- Investment Insight
- 5 minute read
By Sam Barton
When COVID-19 first began its spread to the West, the steep fall in share prices across the globe was not a surprising consequence. Many indices suffered historic drops as investor confidence plummeted following the implementation of national lockdowns and social restrictions.
The following months saw equity markets deliver an extremely lopsided recovery, as investors favoured structural growth stories over sectors and businesses most directly impacted by the pandemic.
There were a number of big-name US tech companies which made the headlines with their rapid share price growth, taking them far above their pre-COVID-19 levels. While these stocks lifted American markets, notably the NASDAQ, these headline figures also hid the fact that many US companies made little headway during 2020.
Closer to home, the Alternative Investment Market (AIM) has, in common with NASDAQ, seen its fair share of winners. Since its initial fall at the end of February 2020, AIM has not only recovered, it now stands at levels last seen before the global financial crisis. Similar to the US, however, these headline figures don’t tell the whole story – and there remain plenty of AIM quoted companies trading well below their pre-pandemic levels.
Survival of the fittest
A sad fact of the matter is that many companies won’t survive the crisis. And as the Government gradually pulls back some of its support measures, more businesses will face insolvency. Unlisted companies are likely to be much more heavily impacted, as their listed peers can more readily raise capital from shareholders.
Many quoted companies took this path in 2020. In some cases, this was to shore up balance sheets and reduce their financial risk. But for other businesses, it was to prime the pumps for growth as economic recovery takes hold. When the world starts to move beyond the crisis, these companies will find themselves well positioned to take market share and boost their sales, both organically and through acquisition.
At the same time, almost all companies – listed and unlisted – have focused on reducing their cost bases. This combination of above-trend revenue growth combined with lower operating costs will be a powerful one, meaning that there are a number of companies primed for impressive earnings growth over the coming years.
This is especially true for companies in the hardest hit sectors which cannot be disintermediated by a virtual or digital equivalent – such as travel, traditional retail and, of course, hospitality. Indeed, the worst impacted companies are also likely to have experienced the biggest reduction in competition during the pandemic, making their recovery more pronounced.
All this means that, in spite of last year’s gains, AIM still looks to offer a good entry point for the seasoned investor. For a start, many of the macroeconomic tail winds from the crisis remain intact, and will likely remain so for some time. Market commentators remain reasonably confident that low interest rates and supportive central banks are here to stay.
That said, inflation has begun to creep back up, and with the Bank of England targeting 2% inflation, it is expected to continue to increase. As higher inflation generally dampens valuations for long duration assets such as growth stocks, we are starting to see investors’ attention turn to those companies yet to see the kind of gains that made headlines last year.
This is unlikely to cause a rapid explosion in prices such as the one we saw last year. Value discovery may take longer, as investors seek cyclical exposure in the next leg. Many share prices aren’t moving until trading statements are released, in spite of conservative earnings estimates. Yet it seems reasonable to think the valuation gap will close as pent-up demand is released.
A Brexit bounce?
Brexit negotiations continued in the background and the end of the year saw the UK and the EU finally sealing a trade deal, setting out the basis for our future relationship with the single market.
Many markets have reacted positively to the agreement. House prices, boosted by a temporary reduction in Stamp Duty, have continued to rise. Sterling has performed extremely strongly against the Euro and the US Dollar since the deal was signed. UK equities with a domestic bias, meanwhile, have seen limited benefit to date.
For businesses, suffering years of uncertainty from the ‘will they, won’t they’ nature of the negotiations, the sense of certainty about the future has been welcomed. This should have a positive impact on investment in the coming years, as will the recent Budget. There has already been a marked increase in M&A activity in response to the deal.
While this may see a temporary bounce in optimism, it’s still too early to fully understand the longer-term consequences of some of the agreement. For example, there is a paucity of details around financial services – despite its importance to the UK economy.
Working through all these issues may well take some time but, as companies get used to the post EU world, we’ll likely see improvements filter through – especially as we move on from the pandemic.
Thanks to the hard work of doctors and scientists, alongside a huge amount of Government spending, we are beginning to emerge from the COVID-19 crisis. As the population is being vaccinated against the disease, the sense of a return to normality is growing.
We have our trade deal, we have a number of efficacious vaccines, and the Government has an enormous amount of debt to service. While a rebound in GDP will see the tax take grow, the additional borrowing taken on in the pandemic has already led the Chancellor to increase corporation tax and freeze income tax thresholds.
Other taxes are unlikely to be reduced. Inheritance Tax fills a nice void of raising revenue for the Government without negatively impacting business performance. In other words, one should not expect Inheritance Tax liabilities to go away any time soon.
Sadly, the loss of life suffered by so many families is a strong reminder of the need for proper estate planning. March is also Free Will Month, allowing charities to provide or update simple wills, free of charge. Now might be the perfect time to bring up estate planning with clients.
Investing in AIM is an attractive option. There remain a wide number of undervalued businesses on AIM, many of which are well-placed to deliver strong growth over the coming years of economic recovery. That makes them ideal investment opportunities for Business Property Relief, where investment objectives tend to be more long term. In order to qualify for the relief, an investor must hold onto their shares for at least two years, after all.
By investing in the tried and tested method of AIM shares, advisers can play an important part in helping more families pass on more of their wealth to their loved ones.
This article is only intended for use by UK investment professionals and should not be distributed to or relied upon by retail clients. Please note there is no guarantee that the CITS investment objective will be achieved. The value of investments will go up and down and clients may get back less money than they invested. Past performance is not a reliable indicator of future returns. The information contained in this document is believed to be correct but cannot be guaranteed. Opinions constitute our judgment as at the date shown and are subject to change without notice. This document is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation.
CITS is a tailored discretionary investment portfolio management service that invests in both the Alternative Investment Market (AIM) and the Aquis Stock Exchange Growth Market (AQSE), with the benefit of major tax advantages introduced by the Chancellor of the Exchequer in his budget of March 2000. CITS is an Inheritance Tax mitigation service based on current tax law and practice. The tax treatment depends on the individual circumstances of each client and may be subject to change in the future. CITS invests in ‘qualifying shares’ in smaller companies which may be more volatile than investments in more established companies. Such companies can be subject to certain specific risks not associated with larger, more mature companies. Consequently this can make the CITS portfolios more volatile as the value of an investment may fall suddenly and substantially. CITS is considered suitable only for informed and experienced investors.