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March 30, 2020 | GSAM Connect

Global Equity Market Update: In Uncertain Times, Quality is King

Global economic activity has come to an unprecedented halt as countries take aggressive measures to slow the spread of the coronavirus, and that is having broad implications for investors. Equity market volatility and trading volumes have surged, liquidity has been scarce, and the outlook for earnings has darkened.

These conditions are highly unusual, but we think the potential to generate excess returns is greater than usual. Even in circumstances as dire as these, there will be companies and industries that adapt, and this can create opportunities for active investors. But we think a deliberate approach that focuses on quality and is rooted in strong fundamental and quantitative research and strong trading ability is essential.

On March 27, senior members of GSAM’s Fundamental Equity and Quantitative Investment Strategies teams discussed recent developments in the equity market and what may lie ahead. Here are the key takeaways:

1. FOCUS ON STOCKS WITH DURABLE SECULAR GROWTH STORIES AND STRONG BALANCE SHEETS

The coronavirus has dealt a tremendous blow to overall demand. That’s why every decision we make about which companies to invest in from a fundamental perspective begins with the balance sheet. Strong balance sheets buy companies time, and with economic activity having suffered an unprecedented halt, time is what everyone needs most. Nobody knows how long the slowdown will last—China’s experience provides some clues, but they won’t all apply to Europe and the US. We look for companies on the right side of technological disruption that also have enough liquidity to get them through an extended shutdown.

2. CHINA’S EXPERIENCE SUGGESTS CONSUMERS WILL BE LAST TO RECOVER

The coronavirus epidemic is slowing in China, and economic activity is starting to pick up again. Industrial production is nearly back to normal and the manufacturers we talk to report being at 80%-90% of typical capacity. But traffic at shopping malls is only about halfway back to normal levels, and there are risks of a second wave of infections in the most economically open regions, including Hong Kong and some coastal cities. We expect eventual normalization in Europe and the US to follow a similar pattern, with consumer sectors likely to be the last to return to normal. Value retail stocks and restaurants that typically do well in recessions will likely struggle this time, as most businesses are closed or seeing reduced foot traffic.

3. WHEN IT COMES TO INVESMENT OPPORTUNITIES, THINK LIKE A MILLENNIAL

We have long focused on attractive opportunities in companies and sectors that cater to millennial interests: technology-enabled consumption, healthy living, experience over things and sustainable living. The pandemic is forcing more people to adopt so-called millennial behavior. Take technology: a growing amount of human activities—working, socializing, watching movies, consulting with doctors—are being done online. In this environment, we think companies without strong digital strategies—big box stores, retail malls—will suffer. Companies with strong digital strategies should be able to strengthen their brand and increase market share. We have also been investing at the intersection of healthcare and technology for many years. We believe a lasting impact of this pandemic will be historical levels of government and capital market support for healthcare innovation. CEOs of genomics companies are telling us that issues that were taking them years to navigate are being resolved overnight as collaboration with governments and competitors increases dramatically in the race for a vaccine.

4. GROWTH STILL TOPS VALUE, BUT QUALITY IS CRITICAL

Despite recent market turbulence, equity factor returns have been remarkably consistent. We think growth will continue to outperform value. Select value opportunities may be had in the best-capitalized segments of the market. But we believe that companies with strong balance sheets and high interest coverage ratios are most likely to weather the current storm, and firms with even marginally higher leverage are likely to be punished by investors.

5. REDUCED LIQUIDITY PUTS A PREMIUM ON TRADING EXPERTISE, ACTIVE MANAGEMENT

Markets have been whipsawed violently in recent weeks, as retail and institutional investors pull money out in large numbers one week and then pour some of it back the next. But record high trading volume has not translated into greater market liquidity. With flows tending to move in one direction, the cost of trading has increased sharply—executing trades is anywhere from two to four times more expensive than normal, depending on region. Navigating these conditions requires strong short-term trading skills and a deep understanding of how the cost of execution will affect return potential and other investment considerations.

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