COVID-19 will promote protectionism and nationalism

"The concern is that foreign companies will take advantage of weak equity market valuations to increase positions through mergers and acquisitions"
COVID-19 will drive trends such as increased protectionism and nationalism. Taking advantage of them will require a long-term investment horizon and a selection of bottom-up stocks"

Positions towards foreign direct investment from China have changed and we are already seeing an emerging propensity for countries to protect their 'national champions'. Take the example of India, which last week passed new legislation limiting foreign direct investment, raising the hurdles for China. In Europe, Germany and Spain have also tightened their rules, imposing a 10 per cent limit on companies of strategic importance. The concern is that foreign companies will take advantage of weak equity market valuations to increase positions through mergers and acquisitions.
Technology and innovation will also be relative winners in the long term. Online banking, e-commerce, streaming and internet gaming companies have all experienced an increase. While there will be some decline in the use of technology after the lockout, we are seeing a clear acceleration of online alternatives and believe these changes will be permanent.

Another important trend we will see is the move from deregulation to regulation and increased government intervention. Not only will we see much higher taxes at the individual and corporate level, but also much more regulation at the corporate level. Previously, there was increased intervention in the banking sector in terms of Tier 1 capital levels, CEO compensation, as well as dividend distributions and share buybacks. This trend is expected to spread to other industries and affect a swath of companies. Industries that have received government support will be particularly subject to regulatory scrutiny.

In terms of portfolio positioning, we have less exposure to global trade due to the increasing trend towards de-globalization. We are looking more at domestic type companies and actively avoiding companies affected by protectionism.

For a long period of time, there has been very little correlation between economic growth and stock market performance. For example, China has grown four times faster than the United States in terms of GDP over the last 25 years. But the returns on Chinese and US stocks have been almost identical. It's important that we look at growth at the company level along with the structure of the industry, and how that may or may not change over time.

Our long investment horizon is a key competitive advantage and an integral part of our bottom-up stock selection approach. It is important to ask what the world will be like in five, six or seven years and which companies will benefit from it. If you look for valuations in the first or second year and don't study long-term perceptions, you may miss key opportunities. It is important to ignore short-term noise in order to navigate through these difficult and unprecedented times.
 

Nicholas Grace, Equity Manager, Capital Group