Over the past three months, the coronavirus has had an unprecedented impact on the world and financial markets. At the time of this writing, the pandemic remains on the rise, infecting and harming hundreds of thousands around the world. Economically, we have no doubt that we are now engaged in at least a two-quarter recession.
When these situations occur, we look to history as a guidepost. A century ago, the Spanish Flu swept the world over a three-year period, infecting 25% of the world’s population and killing anywhere from 17 to 50 million people. Thankfully, the world is much more sophisticated and medically advanced today, allowing for faster reactions and with more resources than could have been imagined in 1918. With regards to equity markets, we look back to the financial crisis of 2008-09, the deflating of the technology bubble of 1999, and the crash of 1987 for precedent. Each of these downturns was man made, the result of aberrant economic cycles and financial excesses, not the subject of human biology run amok.
The lead up to this pandemic saw equity markets reach their peak in mid-February, marking the apex of an 11-year bull market run. As the epidemic became a pandemic, equity markets reacted more swiftly than any time in modern history, declining 35% in one week during the third week of March. Since then, the markets have clawed back, and are now down about 25% from their peak levels.
As stunning as this turn of events has been, your portfolio has held up better than the overall equity market. For the quarter ending March 31st, the overall decline of equities held at Rempart was 11.6% compared to -20.9% for the TSX and -13.0% for the S&P 500 (in C$). We believe this is due to the approach that we take with security selection. Over the years, we have kept our list of equities relatively short and have maintained a disciplined investment approach. In each sector we invest in, we focus on industry leaders. These are companies that feature steadily growing cash flow from operations, intelligent allocation of free cash flow, strong balance sheets, impressive management teams and reliable governance. We avoid highly touted growth companies if they do not measure up to our more conservative financial criteria. In our experience, generating steady returns over time requires not only picking the winners, but perhaps more importantly, avoiding the losers.
Knowing what we know now, where do we go from here? First, we think that harnessing this pandemic will take months, not weeks. In a modern society that has grown used to instant gratification, there is no quick fix to this biological threat. We have been impressed by the swift action taken by governments of developed countries to pump liquidity into the financial system and offer subsidies to those in need. Second, we look back to previous downturns and know that, with time, the economy and financial markets will recover. We concede that, in the midst of every downturn, the timing of a recovery is impossible to predict. We just know that it will.
Meanwhile, there are some companies that we are invested in that are already deeply involved in charting a recovery. Thermo-Fisher Scientific is the world leader in developing and producing testing equipment, and they are in high gear. Johnson & Johnson’s pharmaceutical division is fast tracking a COVID-19 vaccine, which could be ready for testing this fall and in production by early 2021. This company has the considerable financial resources to make this happen. 3M is quickly ramping production of its N95 respirator mask, the gold standard in the industry, as demand is outstripping supply. Costco has been a reliable supplier to those stocking up for a long stay at home. Nestle is the world’s largest food and healthy beverage company, a critical component to mankind’s current supply chain needs. Microsoft’s software and cloud computing services have allowed many businesses to continue operating as employees are able to work effectively from home.
Once we come through this crisis, life should mostly return to normal. However, there will be scars and some elements of society will be forever changed. While we believe that the macro economic cycle will return to a growth bias, some industries and companies will recover faster than others. Many people may change the way they work and live. For example, remote work technology will certainly be more commonplace. Governments around the world will have to take a serious look at how their public (or private) health industries are organized and funded. Further, we believe many countries will repatriate the manufacturing of critical healthcare products to ensure quality criteria are met and adequate supplies available.
Fiscally, national balance sheets will come out of this in much worse shape. The financial assistance and liquidity measures being implemented will result in much higher deficits and debt levels, which could possibly cause inflation in the future. We will watch this carefully, as inflation poses a threat to both equity and fixed income investors.
On a personal note, all of our staff are working remotely, having fully deployed our business continuity plans. Our firm has a robust technology platform that allows all of us to work from home efficiently. We receive all of your calls and emails. Please do not hesitate to contact us and let us know how we can assist you through this volatile and uncertain period. Above all, stay healthy and safe.