Now is not the time to take excessive risks with stock selection
Thursday 30 Jul 2020 Author: Ian Conway

This week saw the publication of the latest EY Item Club forecast for the UK economy, and it doesn’t make for happy reading.

The group uses the Treasury model of the UK economy, but it is free of political or business bias and it certainly isn’t looking at a V-shaped recovery.

EY’s chief UK economist Mark Gregory says that while the changes caused by the pandemic were very visible, there wasn’t the hard data to make predictions. As lockdown was eased, ‘more optimistic voices could be heard,’ he says.

Given the GDP numbers for April and May it’s now clear that a return to pre-Covid levels of activity is a long way off.

EY has cut its growth forecast for the UK economy this year to a fall of 11.5%, much worse than the 8% decline it predicted in June and the 6.8% decline it saw at the end of April. And as it points out, this isn’t even the worst-case scenario – there are still downside risks from a second wave of the virus and a sharp rise in unemployment.

Last week’s second quarter Red Flag Alert Report from insolvency and business advice group Begbies Traynor (BEG:AIM) predicted ‘a dam of company financial distress waiting to break on the UK economy’ in the second half of the year as Government support for businesses is withdrawn.

Particularly at risk are commercial property and retail firms, but the damage isn’t confined to brick and mortar brands as many online retailers are also suffering significant financial distress.

The best news so far is that companies are tending to beat earnings estimates, but according to analysts at Morgan Stanley this is likely because the bar has been set so low as to allow firms to hop over it.

From their analysis of UK and European company results, a small majority (58%) have beaten earnings forecasts by 5% or more, while 24% have missed estimates. Despite a net 30%-plus beating the consensus, however, second quarter earnings per share for the median stock are still 38% lower than the same period a year ago.

Even those firms that have surprised positively on earnings have flagged that costs are set to rise over the second-half due to supply chain reorganisation, counter-Covid measures such as enhanced hygiene regimes, or provisions for job losses later this year.

Investors will need to stick with companies with strong balance sheets and good cash flow generation in order to weather the coming storm.

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