The COVID-19 pandemic and oil price war caused the worldwide equity markets to decline -21.4% last quarter.  Market upheavals are difficult to live through, but our experience with previous corrections reminds us that the U.S. is resilient and willing to do what it takes to get back on a growth trajectory.  Although circumstances are unique, we are confident U.S. corporations and consumers will return to prosperity.

Economic activity has declined as we obey “shelter-at-home” orders, which will impact investment prospects in various ways both good and bad.  As we saw in the 2008-09 financial crisis, the 2000-01 technology bubble, the 2003 SARS virus and multiple international currency crises, there will be winners and losers.  As active managers we are using this occasion to strengthen portfolios with businesses that can manage in the current environment and prosper in the recovery we expect to follow.

Initial adjustments were made in early March as we reduced exposure to the restaurant and aerospace sectors and increased technology, communication services and select retail.  Restaurants and aerospace are impacted by lower consumer spending and travel related to COVID-19. These industries will struggle as many declare bankruptcy or simply will not reopen even after social distancing subsides.  Conversely, technology and communication services will benefit as more business is conducted virtually and entertainment is experienced at home rather than in theaters and other venues. Retail winners will most likely be web based and the bricks and mortar that are currently open.

As our understanding of COVID-19 allows us to learn more, we are looking for progress in the following areas that could help minimize health risks and stabilize the market:

  1. Pharmaceutical success – Finding a current anti-viral that improves successful outcomes.      This is probably the most important near-term positive as it would reduce the fear factor of     acquiring the virus.
  2. Flattening of the curve – providing data that the current strategy is working.
  3. Vaccine – Many corporations are combining efforts for deployment and testing, but success is projected 12 to 18 months out.

We will continue to add to quality businesses that have both the balance sheet and cash flow to weather this current storm, and the business model and addressable market to re-accelerate coming out of it.

The following are our thoughts on each sector and some of the actions we are taking.

Consumer Discretionary – We remain market weight with an emphasis on web-based and essential retailers with smaller holdings in established restaurants.  Consumer spending is shifting as social distancing favors on-line spending and the stores considered “essential”, and away from restaurants, travel and department stores.  While many had written off bricks & mortar retailers, we are seeing first-hand just how vital their employees and services are in times of crisis. Their business models have evolved to ensure that supply chains remain strong under immense pressure.  Critical products and groceries can be attained by those willing to venture out, or delivered to those who cannot leave their home. Higher unemployment will keep this in place for the foreseeable future as many business struggle to reopen or recover and will further empower the current leaders.

Consumer Staples – We are market weight but are looking for new opportunities.  Consumers still need to eat and keep themselves and their dwellings clean.  Shopping at grocery stores for food, beverages and cleaning supplies remains robust.  This sector will remain a good investment even as social distancing unwinds.

Energy – We remain underweight as multiple headwinds plague the sector.  Oversupply from U.S. fracking and Saudi Arabia’s output increase, plus lower demand worldwide will keep prices low as the economy slows.  Additionally, several companies have too much debt and face bankruptcy which will keep pressure on lower prices.

Financials – We maintain an underweight position. Our investments favor insurance companies and market exchanges.  Automobiles and other property still needs to be insured, and market exchanges benefit from companies hedging material costs, foreign exchange and investment volatility.  All financial institutions are concerned about their loans and clients’ abilities to make payments so we favor the higher capitalized money center banks over the regional banks.

Healthcare – We are market weight, but remain cautious.  Healthcare has held up better than the market with pharmaceuticals and instrument companies outpacing device manufacturers and insurance companies.  The COVID-19 pandemic has helped this sector recover, yet we expect U.S. elections in November will impact healthcare, thus our cautious outlook. Medical device companies are dealing with postponed elective surgeries such as knee and hip replacements as resources are focused on the virus.  We expect elective surgeries to recover after the virus subsides.

Industrials – We are underweight after selling some aerospace holdings in early March. Industrials have been one of the harder hit sectors primarily due to the aerospace and railroad companies. Industrials are cyclical and tend to have higher leverage leading to more volatile earnings in tough economic times.  Recessions provide opportunities to find high quality companies that will prosper when the economy recovers.

Technology – We maintain an overweight position. Technology provides several solutions to help people work off-site, maintain productivity and reduce the cost of doing business. Cloud based infrastructure, semiconductor companies and software enable companies and their employees to work remotely through their platforms and software. Supporting connectivity and collaboration with individuals as they work apart is critical to maintaining the integrity of a business’s core functions, and some firms make that possible like never before.

Materials – We maintain an underweight position.  Demand for commodities has fallen with the global economy, but we look for opportunities as the economy finds a bottom and slowly starts to improve. This will take time.

Communication Services – Video game companies and entertainment content companies are benefiting from the significant shift to people staying at home. Wireless network owners also benefit as more on-line traffic and services are consumed.

Utilities – This sector has held up well as business remains steady and dividend yields are higher than the current treasury rates.

Real Estate – We are not invested in this area at the moment. Companies with commercial real estate, malls and personal property have under-performed as investors question the debt levels given lower traffic and higher unemployment.  Bright spots include cloud based warehouses and communication tower properties.