That was quick! Investor sentiment went from extremely bullish to extremely negative in just a couple of weeks. CNN Money is computing a well followed index called the fear & greed index measuring investor sentiment with several indicators like stock price momentum, stock price strength, put/call options, junk bond demand and market volatility. At the beginning of January, that indicator was showing extreme greed for equity investors. With a potential global Corona pandemic in the making, the indicator now shows the extreme fear levels last seen in summer 2019 or fall 2018. European equity markets are entering this Thursday correction territory (price down more than 10%) after falling for 2 weeks. Investors saw the virus spreading outside China in a completely unpredictable way. This is triggering a reassessment of the risks to economic activity, an external shock whose duration is very difficult to estimate.
Source : CNN Business
So how are we reacting at ECP?
First we need to remember that we are investing with a long term investment horizon. In our analysis, we assess a company’s ability to generate free cash flow over a business cycle. Corona has and will certainly have an impact on the short term operating environment of the businesses we are invested in. Think of disruptions in the supply chain, CAPEX freezes by business customers, subdued trade and travel activity or reduced consumer demand. If history is any guide, this will however be temporary. Some of the companies in our portfolio are being punished for avoiding to make any prediction like the Danish cleaning company ISS: “Our guidance is without any direct costs from the cyberattack or the coronavirus because it is impossible to predict the impact”. Our German industrial company Duerr provides an outlook nut with a disclaimer: “The effects of the corona epidemic have been taken into account in the outlook as far as they can be estimated in the light of the current situation.” For our part, we are not convinced the impact can be estimated just yet. We are however convinced that solid businesses with strong balance sheets will be able to navigate through this turbulence and ultimately produce the earning power we expect from them. Corona does not have an impact on the fair values we have estimated for these businesses as it does not affect the long term earning power of these businesses.
Second, investors appear to neglect two important tools that can be used to support the economic activity, fiscal and monetary policy. In Germany for example, Finance minister Olaf Scholz announced this week he is planning to temporarily modify the debt brake provisions in the German constitution, effectively making fiscal stimulus possible. Yves Bonzon, Group CIO of Julius Baer, recently stressed that the US Fed does not have a choice but intervening, if necessary, to support the stock markets. His argument is simple: the US equity market represents 30 trillion USD in wealth. A 30% fall in the market would wipe out 9 trillion USD in wealth. That is more than the nationwide negative wealth shock of 7 trillion USD from the housing crisis of 2008. So the Fed does not have a choice but to support the market.
Are we buying the dip ?
We currently have ample dry powder in our European strategy as our cash position is now above 8%. We are currently screening for new investment ideas as, sooner or later, “babies will be thrown out with the bath water”, providing us with interesting investment opportunities. We will however not take short cuts in our due diligence process and compromise on our investment discipline: we stick to quality companies at bargain prices.