A ‘normal’ recovery is unlikely

David Thornton explores what any kind of post-covid-19 pick-up might look like

 Businessman examining charts to illustrate the concept of market outlook

In order to put off the difficult job of discussing the market outlook, let us take a few moments to consider the historic performance table). There are two striking things about it which help us think about the future as well as understand the past.

The first is the relatively strong performance of AIM during a bear phase. This runs counter to what we would expect. Small caps should underperform during this stage of a market cycle and the more mature members of the FTSE Small Cap index ought to hold up better than the newer public companies on the junior AIM index. This eye-catching outperformance reflects AIM’s heavy exposure to growth stocks. Its leading components like Boohoo, ASOS and Abcam are all beneficiaries of trends and demand patterns that are enhanced by covid-19. 

Taking the top 17 members of the AIM 100, which are those with market caps over £1bn, only Dart Group and Burford Capital have done less well than the FTSE 100 index since the turn of the year. As we have mentioned before – if you want growth in a UK equity market context, you have to look to AIM.

‘Old economy’ stocks take hit

The other hint about what is going on can be deduced from the FTSE Mid 250 and FTSE Small Cap indices. These have both underperformed year-to-date, reflecting their exposure to economically sensitive companies that have been hit disproportionately by covid-19. Both these indices are biased towards ‘old economy’ stocks, with Industrials being the biggest sector in both cases, along with heavy weightings in Real Estate and Travel & Leisure. So it is interesting to see a distinctly better month from the FTSE Small Cap index along with some outperformance from the mid caps. 

This represents some modest catching up as cyclical stocks rebounded from depressed levels, after the better quality stocks had led the way back up from the end of March lows. 

The path of recovery

Talking to companies, things are definitely picking up and in many cases have not turned out to be as bad as initially feared. So if this were a more normal cycle, we would be getting very excited about value stocks and cyclical recovery plays. But it is not normal – we have seen massive government interference in financial and labour markets; so we cannot rely on normal patterns. What happens to employment when furlough programmes are unwound is one important variable influencing the future path of the recovery. That in turn will depend on the financial health and sustainability of SMEs, who do not have the same access to capital that is enjoyed by the bigger, listed stocks we follow. On the other hand, employees who have retained their jobs will have built up unplanned savings in the absence of restaurant visits and holidays; so there will be plenty of pent-up demand in the system to confuse things even further.

My guess is that the government has invested so much in its covid-19 response so far that it will continue to prop up economic activity, rather than step back and undo the good work. In poker parlance, it is ‘pot committed’ and will continue shovelling its chips onto the table. That argues in favour of having some recovery plays in our portfolios.

Capital returns to 23 June 2020

 AIMFTSE SmallCapFTSE Mid-250FTSE 100
1 month6.312.87.75.5
Year to date-6.5-18.5-19.3-16.2
1 year-3.9-12.2-8.9-14.7
3 years-7.5-19.1-10.3-14.9

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