of how this might play out in other markets?

• The experiences of China, South Korea and Singapore are very instructive for the rest of the world at this point. China is just in the process of ‘unlocking’ Wuhan and Hubei, and it feels able to do that because it has had a period of gradually getting people back to work without seeing an increase in the infection rate. That is extremely encouraging so far, although we do have to bear in mind that economic data and company earnings will continue to be weak for some time.
• South Korea and Singapore are both great examples of how economies can continue to operate at a certain level of activity without leading to an uncontrollable increase in infections. Both countries never needed to lock down in the way that most of Europe is now doing, because they controlled the spread very actively and its citizens take the threat seriously. In epidemiologists’ terms, these countries quickly got the R0 factor down to less than 1 and they ensured they kept it there.
• My feeling is that other countries are getting the R0 factor down very quickly as we speak, and they ought to be able to ‘unlock’ over time in a similar way to China.