FTSE Mib and Phase-2

17 April 2020

Over the last two months, the market has reacted to the damage inflicted on global GDP by the almost complete economic lockdown from Covid-19. In less than one month, the fall in primary world share listings from the highs in February to the lows in March (Nasdaq -40%, S&P -35%, STOXX 600 Europe -38%, FTSE Mib -45%) has declared an end (at least on paper) to the longest bull-market in history. Sales swept across all segments and sectors, as happens at times of panic-selling, when the only asset class that investors are willing to take a position on is cash. Subsequently, in the wake of the bold interventions by Central Banks on monetary policy, and Governments on tax policies, especially in the United States, markets bounced back, favouring the companies and sectors that were least impacted by the lockdown, and leaving industries like Retail, Travel & Leisure, Auto, Oil and most of the Industrials trailing behind. This trial of strength by financial markets shows how investors, after the initial fright, are now prepared to consider these long weeks of stoppages in production (Phase-1) as a negative once-off event, and consequently not that significant in terms of assessing companies. What will however become a determining factor for market trends in coming months and probably through to 2021, will be the duration and nature of Phase-2. The different scenarios that could arise range from a gradual but quick return to normality already in the next six months, to a relapse in cases next winter with a second lockdown. Without even considering the possibility that some of the new habits adopted during the quarantine will persist, and that a large section of the population’s propensity to spend will be parred down for an unspecified time, even once the pandemic has been overcome. Considering the extremely poor visibility on economic trends from here until 2021, we need to target the sectors that have a certain investment cycle ahead: (i) Information Technology and (ii) Public Spending.

From discussions with management of many large and smaller companies listed on the Italian exchange, it become evident that once the crisis has passed, there will be a wave of investments in the IT sector directed at the digitalisation of internal process, sales channels and the methods for acquiring customers. The extended closure of offices and points of sales has exposed the gap created in recent years in Italy compared to countries like France, Germany and the United Kingdom regarding digital. With some exceptions, most Italian companies have not invested what they should have to transform their business models, and are now having to play catch up. In other words, Covid-19 has merely pressed down on the accelerator on what was already one of the key structural trends over the last two decades: namely, changing the consumer and worker profile over from the physical to online. The beneficiaries of this investment cycle are the companies that provide support to their customers and partners in designing and implementing the digitilisation process. The “enablers” (to use the highly trendy term) in the digital revolution in Italy can be counted on the fingers of one hand; we have invested in those that in our opinion are the best. Running parallel to this, because it becomes a necessary consequence, is telecom and cloud infrastructure. With the exponential increase in the use of data networks to support smart working, it is inevitable that companies will need to have quick and reliable connections and powerful and secure data centres. This will favour players with the latest generation infrastructure needed to meet the new and more demanding requirements of their customers. In this context, the investments already budgeted to construct a 5G network can only acquire more importance and urgency.

The second sector, which we can reasonably expect to be at the centre of a new investment programme is public spending, especially in relation to large infrastructure works; the most classic leverage in the Keynesian model in support of demand (and GDP). Several more and less authoritative figures within Government have already proposed accelerating and extending the investments envisaged by the State to build public works. Deputy Minister Cancelleri refers to a proposal that has already been submitted to Prime Minister Conte to “accelerate the works for projects entirely funded and included within the contracts for the National Autonomous Road Corporation (Anas) and Railway network programme, for a total of Euro 109 billion”. What needs to be clarified are the time frames that will be needed to implement these measures given the urgency of the situation, but also the proverbial slowness in the necessary bureaucratic formalities. In the meantime, companies in the public infrastructure construction sector are busy gearing up so that they will be ready when investments begin to pour in.

Sectors linked to private demand remain a lot less visible. In a context of uncertainty regarding job retentions, and it being impossible to return to the cherished previous normality, we fear that demand for private goods may be significantly lower than expected. In the financial sector, we prefer to stay invested in asset management and payment systems, because we believe the traditional activity in the banking system could suffer from the cyclical slowdown. With regard to utilities, our preference is for companies with a regulatory asset base (RAB), especially if they operate in sectors where underlying public demand was already destined to grow from beforehand (e.g. the electricity distribution network). It is time for active and decisive choices, with a systematic approach to trends in individual companies; validation will be forthcoming over coming months.

Interview with Massimo Trabattoni, Head of Italian Equity.