The next stage of recovery: A breeding ground for active managers?

With economic and market conditions remaining uncertain and at times volatile, sometimes the only relatively consistent attribute may be uncertainty itself. Yet, as the effects of the COVID-19 pandemic collide with the turning of the business cycle, money is in motion. This leaves the potential for active management opportunities in various market pockets – if you can identify those pockets.

During the long bull market that started in 2009, it could be a struggle for companies to pull ahead of the pack. After all, in times of economic strength, there is a tendency for a rising tide to lift all boats. Now there appears to be a different scenario with the pandemic having a sharp effect on some areas of the economy – air travel, restaurants, and entertainment, for example – but presenting opportunities in others, all making the times ripe for active management. In April, when the S&P 500® Index stood down 14% from the start of the year, one survey showed that 41% of financial advisors were increasing allocations to active strategies, both in domestic equity and fixed income (source: Investment News).

Although the S&P 500 and other indices have since recovered from severe lows, still-high unemployment and other fallout may indicate further uncertainty for a longer period. As a potentially uneven economic recovery continues, advisors may need to apply an active approach strategically. Finding opportunities may be a matter of picking your spots.

Where should active managers be focused in choppy, uncertain markets? Let’s look at a few areas that may develop into new paths for investing.

Active has accelerated in areas like healthcare

Even before the crisis, ecommerce was arguably a growing trend. But the pandemic has appeared to have given a shot in the arm to virtual healthcare companies as an alternative to in-person office visits. For example, one technology company supporting online doctor visits reported a 100% increase in demand between March and April as a result of COVID-19 (source: MarketWatch).

Other ecompanies in the healthcare field are ones that help consumers select health insurance, and software companies that run diagnostics from home, such as tracking insulin, blood pressure, and heart rates. Not only do these kinds of companies offer interesting active opportunities, but other areas – mobile banking, for example – may be accelerating in growth as a result of current unique conditions.

Replacing air travel with road trips?

Concern over air travel continues to affect vacation travel and related industries. However, there are indications that Americans may be switching to different types of holidays, such as road trips to nearby or drivable destinations – offering opportunities to some non-airline related industries.

One indicator is that by June, total volume of petroleum products (a proxy for gasoline and other fuel consumption) had recovered 83% since pre-pandemic levels, up from 65% in April when US lockdowns were most intense. While jet fuel continues to struggle, gasoline consumption rose 5% a week for nine weeks between mid-April and mid-June, recovering to 82% of its five-year seasonal average. (Source: US Energy Information Administration.) While this may point to a return to more normal volume of vehicles on the road, it’s possible that with many still working from home, perhaps a significant portion of the driving may be attributed to vacations. Supporting this theory – according to trivago.com and McKinsey, as seen in Chart 2, vacation rentals appear to have increased in popularity in 2020.

Chart 1. US petroleum products supplied, 2018-2020
Chart 1. US petroleum products supplied, 2018-2020

Source: Energy Information Administration.

Chart 2. Demand for vacation rentals significantly increased during crisis, with reversing trends

Share of vacation rentals based on domestic/international click-outs

Chart 2. Demand for vacation rentals significantly increased during crisis, with reversing trends

Sources: trivago.com, McKinsey. Data as of July 5, 2020.

Online learning comes into play

With widespread uncertainty and debate about whether schools should be open or closed, or have some degree of virtual learning, the pandemic has spelled a real opportunity for growth in online education. These companies tend to center their offerings around helping students learn with video lectures, online seminars, animations, reading materials, and online tests, with some providing online classes, tutoring, or even work skills. While many of these companies are oriented toward higher education, the unique challenges presented by the pandemic appear to be changing the dynamics. Could there be a shift or expansion in the kind of companies involved in education – such as technology providers becoming more directly engaged – as the basic notion of school models changes? With much of the education system currently in flux, active investors may see new opportunities.

Home sales bouncing back

One sector that has seen a rebound is housing. Pending home sales by the end of June had not only recovered but even surpassed pre-pandemic levels, according to the National Association of Realtors (see Chart 3). In July, sales of previously owned homes jumped 24.7% from June, the strongest monthly gain since recording of this data in 1968 (source: National Association of Realtors). This is in part credited to record-low mortgage rates – a 30-year mortgage now comes with a 3.03% interest rate, the lowest in history. Mortgage applications for new homes were up 54% in June from a year ago (source: Mortgage Bankers Association). The surge could also potentially fuel construction of new homes with potential positive effects in related industries and companies that often appear in small- and mid-cap portfolios.

Markets have seen hot housing markets before, but this housing strength may have some additional complexities driving it as a result of the pandemic – everything from a new interest in suburban rather than urban living to more of a focus on living space as a result of working from home. This could be another area that calls for keen analysis that potentially can be found in active management.

Chart 3. Pending home sales index exceeds pre-pandemic levels
Chart 3. Pending home sales index exceeds pre-pandemic levels

Source: National Association of Realtors®. Index data seasonally adjusted.

Keeping active in fixed income may call for a different view

In these unusual market conditions, active equity investing could hinge on identifying trends and opportunities. In fixed income, active, research-based security selection may be crucial as well, but it may be best to view the bond market holistically. Rather than focusing on sectors or names, for instance, you may want to consider larger issues – such as that bond indices are not weighted by market capitalization like equity indices. Instead, broad market bond indices are weighted by debt. Higher levels of debt could be a signal of the debtor’s weaker credit quality.

Skilled management is key

In the end, the key to effective active management in any environment lies in identifying skillful active managers – those who keep watch on developments and use research and other fundamental security selection tools. In these uncertain times, this premise may be more important than ever.


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IMPORTANT RISK CONSIDERATIONS

The views expressed represent the investment team’s assessment of the market environment as of October 2020, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice.

Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.

Diversification may not protect against market risk.

All charts are for illustrative purposes only. Charts have been prepared by Macquarie Investment Management unless otherwise noted.