European equities – identifying winners beyond the COVID bounce

Within one month – from 19 February 2020 to 18 March 2020 – the MSCI Europe Index fell by more than 31%. At the time, we felt this was a significant overreaction to the onset of COVID-19 and looking back now, we were right to have seen the equity market collapse as a buying opportunity. However, the speed and scale of the recovery has been astounding. Just over a year after the onset of the crisis, equity markets advanced to new all-time highs. Source: Bloomberg, as at 18 June 2021.

Vaccine progress altered the investing landscape

The serene progress of equity markets at a headline level has obscured a violent rotation under the surface. The early stages of the COVID-19 crisis were characterised by defensive companies and those perceived as ‘COVID-19 beneficiaries’ significantly outperforming other areas of the market. But on 9 November 2020, Pfizer and BioNTech announced that their vaccine candidate “was found to be more than 90% effective in preventing COVID-19 in participants”. This was the moment that everything changed. From then on, value/cyclical/reopening beneficiaries have performed strongly while growth/quality/COVID-19 beneficiaries have lagged significantly. This has been a very intense period of style factor rotation. To give a flavour of some of the moves that we have seen, the European autos sector has rallied over 50% and banks have gained over 55%. At the same time, the European healthcare sector has advanced merely 12% and utilities, by just over 8%*.

In more recent months, investors’ focus seems to have shifted from reopening beneficiaries towards inflation beneficiaries, although there is clearly some correlation between these two subsets of the market. Economic data has generally come in much stronger than expected and buoyant inflation data, alongside supportive anecdotal evidence, is starting to drive higher inflation expectations.

I believe that the outlook for economic recovery and inflation is perhaps more balanced than some of the recent equity market moves might suggest. While it is true that inflationary pressure is building and that the economic recovery should be powerful, there is much evidence to suggest that investors may be over-extrapolating current economic data, which is heavily impacted by transient factors and by meaningful base effects. We are seeing a sharp demand recovery alongside a slower supply-side response and this is causing a spike in economic data and year-on-year inflation. If you try to remove the COVID distortions by looking at economic data and inflation compared to 2019, rather than 2020, you see a much more balanced picture.

Identifying the structural winners that were left behind

Taking a step back from current market oscillations, it is clear that there will be structural winners from the changes that occurred under COVID-19. New consumer habits are formed quickly and often prove stickier than envisaged. Will mask wearing, frequent hand sanitising and higher use of household disinfectant become a distant memory as we exit this crisis? Will ordering food using a takeaway food platform app be soon forgotten? Will it soon be all-to-easy to get an Ocado food delivery slot? Will the younger (and not so young) generations stop socialising online? In many cases, COVID-19 simply sped up structural changes that were already taking place. In investors’ eagerness to ‘play the recovery’, many of the companies that have structurally benefited from the pandemic have been left behind; the ‘COVID bounce’ in the share prices of some companies has been erased entirely and this could create some interesting opportunities.

German online takeaway food delivery platform Delivery Hero is just one example of this. We see the business as one that has emerged well from COVID-19, having garnered many more customers and generally achieved a higher order frequency and spend rate per customer. However, since the shares peaked in January, they have fallen around 25%. Another example is Swedish mobile gaming company Stillfront, which observed a meaningful pick up in customer activity and revenues in 2020 as lockdown restrictions gave consumers more time to spare for indoor leisure-related activities. It is likely that activity levels will slow somewhat this year as lockdown measures slacken; however, we believe that the growth of mobile gaming is a structural theme and that consumers who re-engaged in gaming during periods of lockdown may continue these habits as restrictions ease. Both Delivery Hero and Stillfront illustrate a general theme that we have observed across our portfolio and across the wider market; we are keenly focused on this and will look to take advantage of it where we can.

We operate an investment process based on the fundamental analysis of companies and the scoring of those companies. This enables us to compare different potential investments and to make objective investment decisions largely based around comparisons of the scores that we have given to different businesses. If our score for a business improves, then we are likely to consider buying more shares and vice versa when our score for a business decreases. Naturally, this leads us to be much more focused on the companies themselves than on the macroeconomic environment.

As we progressed through 2020, we began to find a number of potential investment opportunities among those companies most heavily impacted by COVID-19 including airlines, auto parts manufacturers and even semiconductor firms. Although these decisions were all based around specific fundamental analysis of each company; taken together, they represented quite a meaningful shift towards businesses that may benefit from a reopening of the global economy. However, since the start of 2021, we have not continued to move in this direction and our trades have been far more balanced in nature to account for the fact that we believe the recovery trade may be running too fast, too soon. In our eyes, a balanced exposure is the most sensible approach to the recovery trade.

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