How have industries that boomed during the Covid pandemic dealt with the aftermath? Iain Fulton, Portfolio Manager, Global Equity, Nikko Asset Management, considers how both industries and individual companies have been affected and how the pandemic is still impacting the markets.
The COVID-19 pandemic brought profound changes to household dynamics, consumer behaviour, and industry demand cycles. As an investment team, we’ve observed how the pandemic impacted different industries and how this impact is currently unfolding and whether it is creating opportunities for long-term investment.
Psychologists attest that we remember events to which we attach emotions, like the pain of a stock investment that went wrong. So why is it so hard to remember the details of the pandemic? Almost two years of our lives were turned upside down, yet we struggle to recall precisely what happened and when. According to one theory, we were overloaded with emotion during the pandemic as we grappled with stressful daily updates about death rates, lockdown rules and restrictions on liberty. Faced with such a daunting picture, the theory goes that it is much easier for us to simply forget.
With the aid of Google and a bit of Chat GPT, it is possible to piece this tricky bit of history back together and remember the industries that were impacted the most. So here is the top 10 or so activities that saw an increase during lockdown:
1) Video gaming and increased consumption of digital media
2) On-line shopping / scramble for consumer essentials (remember the toilet paper wars?) / digital payments
3) Work from home / video communication
4) Home improvement
5) Home fitness workouts
6) Outdoor pursuits (golf, running, cold water swimming)
7) Pet ownership
8) Home cooking / meal kits
9) Athleisure
10) Investing in Bitcoin and loss-making growth stocks
11) Increased spending on drug and vaccine development
Then the things we did less of:
1) Travel
2) Paying in cash
3) Eating out / socialising
4) Shaking hands
5) Wearing ties
Whilst the examples above may seem somewhat anecdotal, the consequences of these demand cycles are still being felt throughout the economy. Take, for example, Mark Schneider, the outgoing CEO of Nestle, or Laxman Narasimhan, recently ousted CEO of Starbucks. Both were leaders of multinational consumer brands who struggled to adapt to the post-COVID world of volatile inflation and shifting consumer preferences.
In fact, the list of consumer-facing businesses struggling with these issues is extensive. Companies like Diageo, Remy Cointreau, LVMH, L’Oreal, Estee Lauder, Burberry, Kerry Group and Kering, to name a few, have all suffered sharp share price reversals after the pandemic. The virtuous cycle turned vicious, and while these companies will likely recover, the dismissal of otherwise talented executives with successful track records shows the difficulty of distinguishing between cyclical trends and structural changes.
We are likely witnessing these consumer-facing industries going through a classic long-tailed inventory cycle. Investors, including ourselves in the case of Diageo, became overly optimistic about the trajectory of demand for luxury goods, cosmetics and spirits in the reopening phase of the pandemic. Many investors appear to have mistaken a stimulus-fuelled acceleration in demand, further boosted by inventory restocking, as a structural shift rather than a cyclical one. Currently, it is possible that the reverse is starting to occur. As tighter monetary policy hurts consumption, an inventory destocking phase began. Weaker demand, inventory destocking and falling valuations could be creating a compelling long-term investment opportunity. However, we may need patience—a virtue that is in short supply in this post-pandemic world.
These consumer-facing companies will likely bounce back, just as those left in the wake of the 1990s tech bubble emerged as some of the leading stocks of the early 2000s. One industry in particular that may be springing back to life is video gaming. After a pandemic-induced boom in gaming, growth rates naturally moderated in the aftermath. Sony, for example, saw their operating margin within its gaming division drop from over 10% to just 5%, causing their share price to stagnate while the rest of the Japanese equity market surged. However, demand is now recovering, as evidenced by Sony’s most recent results, with the company posting a gaming operating margin approaching 14%. The gaming recovery has been further confirmed by positive earnings reports from Tencent’s gaming division and sports-related software producer Electronic Arts. We should not forget that all cycles turn eventually.
The medical device sector is another industry that experienced a COVID boom followed by a dramatic post-pandemic slowdown in the last few years. While we were busy consuming alcohol, buying luxury goods and playing video games during the pandemic, the pharmaceutical and biotech industries were spending record amounts on developing new drugs. This created an excess inventory in equipment used to discover and produce these new therapies. Companies like Danaher and Bio-techne have struggled to contend with high inventories in their key end markets and a moderation in demand. Fortunately, this trend appears to be turning a corner, with an acceleration in orders and shipments being seen across the industry. This shift has been welcome news for the companies in which we are invested. Patience indeed seems to be a virtue.
Finally, it would be an oversight not to mention politics, which was impacted the most by COVID. It is hard to explain how a candidate who, while president, suggested that COVID could be defeated by ingesting bleach, could subsequently be re-elected. Collective amnesia brought upon by COVID could have played a part; however, the shift in the US political landscape may have more to do with the impact inflation had on the real incomes of the lower-income households. Perhaps for the first time in recent history, the Republicans attracted majority support from less affluent voters, a sobering thought for Democrats reflecting on their last four years.
The outlook for the post-election world remains uncertain. The impact of a truly “America first” policy could be far reaching. However, it appears that the tail risks of such a policy are inflationary rather than deflationary. As such, we feel more strongly than ever that investors should strive for a diversified global portfolio of quality companies that can thrive in an environment where the cost of capital may be higher than previously expected. Our collective experience of the pandemic reminds us that such an approach is a fairly good idea.
