We are emerging from a year that saw the steepest economic decline in the U.S. since the government started keeping records. The path to recovery is centred around two currently approved vaccines, with potentially more to come. The current timeline is for the vast majority to receive a vaccine by mid-year.
As a result, we continue to expect elevated cases of COVID-19 and slowing economic growth in the first half of the year. However, once herd immunity has been reached following widespread vaccination, we should see a rapid snapback. Driving factors of an improving economy and corporate profits include:
- Elevated consumer savings: So far this year, consumers have saved 16.8% of their disposable income, well above the historical level of 7.5%.
- Declining unemployment rates as businesses reopen: Unemployment is currently double pre-COVID-19 levels at 6.7%.
- Higher corporate margins following significant cost restructurings and accelerated adoption of technology solutions.
- Record low interest rates and easily available liquidity should allow for business investment to quickly follow consumer demand.
- Loss of small businesses resulting in larger (typically public) companies gaining share: Concerns regarding the long-term impact of the pandemic on small businesses should be offset by elevated levels of new business formation. These new businesses tend to focus on opportunities created by changes in consumer behaviour.
Positioning and opportunities
As bottom-up investors, we make investment decisions on a company-specific basis. However, in general we are positioning our portfolios to benefit from a return to normal. Within this theme, we remain focused on companies with structural tailwinds that can compound capital overtime. It is likely some businesses may never fully recover due to changes in consumer behaviour. We look to avoid these businesses despite very attractive valuations in many cases. We are finding opportunities within small caps, which tend to outperform large caps when the economy is improving.
Two companies that we believe to be attractive within this framework are:
Boston Scientific Corp.: Boston Scientific develops and manufactures minimally invasive medical devices. Hospitals faced shutdowns and reduced capacity in 2020. During peak lockdowns in the second quarter, revenues dropped 28.7%. Most of these procedures have been deferred as opposed to cancelled due to their non-discretionary nature, such as changing a pacemaker. As such, we believe that once restrictions are removed, they should be able to grow above the historical mid-single digit growth rate for an extended period.
Sensata Technologies Inc.: Sensata manufactures sensors and controls to global consumers in automotive, heavy vehicle and industrial applications. These components provide mission-critical functionality and are a small portion of the overall cost of the product. As vehicles and electronics become more complex, they require more sensors. This creates a natural tailwind for Sensata to grow at a rate faster than underlying production. In general, most of Sensata’s end markets have seen demand outpace supply in 2020. This is predominately due to plant shutdowns that occurred in the second quarter due to government mandates. During that time, Sensata significantly reduced costs. We expect once restrictions are lifted, these industries will begin to produce above demand as inventories are very low. This, combined with the cost reductions, should result in above trend growth and margin expansion.
- Short-term results will likely remain weak if not worsen for some companies due to elevated case counts and increased government restrictions. We continue to stress test liquidity scenarios for our most impacted holdings.
- The rollout of the vaccine is either ineffective, slower than anticipated or the virus itself mutates, limiting the efficacy.
- Inflation could become a problem. Governments have added a significant amount of money supply to the system. As consumer confidence improves, we would expect the velocity of spend to also rise, which could increase inflation and ultimately result in higher interest rates.
- Tax hikes are a likely possibility. Government deficits have skyrocketed and the U.S. has a new ruling party that seems more open to raising corporate and personal capital gains taxes.
Despite these risks, we remain fully invested and believe the worst of the COVID-19 pandemic is behind us. Despite being cognizant of certain pockets of the market that seem extremely overvalued to us. We still see many attractive areas to invest in. Equities are still of great value to us, especially relative to other asset classes.
Source: CI Global Asset Management and Bloomberg Finance L.P. as at December 22, 2020.
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© CI Investments Inc. 2020. All rights reserved. Published December 30, 2020