Demand for equity holds up

The covid-19 bear market seems to have turned decidedly bullish. David Thornton picks apart the puzzle

 market outlook from Growth Company Investor

To say this is a difficult stock market to read is something of an understatement. We have been witnessing a ‘pain trade’. The unique set of circumstances and huge uncertainty caused by the pandemic meant a bearish consensus quickly formed, taking stock indices down 35% in short order. Yet massive injections of liquidity by the authorities and related near-zero interest rates and bond yields have thwarted the bears. 

Following the strong bounce we reported on last month, there has been no attempt to sell the rally. In fact companies have found it easy to raise new money to shore up their balance sheets and provide liquidity headroom. Most deals seem to have been done very close to the prevailing market price, implying there is plenty of demand from institutions for equity. There were 56 placings on AIM in April raising just over £700m, led by ASOS (£247m), Abcam (£110m) and Blue Prism (£100m).  

Meanwhile the tech-heavy NASDAQ index in the US is now up 3% year-to-date, while the more broadly-based S&P 500 is down just 7.5%. These are astonishing returns when we remember that covid-19 was unheard of at the turn of the year. Of course our UK indices, along with other European markets, have lagged the US markedly. Amazingly though, AIM stands out as having held up much better than its larger UK cousins and it is easy to see why when we compare its constituents with those of the larger cap indices. 

A familiar feel

There is almost an element of the dotcom era about this. The FTSE 100 and Mid 250 are full of ‘old economy’ stocks which are vulnerable to both the economic impact of the pandemic, and to prevailing technology-driven changes which are being accelerated by lockdowns. We had Royal Dutch Shell (-43% year-to-date) and HSBC (-33%) as our largest companies going into this; rather than Amazon (+31%) and Microsoft (+15%).  And while we would not dream of suggesting AIM is a proxy for NASDAQ, stylistically it has a bit more in common with it than the FTSE 100 does.    

Of course we have to decide what to do now. Just as in the dotcom boom, valuations are looking scary in some of the market favourites (they could of course get even scarier). Yes we might feel comfortable about their earnings prospects, but the four largest stocks on AIM all trade on p/e’s over 50x (Boohoo, Abcam, ASOS, and Fever-Tree). 

Dashed expectations

Prior to covid-19 we had been looking for domestic cyclicals to provide leadership, with reduced political uncertainty post-election acting as a catalyst. That theme has been kicked into touch for now. This year will be a write-off for many of those cyclicals and getting back to square one next year might be the best we can hope for – meaning two lost years, which their stock prices have discounted by falling 25-30%. A powerful economic recovery would return this theme to the spotlight, but it is too early to have a view on that. And with the market having held up so well, their valuations do not feel low enough to take on the risk of a weak recovery. As we said, difficult to read.

 

Capital returns to 26 May 2020

 AIMFTSE SmallCapFTSE Mid-250FTSE 100  
1 month9.24.87.95.5
Year to date-10.9-19.6-22.6-19.6
1 year-11.0-14.7-11.5-16.6
3 years-13.8-15.5-15.4-19.6

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