The rollercoaster in global equity markets during the first half of the year is now behind us, and although the market has rebounded, many industries still remain affected by COVID-19. With an upcoming US election creating further uncertainty and a dull economic outlook, many investors and advisers are currently thinking – where to from here?
The unfortunate reality is that we are in the very late stages of what has been an incredibly long bull market in equities. COVID-19 has exposed the multitudes of risks in global markets for all of us to see, and we are now staring down more earnings volatility on the horizon.
For those who were contemplating changes in global equity portfolios earlier this year but did not act – the recent rally could prove to be a very timely opportunity to make some changes to sub allocations within global equities.
We believe the current environment makes a good case for an allocation to global small and mid cap (SMID) stocks for investor portfolios − they generally have less valuation risk than large cap growth, less absolute risk than emerging markets and less liquidity risk than small caps.
From our point of view, global SMID stocks can play an important growth role in a diversified portfolio.
COVID-19 reality to impact current earnings season
While current 2020 earnings per share (EPS) estimates are much more realistic than they were a few months ago, the same cannot be said for 2021. Although we would expect corporate earnings to stage a recovery of sorts in 2021, the ~29% year on year increase implied in current estimates seems overly ambitious in light of the pandemic crisis.
Quarter one earnings season only really captured roughly two weeks of COVID-19 conditions, and therefore reported earnings were subdued but not materially lower in most cases.
The second quarter earnings season in the US was the first full quarter of COVID-19 conditions. While earnings estimates had been dramatically rebased in advance of the earnings releases – the actual revenue and earnings results showed material weakness. The commentary from company management was understandably cautious and there seemed to be a tempering of expectations as we look into 2021.
The resulting uncertainty in the second half of this year will most likely precipitate more and more buying opportunities in some high-quality companies. It sounds counterintuitive to be buying SMID stocks at a point when earnings are troughing, but history would basically suggest that that it could be the perfect opportunity to be allocating to this asset class.
Opportunities in healthcare and consumer discretionary sectors
While many industries have suffered due to the COVID-19 pandemic, others have thrived. We have seen growing global businesses in the healthcare and consumer discretionary spaces.
The healthcare sector continues to boom as spending supports flows from consumers and governments, particularly towards research and development in pharmaceuticals and biotech industries. Stocks that we are watching in this space include Align Technologies, Idexx Laboratories, and Danish medical devices maker Ambu.
Likewise, consumer discretionary has seen increased demand during COVID-19 as consumer behaviour changes materially. We believe that these changes will lead to opportunities in sectors such as home improvement plays, localised vacations and outdoor activities. Consumer discretionary stocks that we believe are poised to ‘win’ in a world transformed by COVID-19 include Tractor Supply, Pool Corp, O’Reilly Automotive, and YETI Holdings.
For investors looking to diversify their global large cap exposure, now may be the ideal time to invest in global SMID equities, given where valuations are at. The ongoing market volatility has presented investors with some fantastic opportunities to start positions in names that we think will do well over 3-5 years and beyond.
* Ned Bell is the Chief Investment Officer of Bell Asset Management.