From pandemic pups to investment peaks

Like many other households during the global COVID pandemic, we welcomed a new resident into our home: a small furry pooch named Benji. As our eldest son was leaving the family nest, getting a dog was a shameless act of replacement. It is not that our son Jamie used to follow us around the house and beg for food (at least not all the time) but the sense of quiet at home when he moved away to university became even more acute during the pandemic lockdown. Like many, we found solace in the comfort, loyalty and affection that dog owners will understand only too well.

For those of you wondering what relevance this has in an investment article, it might be worth noting that Benji is now approaching the ripe old age of four. Although still a puppy at heart, he is moving through his adolescent phase and entering the human equivalent of his 20s. He is in his prime, but not for much longer. In the next couple of years, the millions of pets around the world adopted during lockdown will start to reach middle age. As humans of a certain age know only too well, this is when medical bills begin to rise.

In short, we believe that there is a coming boom in pet healthcare never seen before (if only my son had studied something practical like veterinary medicine). In our view, this boom will not only benefit veterinarians but also present opportunities for companies in the animal pharmaceutical industry — a sector where we have been doing some additional research recently.

As an investment team, this link between the pandemic and pet healthcare got us thinking about other industries that were impacted by COVID-related demand cycles. We were prompted to consider how this might be currently unfolding and whether it is creating opportunities for long-term investment.

The first thing that struck us during our reflections was the apparent existence of a COVID-related cycle in human memory, which seems to hamper our attempts to remember certain parts of the past. This could be the continuation of an existing trend, although we could not quite remember. Have we been systematically outsourcing our memory to Google for the last 20 years? In my case, almost definitely. Are we about to outsource our imagination to AI? Very possibly.

Psychologists attest that we remember events to which we attach emotions, like the pain of a stock investment that went wrong. So why is it so difficult to remember the details of the pandemic? Almost two years of our lives were turned upside down, yet we struggle to recall precisely what happened and when. According to one theory, we were overloaded with emotion during the pandemic as we grappled with stressful daily updates about death rates, lockdown rules and restrictions on liberty. Faced with such a daunting picture, the theory goes that it is much easier for us to simply forget.

With the aid of Google and a bit of Chat GPT, it is possible to piece this tricky bit of history back together and remember the industries that were impacted the most. So here it is—the painful (though not exhaustive) top 10 or so activities we did or saw during lockdown. For those with a nervous disposition who still wish to forget, feel free to look away now…cue the music please Benji.

Let us start with the things we saw more of…

1. Video gaming and increased consumption of digital media
2. On-line shopping / scramble for consumer essentials (remember the toilet paper wars?) / Digital payments
3. Work from home / video communication
4. Home improvement
5. Home fitness workouts
6. Outdoor pursuits (golf, running, cold water swimming)
7. Pet ownership
8. Home cooking / meal kits
9. Athleisure
10. Investing in Bitcoin and loss-making growth stocks
11. Increased spending on drug and vaccine development

Then the things we did less of…

1. Travel
2. Paying in cash
3. Eating out / socialising
4. Shaking hands
5. Wearing ties

While the examples above may seem somewhat light-hearted and anecdotal, the consequences of these demand cycles are still being felt in many cases. Take, for example, Mark Schneider, the outgoing CEO of Nestle, or Laxman Narasimhan, the recently ousted CEO of Starbucks. Both were leaders of multinational consumer brands who struggled to adapt to the post-COVID world of volatile inflation and shifting consumer preferences.

In fact, the list of consumer-facing businesses struggling with these issues is extensive. Companies like Diageo, Remy Cointreau, LVMH, L’Oreal, Estee Lauder, Burberry, Kerry Group and Kering, to name a few, have all suffered sharp share price reversals after the pandemic. The virtuous cycle turned vicious, and while these companies will likely recover, the dismissal of otherwise talented executives with successful track records shows the difficulty of distinguishing between cyclical trends and structural changes.

We are likely witnessing these consumer-facing industries going through a classic long-tailed inventory cycle. Investors, including ourselves in the case of Diageo, became overly optimistic about the trajectory of demand for luxury goods, cosmetics and spirits in the reopening phase of the pandemic. Investors appear to have mistaken a stimulus-fuelled acceleration in demand, further boosted by inventory restocking, as a structural shift rather than a cyclical one. Currently, it is possible that the reverse is starting to occur. As tighter monetary policy hurt consumption, an inventory destocking phase began. Weaker demand, inventory destocking and falling valuations could be creating a compelling long-term investment opportunity. However, we may need patience — a virtue that is seemingly in short supply in this post-pandemic world.

These consumer-facing companies will likely bounce back, just as those left in the wake of the 1990s tech bubble emerged as some of the leading stocks of the early 2000s. One industry that may be springing back to life is video gaming. After a pandemic-induced boom in gaming, growth rates naturally moderated in the aftermath. Sony, for example, saw their operating margin within its gaming division drop from over 10% to just 5%, causing its share price to stagnate while the rest of the Japanese equity market surged. However, demand is now recovering, as evidenced by Sony’s most recent results, with the company posting a gaming operating margin approaching 14%. The gaming recovery has been further confirmed by positive earnings reports from Tencent’s gaming division and sports-related software producer Electronic Arts. We should not forget that all cycles turn eventually.

The medical device sector is another industry that experienced a COVID boom followed by a dramatic post-pandemic slowdown in the last few years. While we were busy consuming alcohol, buying luxury goods and playing video games during the pandemic, the pharmaceutical and biotech industries were spending record amounts on developing new drugs. This created an excess inventory in equipment used to discover and produce these new therapies. Companies like Danaher and Bio-techne have struggled to contend with high inventories in their key end markets and a moderation in demand. Fortunately, this trend appears to be turning a corner, with an observable acceleration in orders and shipments across the industry. This shift has been welcome news for the companies in which we are invested. Patience indeed seems to be a virtue.

Finally, it would be an oversight not to mention politics, which was impacted the most by COVID. It is difficult to explain how a candidate who, while US President, suggested that COVID could be defeated by ingesting bleach, could subsequently be re-elected even after alleging that citizens were eating their neighbours’ pets (I’ll let you know when it’s safe to come out from under the sofa Benji). Collective amnesia brought upon by COVID could have played a part; however, the shift in the US political landscape may have more to do with the impact inflation had on the real incomes of the lower-income households. Perhaps for the first time in recent history, the Republicans attracted majority support from less affluent voters, a sobering thought for Democrats reflecting on their last four years.

The outlook for the post-election world remains uncertain. The impact of a truly “America first” policy could be far reaching. However, it appears that the tail risks of such a policy are inflationary rather than deflationary. As such, we feel more strongly than ever that investors should strive for a diversified global portfolio of quality companies that can thrive in an environment where the cost of capital may be higher than previously expected. Our collective experience of the pandemic reminds us that such an approach is a fairly good idea.

The Yarra Global Share Fund is invested in the Nikko AM Global Equity Fund managed by the Global Equity Team of Nikko Asset Management Europe.

The Global Equity team is a proud partner of Future Generation, an Australian-based social impact investment organisation that supports children and youth mental health.