Lessons from COVID-19

Just over three months have passed since equity markets tumbled in reaction to the rapid spread of the coronavirus outside of China and the World Health Organisation (WHO) classifying COVID-19 as a pandemic. The rout in equities was also coupled by the sharp decline in the price of oil as OPEC and Russia had failed to reach an agreement to slash production amid a collapse in demand for energy. This resulted in Saudi Arabia abandoning attempts to limit supply but instead focused on increasing its market share with the oil price tumbling 30% on 9 March – the steepest daily decline since the Gulf War in 1991. The worrying developments both in the oil market and the virus which began to shut many economic sectors of several countries worldwide, sent global equity markets in an unprecedented tailspin.

In February, European equity markets experienced their fastest correction in 30 years. In just nine trading days between 18 and 28 February, the MSCI Europe index fell by 12.5%. In the US, the S&P 500 had touched an intraday all-time high of 3,393.52 points on 19 February but it dropped by an extraordinary 35.4% in only 5 weeks to a low of 2,191.86 points on 23 March including an impressive 7.6% decline on 9 March in reaction to the oil price slump.

While equity markets tumbled in a spectacular fashion between the end of February and the third week of March, the recovery since then has been equally impressive. In fact, the S&P 500 staged a significant rally of 47% with several share prices like Amazon, Microsoft and Apple also surpassing their previous record levels registered prior to the outbreak of coronavirus sending the S&P 500 into positive territory for the year and the NASDAQ 100 rising to a new record level.

Although countless articles have been written about the impact of COVID-19 on capital markets, it is worth highlighting some important lessons that emerged from the extraordinary developments over recent months.

One of the most telling lessons that investors may have learnt from the past few months is that dividends can never be taken for granted until the actual payment is received. This would have been unthinkable until a short while ago, but we have seen several instances in Malta as well as internationally, where companies initially recommended the payment of dividends but then either suspended or cancelled their dividend distributions. Many analysts and financial commentators had correctly always stated in the past that the sustainability of a company’s dividend is very much dependent on the strength of a company’s balance sheet as well as the relationship between the profitability and the dividend outlay, commonly referred to as the dividend cover. However, despite the low leverage of certain companies, dividends were nonetheless cancelled and/or suspended as many companies resorted to hoarding cash in view of the huge level of uncertainty. Many Maltese investors would surely think of Malta International Airport plc, HSBC Bank Malta plc and GO plc in this respect as these have been very consistent dividend-paying companies over the years (with the exception of only one year for GO due to the unfortunate events related to the Greek company Forthnet S.A.). The airport operator cancelled its dividend despite having no borrowings and over €40 million in cash as at 31 March 2020. On the other hand, HSBC had to succumb to regulatory recommendations from the ECB which impacted all banks in Europe.

Another lesson for equity investors following the sudden change brought about by COVID-19 is that one must always ‘expect the unexpected’. This dimension may influence the decision of a certain section of the investing community to become less inclined to equity investing specifically due to the unfortunate lack of assurances on the payment of dividends and the unpredictability of events which leads to significant volatility in equity markets.

Also, due to the fast-changing circumstances that we experienced in recent months when many companies unfortunately ended up having to close their doors to business due to the restrictions imposed, investors must be more willing to adapt to the times and take certain decisions when circumstances change very rapidly. Moreover, one must remember that even the most successful investors like Warren Buffett also make mistakes. The spectacular recovery in the share prices of the four largest US airline companies (namely American Airlines, Delta Air Lines, Southwest Airlines and United Airlines) since late May after Warren Buffett had disclosed that he had sold all his shares in airline stocks could possibly rank as a very costly mistake and a stark reminder that even such great investors at times make costly decisions.

Another very important lesson is to avoid being a ‘short-termist’ and instead focus on a 5-year or a 10-year investment horizon. During the peak of the pessimism in recent months when share prices were tumbling almost on a daily basis, several articles were written across the international press warning investors not to panic and ‘stay invested’. As indicated in some of my recent articles, the sharp recoveries in the share prices of Amazon and the payment processing companies are very good examples of how investors may have unduly panicked as a result of the anxiety caused by the pandemic and disposed of their shares in what was surely a rushed decision. Another very good example last week was from RS2 Software plc as the company announced a milestone agreement in the US with one of the largest acquirers for a 10-year term which may be renewed thereafter. This is exactly in line with the company’s strategy for the US market which had been initially disclosed exactly two years ago at the 2018 Annual General Meeting. Those investors who had been following the company regularly over recent years should not have been taken by surprise by last week’s announcement following the indication in recent months by the company of the progress in negotiations with prospective clients in the US. The share price of RS2 jumped by 18.6% on the news representing a recovery of over 35% from the 2020 low of €1.69 recorded on 24 March as the share price had also slumped in the midst of the panic sell-off at the time.

Investors should always aim to have an allocation in their portfolio to companies whose goods and services are always likely to be in demand even in what may be referred to as the ‘post-COVID world’. Until recently, it may have been unthinkable for anyone to have ever imagined that, for example, airports around the world would be forced to operate at an almost complete stand-still for an undetermined period of time. As a result of the drastic actions taken by most countries around the world to reduce the spread of the virus, the revenue generation of all airport operators was substantially reduced with a ripple effect on other sectors especially those dependent on tourism. Meanwhile, the products and services of food manufacturers and those companies manufacturing and distributing other household products (including detergents) will always be in demand. Some of the largest companies that come to mind are Nestlé, Unilever, Danone and Reckitt Benckiser. In Malta, the recovery in the share price of PG plc, as owner of the PAMA and PAVI supermarkets, is testament to this with the share price now just below its all-time high.

The extraordinary events of recent months may have a lasting impact on the psychology of many investors. However, important lessons need to be noted and kept in mind for the future especially when it comes to companies that have robust fundamentals and a considerable economic moat. From the developments that took place over recent months, it is evident that the share prices of those companies whose goods and services will remain in demand, eventually end up recovering the steep losses registered in the midst of a wide market sell-off. It is always impossible to time the market. The significant rally across international markets in recent weeks despite the significant economic headwinds ahead is a clear indication that investors should do their best to ignore the ‘noise’ and focus on their medium to long-term investment objectives.

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