Covid strikes again

It’s been nearly two years since the beginning of the dreadful Covid-19 pandemic and, whilst it has been an extraordinarily difficult period for so many, we remain optimistic that the combination of mass vaccination programmes, together with acquired immunity through previous infection, will ultimately see Covid-19 demoted to the ranks of another seasonal respiratory virus, still serious but capable of being managed by dedicated health services around the world. That being said, we are clearly not there yet, as the latest surge in infections across large parts of, relatively well vaccinated, Continental Europe highlights. The chart below illustrates just how dramatic the situation is in several countries, relative to their previous experiences.

Quite why certain geographies are seeing such accelerating trends currently, and others much less so, remains in debate. Undoubtedly there will be numerous factors including levels of vaccine take up, scale of previous exposure, particularly to the much more infectious Delta variant, and plenty more besides. Whatever the causes, the return of meaningful national lockdown measures, starting this week with the Netherlands and Austria, and potentially expanding elsewhere, is a disappointing, even if necessary, development.

The response in stock market terms has been somewhat predictable, with areas such as the travel and leisure sectors being hit particularly hard by the prospect of further disruption on an as yet unknown scale or duration. We own several stocks in the UK, such as EasyJet, WH Smith, National Express and JD Wetherspoon, that are impacted by these developments and their share prices have reacted negatively as you might expect. However, despite this near-term setback, we remain convinced of their medium-term potential for recovery, and here we offer a few thoughts as to why.

The chart below, from German index provider Solactive, shows the performance of an index of ‘global vaccine recovery’ stocks relative to the S&P 500 in the US. As can be seen, after the initial vigorous recovery at the end of 2020 when vaccines were first approved, these shares have been underperforming for most of 2021, and are currently back testing the relative lows of early 2020, when the pandemic was just starting to build.

You can see a similar story at the individual stock level as the chart below, of the EasyJet share price relative to the UK market, highlights.

What is our point? To the extent that stock markets are forward looking in nature then arguably the underperformance that has occurred this year has most likely been predicting further disruption to these stocks and sectors before some form of normality can return. The fact that such disruption is now happening does not necessarily imply the need for further sustained share price weakness.

If we are being truthful, when we invested in several of these businesses, we had some expectation that the degree of ongoing disruption would be significantly less by now than it currently is. However, whilst that outcome has delayed the recovery we were expecting, it doesn’t alter, in our minds at least, the ultimate potential of these businesses on a medium-term horizon.

The chart below, of personal expenditures in the US, shows vividly how the very consistent trend towards spending more on ‘services’ relative to ‘goods’ was dramatically disrupted by the pandemic, and those effects are still clearly being felt today. We do not believe this represents some form of ‘new normal’ and as such, when we are able to live with Covid on a sustainable basis, there exists a huge amount of recovery potential for services expenditure – think pubs, restaurants, holidays, experiences etc.

Indeed, as the chart below from Bank of America’s card spending data highlights, as Covid cases became somewhat more subdued in the US this year, spending on travel and entertainment services recovered significantly. If cases do accelerate sharply again then of course this will most likely deliver another setback in this spending recovery. But a setback it will be, rather than a fundamental shift in medium-term consumption patterns, in our view at least.

We make our investment decisions over a medium-term time horizon. At the time of purchase, all our holdings in these affected areas had already suffered significant share price weakness and, on our analysis, had substantial upside potential on a 3-5 year view. That upside remains very much intact today and arguably their respective competitive positions are getting stronger, compared to weaker peers, the longer disruption persists. Whilst we might have hoped that the recovery would be further advanced by now than it is, we are reminded that ‘hope’ is not an investment strategy. Buying good businesses with excellent long-term prospects, at attractive valuations, and being patient enough to see those prospects come to fruition, seems to us to be a much more sensible plan.