Note Précis May 1,2020: No Time To Be Coy On Capital Budgeting- Central banks like the Federal Reserve in its April 29,2020 FOMC statement and the European Central Bank have variedly emphasized zero interest rates and quantitative ease including lending to assist liquidity for businesses but solvency appears still at risk. Contrary to skepticisms at the infancy of the now three decade quantitative ease path of the Bank of Japan, major central banks appear by circumstances forced to follow. Emerging country central bank policies face both domestic weaknesses and debt – currency mismatch risks. While sharp economic global recovery would relieve many stresses, a plodding path remains a risk. We see the potential for currency volatility amid political acrimony and favor diversification including precious metals.
The Bank for International Settlements Bulletin 10 released April 28,2020 and titled “Covid-19 and Corporate Sector Liquidity” offers a timely perspective by globally analyzing the 2019 results of some 40,000 public and private companies. For capital budgeting now, we expect changes. Currently, urgent liquidity needs appear being addressed. Upcoming and for solvency reasons, greater credit scrutiny (not unlike the 1940s/50s) is likely to favor buildup of equity cushions on corporate balance sheets unlike the recent fervor for leverage financial engineering. From Information Technology to Communications to Consumer Discretionary to Banking and beyond, some companies have already led in building equity. Even ahead of the Covid-19 pandemic, others even in the same industry appeared lagging. As seen in banking post 2007, the competitive cost is likely to be high for laggards.
From the 1960s onward, cumulative global growth above prior decades led in capital structuring to leveraged buyout tilts in the 1980s which evolved to include concept driven financing into 2000. It in turn evolved to include record equity buybacks into 2019. Amid assumptions of backstop from quantitative ease, momentum gained. Were upcoming revenues to be more plodding as we expect, investor preferences will likely shift from momentum and towards quality of operational delivery and internal financial robustness from companies. In turn, better balance between operational and financial engineering M&A would be likely.
So far from late March 2020 amid economic weakness, the market response has appeared to be to favor momentum from record monetary and fiscal largesse. Still, events like Covid-19 demonstrate how encompassing revenue shocks can be, notwithstanding zero rates. No longer to be consigned onto the shelves of business schools, it is no time to be coy on capital budgeting.
Company results have started to flow out for Q1/2020.It is noteworthy that guidance withdrawal has included companies reporting earnings above consensus and relatively strong revenues. The corporate results for Q2/2020 will be more relevant on shutdown risk to operations and financial structure. We envisage investment environments different from financing during momentum. High market volatility can be expected.
Equity valuation appears high and expanded at the cusp of an earnings decline in contrast to such developments happening closer to the bottom of an earnings decline as recovery is anticipated. In overarch across sectors and geographies, minuscule rates may be secondary to quality. Aspirational leveraged Consumer Discretionary may be secondary to the pedantic. Logistics reconfigure favors Industrials; and in Financials, we favor banks over non-bank financials where from the last cycle, proportionately more excess may also reside. In growth, strong balance sheet Information Technology and Healthcare seem better positioned than overall Consumer Staples. StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.