Full episode: Market Call for Thursday, April 16, 2020
Zach Curry, president and portfolio manager at Davis Rea
Focus: North American large caps
Encouraging economic signs mid-January were snuffed out by the rapid global spread of COVID-19. U.S. and Canada and the world are in deep recession after governments shut down their economies to halt the virus’ spread. Unemployment is soaring and both firms and households face major income disruption, a problematic development for a heavily indebted world economy. Canada is particularly vulnerable, with household and non-financial corporate debt-to- GDP ratios above 100 per cent.
Global policymakers have responded extremely aggressively and quickly. Canada and the U.S. have both introduced spending and tax initiatives that exceed 10 per cent of GDP, while central banks have committed trillions more in support. These policy actions should help fuel a recovery once governments begin relaxing the lockdowns, which will likely take several more months.
We estimate that the recession will be six to 12 months in length. Earnings and commodity prices will weaken as the recession unfolds, but both should recover in tandem with the economy. The Canadian dollar is likely to remain weak until the recession’s end is in sight, but as prospects for recovery improve, both commodity prices and the Canadian dollar should turn upward.
Equity prices fell sharply in late February and March as recession risk turned into reality. Aggressive policy actions have since helped markets rebound from their late March lows. Amidst the recent price volatility, market valuations went from high to low to roughly average in early April. An average valuation implies roughly average long-term returns. Given the deep recession that is barely a month old, valuations appear too high and we are likely to see larger declines in earnings. This points to another round of weakness in equity markets ahead.
VISA (V NYSE)
Visa operates the world’s largest retail electronic payments network, facilitating global commerce through the secure transmission of information between consumers, merchants, financial institutions, and governments. We believe that the global shift towards electronic payments and e-commerce will continue to take a greater proportional share of total consumer and business spending, providing a long-term secular tailwind for the company.
MICROSOFT (MSFT NASD)
Microsoft is well positioned to benefit from the global enterprise shift towards cloud-based computing, due in part to their existing Windows/Office product relationships. Azure is the second-largest cloud computing business behind Amazon’s AWS and offers the industry’s most comprehensive productivity tools, Office 365. These assets provide companies with a virtual workspace where documents are created, stored and shared through the cloud. It also provides digital meeting spaces through Microsoft Teams. Discussing the effects of COVID-19 on their business, Microsoft disclosed a major surge in the demand for their various cloud-based businesses.
AMAZON (AMZN NASD)
Amazon operates the rapidly growing Amazon Web Services (AWS) and Amazon Marketing Services (AMS) businesses, serving over 300 million customers worldwide. Its retail operations sell and distribute private label and third-party merchandise both through physical stores and online, offering free same-day delivery on many products for their 150 million Prime members. While the core business remains rooted in retail, it is important to note the growing importance of AWS and AMS on the business as a whole, generating between 25 to 35 per cent operating margins. These businesses are backed by long term secular tailwinds with massive addressable markets.
PAST PICKS: JUNE 4, 2019
JPMORGAN CHASE (JPM NYSE)
- Then: $109.74
- Now: $88.10
- Return: -20%
- Total return: -17%
BROOKFIELD INFRASTRUCTURE PARTNERS (BIP-U TSX)
Spin-off on March 31: Brookfield Infrastructure Corp (BIPC TSX)
- Then: $56.16
- Now: $52.45
- Return: 3%
- Total return: 6%
STRYKER CORP. (SYK NYSE)
- Then: $186.45
- Now: $172.08
- Return: -8%
- Total return: -7%
Total return average: -6%