There is always a sector to buy. In all market environments, certain sectors offer the opportunity to play the dominant themes and appeal to investor sentiment.
While we have seen necessary policy support and effective response to virus controls, the path to health and economic recovery is still uncertain.
Our favoured sectors continue to be those that are either defensive or have the potential to be less affected by the COVID-19 crisis.
While it appears that infection rates have peaked, and economies are starting to reopen, the recovery trajectory remains uncertain. Reoccurrences of the virus appear fairly likely, which would necessitate keeping or re-imposing physical distancing measures. As such, we anticipate a delayed recovery with bumps along the road, as economic damage could be greater than initially feared. Against this backdrop, we see opportunities in defensive sectors and those that stand to benefit from the ‘new normal’ brought about by COVID-19.
Health Care: the investment case has improved
This has been our preferred sector and remains so in uncertain market territory as reality over the length of economic recovery sets in.
Q1 earnings results in Health Care came second to any announcements about hoped-for vaccines or medicines for COVID-19. There has been positive news from Gilead on its anti-viral treatment, Moderna on its COVID-19 vaccine and reports of promising research and trials from other biotech firms and pharmaceutical giants, such as Sanofi, Roche and Johnson & Johnson.1 Many companies have ramped up testing and the search for vaccines and a cure; diversification (buying the whole sector) is key to capturing the potential winners.
Technology: not without risks but the themes have strengthened
Technology offers a range of near-term attractions but has also started to look better from a long-term perspective. And yet, we cannot ignore the threat of geopolitical interference: threats of reigniting a trade war could hang over tech and its global supply chain. So while IT spending could actually go higher than pre-COVID-19 in support of data ambitions, new infrastructure and technologies, the sector could become more volatile.
IT companies had a strong Q1 reporting season and sentiment was boosted by company statements and small earnings downgrades relative to the rest of market. High cash levels continue to stand out and the ability to pay a dividend is at a premium.
Technology’s index weight is back to record levels (equivalent to start of this century). If we are to believe in future trends, this sector remains a significant decision for investors to get right and not be underweight in their portfolios. Sector ETFs offer one convenient option for Technology exposure, and near-term volatility could be used as a buying opportunity.
Communication Services: interesting in the new normal
The Communication Services sector shares many themes with Technology, and the habits of businesses and consumers learned during this current crisis could drive long-term growth prospects. Trends on social media and subscription services benefit the largest stocks in this sector. As business activity collapsed, there were initial fears that internet giants, namely Facebook and Alphabet, would gain users but suffer lost advertising revenue.2 However, it appears now that advertising share has actually increased for digital.
There is concern over concentration among the FAANG3 names but any weakness is likely to be used as an opportunity by many investors to increase their positions.
Consumer Staples: resilient demand and defensive properties
Many behaviours have changed in the COVID-19 era, among them a stronger connection between the producer and the consumer. Moreover, more consumers have discovered the convenience of the e-commerce channel. Consumer Staples could see persistent benefit at the expense of some Consumer Discretionary companies.
Consumers have moved beyond panic buying, but categories such as food, tobacco and hygiene have remained resilient due to the lower elasticity of demand for their products. Beverage manufacturers and food service providers have not had such an easy time.
As always with the sector, we need to watch margins, which could suffer as consumers buy basics, and not luxuries, in response to lower earnings or unemployment. Meanwhile, higher logistics costs and supply chain disruption will also threaten profits. However, costs could be clawed back from a cut in advertising and promotional spend (which is happening across staples industries and therefore not necessarily at the expense of market share), lower input costs (including oil) and product rationalisation.
The sector’s low beta, low volatility and low sensitivity to bond yields, provide a defensiveness that could be welcome in a worsening economic scenario.
Utilities: there when needed
Utilities were left behind in the bear market rally of April, and now their performance has largely decoupled from historical rate correlation. The sector has always been known as a bond proxy and seen as somewhere to hide if interest rates fall sharply.
The sector retains one of its traditional attractions: high dividend yield, now at a higher premium to the rest of the market. MSCI World Utilities has a forecast yield of 4.1% this year, almost 70% higher than the market average and with a much more comfortable earnings cover. The low volatility and beta to the equity markets can be seen in the chart below.
The Utilities sector could emerge relatively unscathed by the COVID-19 crisis. Electricity and gas provisions are relatively resilient, as regulated utilities recover fixed costs through charges set by regulators and pass fuel expenses on to customers. During the limited economic activity levels during lockdown, companies have reported that commercial and industrial use is down but residential demand is up, which is helpful as residential prices can be 25% higher.
World Sectors: Volatility and Beta to MSCI World Index