At the Switzer Small and Micro-Cap Investor Day in Sydney last Tuesday, Peter Switzer asked me on stage if it was time to buy shares after Coronavirus-related falls.
My response: relief rallies would punctuate the global equities correction, but the worst was still to come. Investors who went bargain hunting in market volatility had to be prepared for the risk of further 5-10% losses over coming weeks/months.
Nobody could have anticipated what would follow on the next five trading sessions, as global equities plunged and the collapsing oil price whacked financial markets. Talk turned to the risk of global recession, a seizure in corporate credit markets and a new Global Financial Crisis.
Officially, US and Australian equities are in a bear market (20% fall from the high).
However, my core view at the Switzer Investor Day – that long-term investors need to capitalise on bouts of elevated market volatility such as now – remains. Don’t try to pick the absolute market bottom; focus instead on buying high-quality companies at valuation discounts, be able to tolerate further price losses if they occur, and have a 3-5-year investment time frame.
That does not mean aggressive bargain hunting. As I wrote two weeks ago in this Report: “My sense is the virus could linger longer than markets expect… I wouldn’t be buying tourism, travel or education stocks that have been pummelled on Coronavirus concerns … Nor would I bargain hunt in the market just yet because the next two weeks will be crucial for news on whether Coronavirus containment is working. Better to watch and wait for signs that the virus is being contained.”
At least the rate of growth in new COVID-19 cases reported daily in China is falling. There have been several single-digit daily percentage increases in the past week, compared to double-digit daily increases before that.
The flattening in case numbers in mainland China – and good progress in Singapore and Hong Kong – suggests efforts to contain COVID-19 are working in those countries.
However, infection volumes are still surging in parts of Europe, notably Italy, now in lockdown. Sharply higher volumes in the United States are another huge risk.
A slowdown in daily case rates outside of China would boost markets. That would suggest China’s containment experience is likely to be repeated elsewhere, meaning more countries could start to take control of the virus in the next few weeks. But we’re not seeing it yet.
Imminent massive government stimulus overseas and in Australia is another positive – and vital to stave off global recession. However, nobody should underestimate COVID-19’s potential to spark a global recession, potential credit crisis and prolonged bear market in equities, if government intervention fails or the virus mutates and spreads faster.
Still, I struggle to align the market’s incredible reaction to COVID-19 to the health data. On March 10, there were around 114,000 cases worldwide, and rising. About 68,000 were closed cases (the patient recovered); leaving 46,000 active cases. Of those active cases, about 12% (5,711) were considered serious or critical. Sadly, there have been just over 4,300 death so far.
For context, an estimated 34-49 million people had flu illnesses in the 2019-2020 flu season in the United States – and there were an estimated 20,000-52,000 flu-related deaths that year.
Like many in business, I think local panic over COVID-19 and share market falls are overdone. But like most cover this issue, I don’t have a background in epidemiology and accept that case numbers could snowball if the virus is not contained.
Having covered many share market crises over the years, the selling this week reeked of panic and capitulation that defines market bottom. Nevertheless, expect market volatility to remain elevated in the next few weeks.
Slowly, selectively adding high-quality stocks to your portfolio (or buying more of ones you own) is the best bet for now.
Stock/sector ideas
I outlined several ideas in the last two reports. At a company level, I wrote favourably about accounting-software star Xero and circuit-board software designer Altium: “(both stocks) deserve a spot on portfolio watch lists. I’ll be watching and waiting for better value in both stocks over the next few weeks as market uncertainty about the Coronavirus lingers.”
That value opportunity has arrived faster than I expected – and Xero has held up relatively well in the market correction. Altium, down from a 52-week high of $42.67 to $28, looks oversold.
At a sector level, I favoured adding exposure to global technology, agriculture and energy when markets stabilised. Oil in particular looks interesting for long-term investors after the brutal sell off this week.
Tech
Buying beaten-up, software-as-a-service companies is my preferred strategy for bargain hunters. I avoided the so-called WAAAX stocks (Wisetech Global, Afterpay, Altium, Appen and Xero) this year and last because of their soaring valuations. The COVID-19 crisis has provided an opportunity to buy into them at much better valuations.
Tech was the best-performing sector in the year after the market low from the 2003 Severe Acute Repository Syndrome (SARS) crisis, up 26% in Australia. The Morningstar ETFS Global Technology Exchange Traded Fund (TECH) is my preferred tool for global tech exposure.
Markets rise and fall, but the megatrend of “software eating the world” is alive and well. Technology companies with high-margin, recurring business-essential software look a lot less risky than firms in other sectors that are more leveraged to domestic economic fluctuations.
Emerging tech companies that have a capital-light business model often generate lots of cash that gets poured back into product development. When market conditions deteriorate, they can ease up on capital investment – a strategy I recall Seek using successfully years ago.
One can envisage consumers in their droves cutting back on holidays or buying fewer discretionary fashion goods. But I can’t see small and medium-size enterprises dumping their Xero accounting software or circuit-board designers ditching Altium products.
This week I add two other tech-related names. The first is former market darling Wisetech Global (WTC). Shares in the provider of logistics software slumped from a 52-week high of $38.80 to $13.17 during the COVID-19 panic.
Chart 1: Wisetech
Source: ASX
The market belted Wisetech after its interim FY20 profit report, released in February, disappointed. Wisetech was an easy stock to take profits on during the current market correction.
Wisetech has more exposure to a global trade slowdown given its position as a leading logistics software provider. Unlike other software providers that charge a subscription fee (for unlimited use), Wisetech’s business model generates revenue based on customer usage of its software, meaning a prolonged downturn in global trade would hurt its earnings.
However, Wisetech’s customer-retention rate of 99% shows the incredible “stickiness” of its product and high switching costs to move to alternate providers. If, like me, you believe COVID-19 is a temporary rather than permanent blow to the global economy, and that trade will eventually return to normal, Wisetech, trading at almost a third of its 52-week high, will look interesting.
My other preferred “tech” stock is JB Hi-Fi (JBH). The star retailer of tech gadgets and other electronic devices has fallen from a 52-week high of $46 to $31 during the COVID-19 crisis.
I went cold on JBH at the start of 2020, believing it was overvalued, after having a favourable view on the company for many years. The correction offers a chance to buy back into JBH.
Chart 2: JB Hi-Fi
Source: ASX
Retail looks like the last sector to invest in as the domestic economy slows or goes into recession – or if many people are forced to self-isolate because of the virus and shopping centres resemble ‘ghost towns’. Sadly, more retailers will go bust in the next few months.
JB Hi-Fi is not immune to these problems, but longer-term demand for tech products will remain strong. Federal government cash stimulus for consumers or expanded depreciation allowances for small business or other concessions could also help JBH through a soft patch in the economy.
At $31.88, JBH is on a forecast FY21 Price Earnings multiple of 18.5 times, using Morningstar numbers. That appears reasonable for a company of JBH’s quality and growth prospects.
A 28% fall in JBH since mid-February seem excessive – and appears to be factoring in an Australian recession when one is not inevitable if the Federal Government provides appropriate, timely fiscal-policy stimulation, interest rates are cut again in April, and more countries start to get COVID-19 until control.
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 10 March 2020.