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Intelligent Investing

Not yet time to aggressively buy COVID-19 sensitive stocks

/ 03:59 AM September 28, 2020

Since the start of the pandemic, we have recommended investing in resilient or COVID-19-proof stocks. So far, the strategy has worked as proven by the outperformance of resilient stocks vs the PSEi index.

However, although the performance of most traditional companies was severely hurt in the second quarter, it seems like the worst is over as governments around the world have largely reopened their economies.

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Moreover, the US market is currently undergoing a correction led by tech issues which are trading at very lofty valuations given their significant outperformance in the past few month.

Unfortunately, it seems like the improving outlook of the global economy and the expensive valuation of tech stocks are not compelling enough reasons to trigger a rotation into emerging markets, such as the Philippines, and COVID-19-sensitive issues, such as banks and property stocks, which are trading at much lower valuations

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Since early September, when the US market began to correct, the performances of the S&P 500 index, and the indices representing Asean (Association of Southeast Asian Nations) stocks, technology, property, and financial sectors have not decoupled.

Several factors continue to hurt sentiment for COVID-19 sensitive issues. The most important of which is the uncertainty as to when the COVID-19 pandemic will come to an end.

The number of daily new infections remains elevated, not only in the Philippines but in numerous countries around the world. In fact, several countries in Europe including Spain, France and the United Kingdom are currently suffering from a second wave of infections.

Because of this, there is an increasing threat that governments could reimpose lockdowns or tighten restrictions. For example, during the first two weeks of August, the Philippine government put the National Capital Region and four neighboring provinces back under a stricter Modified Enhanced Community Quarantine (MECQ). Meanwhile, Spain partially locked down 37 of the most affected parts of Madrid. In some cities in France, dancing was banned at bars and weddings and so was the consumption of alcohol on streets after 8 p.m. Wearing of face masks also became mandatory. In the United Kingdom, new measures to control the spread of the virus include encouraging work from home, a 10 p.m. closing time for pubs and restaurants, and an increase in fines for violating laws on social gatherings and mask use.

Even if governments do not tighten restrictions, the increasing number of infections will itself discourage people from going out. This is not good, especially for companies belonging to sectors that are vulnerable to the COVID-19 pandemic. Take Sweden for example. Although the country never imposed any lockdown measures, its second quarter GDP still contracted by 7.7 percent.

Aside from the elevated number of infections, there are new regulations under the Bayanihan 2 law that will negatively affect earnings visibility of banks and property companies locally.

For example, banks are required to implement a mandatory 60-day grace period on loans outstanding falling on or before Dec. 31, 2020. This will make it more difficult for banks to determine its borrowers’ ability to pay, delaying the visibility of nonperforming loan (NPL) formation to sometime next year. In addition, borrowers’ payment behavior might be affected as they grow accustomed to not paying anything during the grace period.

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Although Bayanihan 2 will allow banks to stagger the booking of allowance for credit losses over the next five years, they are not keen on taking advantage of this benefit. Banks say they prefer to book more allowances this year because they can offset this with the substantial trading gains they expect to book as a result of the steep decline in interest rates.

Meanwhile, to help generate additional revenue to fund the maximum amount of stimulus under the Bayanihan 2 law, the government raised the franchise fees of Pogos to 5 percent of gross bets from 5 percent of net winnings. The resulting increase in taxes could potentially drive away existing Pogos and discourage new ones from setting up shop, which in turn will lead to higher office vacancies, negatively affecting property companies that are already suffering from weaker demand.

Do not get me wrong though, investors with long-term investment time horizon should continue to slowly accumulate COVID-19-sensitive stocks that are trading at very low valuations. After all, these stocks would not be trading at such an attractive valuation if not for the short-term challenges they are facing. However, I do not think that COVID-19- sensitive stocks are ready to turn around soon, so there is no need to change the strategy on how they are bought and to start buying them aggressively. INQ

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