Amid a one-in-100 year global health pandemic, stock markets have been nothing if not resilient over the past couple of months.

Coming off a historic fall in March, April marked the best monthly performance for the ASX in 32 years.

But after those gains were consolidated in May, it became clearer that markets are now pricing for a stronger rebound, even though the Australian economy is set for a sharp contraction in the June quarter.

It makes for an interesting setup ahead of what could be an illuminating earnings season for the 2020 financial year, and just prior to the June long weekend Stockhead caught up with two professional fund managers to get their view on the outlook.

Both Ed Prendergast (senior manager, Emerging Companies Fund at Pengana Capital) and Dean Fergie (director, Cyan Investment Management) conveyed a degree of scepticism about the economy.

But despite the uncertainty, they’re still maintaining exposure to companies and sectors that meet their long-term investment criteria.


Stocks vs The Economy

Prendergast said that already this year, Pengana had responded to two dramatic changes; the March lows where everything felt “unquantifiably bad”, before more positive sentiment gained traction in early May.

Along with the effect of historic stimulus measures enacted by governments and central banks, Prendergast said that was when evidence started to show the rate of infection spread was coming under control.

“That ‘unfreezing process’ is reflected in confidence which to a certain extent has returned. Economic scenarios which we all thought in late March have actually turned out to be way too bearish,” Prendergast said.

“So if you think about it as a dial, we dialled risk down quickly, where that risk was expressed as liquidity, balance sheet strength and industry exposure. And we turned the dial back early May, when the world changed from ‘complete disaster’ to ‘maybe we can see a quantifiable way to recover’.”

Fergie said the rising gap between share prices and underlying economic growth was puzzling.

“I’m still trying to work out where all the buoyancy has come from because it’s clearly not related to economics, so it seems more ‘flow’ related,” he said.

Despite the shift in sentiment, Fergie said he still saw challenges in the second half of the year.

“You’ve got unemployment, government stimulus and how to roll that off, I think there’ll be some tough budgets coming up — it’s hard to see much positive economic news,” he said.

At the same time, both Prendergast and Fergie said emergency stimulus measures had helped push capital flows into equities by reducing returns elsewhere.

“Our view is there must just be a lot of money around, or money not working very hard in other asset classes — sitting in bonds and the like not making any return,” Fergie said.

“If investors are making in a month what could take them four to five years to make elsewhere, they might look at equities more favourably and look through the short- and medium-term risks.”


Government backstop?

With all of those competing forces, it would take a brave investor to confidently forecast how the next six to 12 months will play out.

“There’s still very large wildcard factors here no one can predict, the most important of which is: can the disease reignite?” Prendergast said.

But he highlighted that while central bank stimulus measures helped prevent a liquidity crisis, it wasn’t until markets saw the prospect of decisive government support that shares started to rally.

“If you look at Australia before JobKeeper, it looked like retailers in Australia would go broke, not to mention pubs and gyms,” he said.

“No one predicted the stimulus that came through and flattened those disastrous economic implications. So you have to make an assessment from here — if things get worse that’s bad but equally, will there be another cheque written to take the edge off that negative impact?”


Sector view

It’s a complex picture, but as the manager of an emerging companies fund Prendergast said shifting macroeconomic forces had only resulted in portfolio adjustments at the margin. The bulk of his focus remains on finding and investing in companies with a durable competitive advantage.

By sector, the fund maintains exposure to the growth in cloud computing with positions in Rhipe (ASX:RHP) and Megaport (ASX:MP1), while City Chic Collective (ASX:CCX) is its pick to leverage the shift towards online sales.

Prendergast also highlighted mid-cap stock Lifestyle Communities (ASX:LIC), the residential property developer which builds retirement villages.

“We held that stock all the way through (the crisis) — painfully because it fell so much, but we knew to hang on because this is a very solid business,” he said.

“They started with one village, they’re up to 15 or 16 and over a period of time they’re planning to get to 40 or 50 villages. The share price got slammed with the fear that property prices would really tank, but they’ve more than doubled from those March lows.”

The fund also maintains exposure to some other property themes, including commercial logistics via its holding in New Zealand-listed Mainfreight (NZE:MFT) and real estate group Charter Hall (ASX:CHC).

“They (CHC) got carted during the March downturn, but the yields are still attractive,” Prendergast said.

“If you’re a sovereign wealth fund or global insurer looking for yield to fund your liabilities — fixed interest is largely providing them with zero return. So at the margin, Australian property is still well priced.”

Fergie said the crisis had helped provide some tailwinds for medtech company Alcidion (ASX:ALC), in which Cyan currently holds a position.

READ: Zero To Hero: How Britain’s NHS sent Alcidion up 575pc in just 7 months

“When you have a shock to system like COVID-19, I think it makes improving the efficiencies of major networks like health systems a bit more top of mind. So if anything I think their work’s been accelerating in the last few months,” he said.

Cyan also sees growth opportunities in the education technology sector, where it holds positions in Schrole Group (ASX:SCL) and Readcloud (ASX:RCL).

And the fund has added to its position in financial services payments platform Quickfee (ASX:QFE), which has been one Cyan’s “better performers” lately.

“I think accountants have had a good time of it recently — there’s been a lot of tax implications for businesses and individuals. Companies want to collect their revenue in a timely manner and Quickfee helps them do that.”

Looking into his crystal ball though, Fergie said the outlook was murky.

“There’s been a lot of talk about a W-shaped recovery with a second dip, and that hasn’t happened. There’s hardly been a day where there’s been a chance to get back in at lower valuations,” he said.

“So you can make really strong arguments either way. I don’t think anyone could argue that the economic outlook is pretty bad, but how the market’s going to react to that is a complete unknown.”