COVID vaccine a cure for some, a curse for others

The Covid-19 pandemic may have brought the world to its knees through both its impact on health and the restrictions imposed in an attempt to control the virus. But not all sectors have been impacted equally and even within a sector like healthcare, some companies are thriving while non-COVID-19 clinical research and elective medical procedures are suspended. 

With this disparity in mind, we asked fund managers Andrew McAuley from Credit Suisse, Olivia Engel from State Street Global Advisors, and Anthony Aboud from Perpetual Investments to discuss the sectors or industries they feel will benefit significantly from a treatment or vaccine, but which are not yet fully appreciated by investors. They were also encouraged to name those sectors that might be harmed by a treatment or vaccine.

Oversold sectors to bounce back but beware of ‘stay at home’ shares

Andrew McAuley, Credit Suisse

It’s a cliché but true that, in the short term, the market is a voting machine and, in the long term, a weighing machine. That means a number of sectors are being priced on an overly pessimistic, Covid-19-inspired view. We agree that there are long-term implications due to the global pandemic. New trends have been established and others have been accelerated. When a vaccine will be developed and able to be distributed widely anyone’s guess. 

But when a vaccine is proven to work safely, you will see a bounce back in oversold sectors. This includes travel, infrastructure such as roads and airports, and listed real estate with exposure to retail and office. 

These sectors have already bounced from the March lows, but the market doesn’t factor in 100% probability of any event until it is done. That is until a vaccine is proven, investors won’t see the full recovery in share prices.

However, this does not mean share prices will return to pre-Covid levels. Trends such as working from home, conducting business meetings online instead of in-person and buying goods and services through the internet, will continue. Thus, the impacted sectors will see a rebasing in valuation that reflects a more confident forward-looking view. The flip side is there are sectors and stocks reflecting an unrealistically positive view of earnings in the short term. This group of stocks can be called the “stay at home basket”. It would include sectors such as biotech, digital economy, software and consumer staples. Will Amazon with a PE ratio of 100x, or vaccine developer Moderna, which has tripled this year but is yet to make a profit, look like such good value if the Oxford vaccine is proven by the end of 2020 and Moderna’s isn’t? The answer is probably not.

Healthcare diversity reveals clear winners and losers

Olivia Engel, State Street Global Advisors

Resilient earnings are the best way for investment portfolios to survive the crisis and the uncertainty of vaccine discovery. Healthcare has been one of the segments that has produced consistent earnings in crisis after crisis. Calendar year 2020 earnings growth for the healthcare sector is estimated to be higher than the tech sector (5.6% vs 4.4% as at 18 September). Investors haven’t fully appreciated this earnings resilience, as indicated by the valuation multiple of approx. 18 times earnings while the rest of the market is at 21 times earnings (18 September). Utilities and consumer staples have flat earnings growth, and everything else is deeply negative.

The healthcare sector contains a lot of great diversifiers within it – some which have benefited in a pandemic environment and others that have suffered. For example, a halt in elective surgery and a drastic reduction in doctor visits has hurt the medical supply industry as well as pharmaceuticals. Medical insurance companies have done well as people continue to pay their premiums but claim back a lot less. Medical research companies, with tools and diagnostics, have been doing well from the increase in medical research to find a vaccine, diagnose and treat the disease.

Building a portfolio for lots of potential outcomes (vaccine, no vaccine, slow vaccine, etc.) is the best way to survive, rather than betting on any one outcome.

Why banks will benefit from positive treatment, vaccine outlook

Anthony Aboud, Perpetual Investments 

There are some obvious sectors which will benefit from a vaccine or treatment like the travel names, casinos or office/retail property trusts. However, a little less obvious beneficiary are companies leveraged to economic activity such as banks. For obvious reasons, banks’ share prices have been decimated due to COVID-19 with NAB, ANZ and WBC falling around 40% over the last year. There is a material accounting change which is important to understand. From 2018 onwards AASB 9 was implemented. Put simply this meant that all companies - but more specifically banks - had to front-end load their provisioning during a recession.

Historically, banks had to wait until they saw credit quality deteriorate before they provisioned. This meant that historically, going into a recession, banks’ earnings downgrades were “death by a thousand cuts”. There is a lot of subjectivity when it comes to trying to work out the “expected credit loss” of a massive home loan book. The two biggest variables are the probability of default (unemployment) and loss given default (house prices). Three of the big four banks had to make this estimation in the depths of the crisis in April 2020. General sentiment towards the economic outlook could not have been worse at that point in time.

If there were to be a vaccine or treatment discovered tomorrow, it is unequivocally positive news for the economy. If you combine this with loose fiscal and monetary policy globally as well as loosening regulatory environment (changes in responsible lending being a case in point) the outlook for bank loan defaults improves significantly. The point here is that even before any vaccine discovery there was a risk of provision write-backs! 

However, in the event of a vaccine discovery, the probability of a write-back increases materially. This should be positive for the banks trading at 20% discounts to book value.

On the other side of the coin, in the event of a vaccine or treatment discovered tomorrow, the obvious companies to suffer will clearly be the Covid-19 winners like Zoom or non-discretionary retailers like Coles or Woolworths or online specialists like Kogan or Temple & Webster. However, a little less obvious are long-duration assets. In the event that there is a positive shock to economic forecasts this could provide the catalyst for longer-term Treasury yields to strengthen. Ironically any steepening of the curve would be disastrous for high P/E stocks. If this were to occur, then the widowmaker trade (i.e. buying value over growth), could actually start to work again.

Conclusion

Australia’s major banks could be a surprisingly significant beneficiary should a vaccine or effective treatment for Covid-19 be found sooner rather than later. Investors should consider all their holdings through a Covid-19 lens and backing resilient earners is best way for investment portfolios to survive the crisis.

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