Usually during a market downturn certain sectors, dubbed defensive, don’t suffer as much as more cyclical companies. However, research has shown that given the magnitude of COVID-19’s impact on the economy, practically every sector on the Euro Stoxx 600 (SXXP) losses are closely correlated within the index.
Analysts at Investment bank Jefferies have put out a note entitled “Collective Punishment” and suggest the reason for this wide correlation across all sectors is because ‘securing cash may have been the primary motive of investors’. Therefore they have been indiscriminate in their selling of stocks, preferring to focus on building cash positions than remaining in risk assets, even if some are decidedly less risky than others.
The analysts focused on the telecoms sector, known for its defensive qualities. However, since 20 February this year, telecoms have grown closely correlated to the wider market, the SXXP, hitting 0.9 (with 1 being precisely in line).
Within the sector, the team at Jefferies clearly have their preferred names, decided by an analysis of credit default swaps, bond yields, leverage, maturity profiles, free cash flow, dividend cover, and ultimately liquidity.
In descending order of preference, analysts named Vodafone (VOD), BT (BT.), Telia (TEL1L), Telenor (TEL), Telecom Italia (TIT), Deutsche Telecom (DTE), Swisscom (SCMN), Proximus (PROX), Koninklikje (KPN), Telefonica (TEF), Orange (ORA) and Telekom Austria (TKA). Jefferies added that Telecom Italia would have trailed further down the list if it were not for the sale of its stake in INWIT, the largest Italian mobile phone mast business at the end of last year.
For fund managers or other investors holding paper issued by the above telecom firms, they should be buoyed by analysts stating that all operators can cover bond payments with maturities for the next two years. The ratings of the companies mentioned range from the lowest level of investment grade to junk status, with some potential downgrades on the horizon meaning certain institutional investors would no longer be able to hold a company's bonds. Re-financing may also be difficult for companies facing a downgrade.
As stated, while there is an unusually high level of correlation between various sectors, some have certainly been hit harder than others, for instance oil & gas and travel & leisure. At the same time, traditional defensive sectors have been punished less including healthcare, personal & household goods although using Jefferies scale are still approaching ‘1’ or complete correlation.
What happens now?
Jefferies noted that from 17 March, there were signs that this popular sector had begun returning to more normal market behaviour. On that day, the telecom sector outperformed SXXP by eight percentage points. Analyst Jerry Dellis said in the note: “We would not be surprised if this marks the return to more differentiated sector behaviour. Not only is the telco business defensive, but specifics of the virus threat could spell FCF upside in certain areas.”
So for TMT specific funds, be they passive or active, it looks like there may be light at the end of the tunnel. Christine Lagarde’s promise to do ‘anything it takes’ and announcing The so-called Pandemic Emergency Purchase Programme worth £700 billion may be enough to kickstart the European economy once more.
