Is There Opportunity in COVID-19 Valuation Dislocations?
Capital markets have rebounded from their COVID-19-induced lows, but impacted industries have lagged substantially. That pessimism may be overdone in some cases, creating opportunities for multi-asset investors to exploit dislocations.
A massive post-March rally boosted the MSCI All-Country World Index roughly 50% from its trough on March 23, returning it near its pre-pandemic highs. But a closer look at the patterns of equity valuations suggest the market is pricing in a “new normal” of economic activity that’s largely virtual, with service and travel-related businesses never fully recovering.
We certainly agree that the new normal will be very different, but we also see excessive pessimism toward some of the sectors hit harder by COVID-19 social distancing and shutdowns. Even in these segments, businesses have continued to adapt—often in ways that foster greater operating efficiency and lower labor input, which help profitability.
Longer-Term Outlook Suggests More Solid Ground
There’s no doubt that prominent risks still loom. The potential for a second virus wave and possible further lockdowns is ever-present, especially with fall and winter around the corner in many parts of the world. Geopolitical risks include US elections in November and ongoing trade tensions with China. However, the tremendous global innovation effort in the race for vaccines and treatments could eventually offer a path forward, and in our view the longer-term outlook is on more solid ground.
For one thing, COVID-19 adaptation is accelerating the pace of digitization, which will most likely benefit scalable, capital-light technology business models disproportionately—and is also a positive for corporate earnings. The valuations discounted for the perceived winners aren’t anywhere close to the levels we saw during the tech bubble: unlike 2000’s loss leaders, these firms possess substantial cash flows and market share.
Massive central bank stimulus should keep yields in check for a while, giving the global economy time to heal. This environment should be particularly friendly to growth stocks: their cash flows are farther in the future, so their valuations should benefit from persistently low interest rates. Positive economic surprises as well as improvements in high-frequency data on spending and transactions suggest a gradually healing global economy.