As we moved into the new year the mammoth impact of the COVID pandemic had the inevitable toll on growth expectations. In March 2020, the European Central Bank staff macroeconomic projections were already envisaging much muted GDP growth in the first half of the year, followed by a possible improvement in the last six months of 2020. Undeniably, uncertainty surrounding the outbreak of COVID-19 implied negative shock to the economy. Actual figures during late August showed that the Maltese economy shrank 16.2% year-on-year (y-o-y) in the second quarter of 2020, the biggest contraction ever due to the coronavirus crisis. It follows an upward revised 1.4% y-o-y gain in the first three months of 2020. This was due to widespread contractions across all main sectors of the economy, with declines in household consumption and fixed investment. Recently published International Monetary Fund data for Malta, now shows that GDP for 2020 is expected to contract by 7.9% as opposed to the 2.8% contraction previously forecasted during April 2020. The Euro Area GDP contraction is expected to be 8.1% for 2020, and thus Malta is still expected to contract slight below the EU average. 

Understanding and analysing this data as soon as it is published is important as it will provide you with a good understanding in which cycle the economy is in. This will allow you to rebalance your portfolio in such a way to reflect the economic trajectory. Many investment managers commonly segregate stocks and equities into cyclical and non-cyclical equities. Generally, a cyclical stock is directly affected by the economic business cycle. In an economic boom, it is normal that spending and investment patterns increase within an economy, which have a spiral effect, where people start to spend more with the result that companies will be more profitable. So a cyclical stock tends to give better returns when the economy grows, and is effected negatively in an economic downturn. Conversely, a non-cyclical stock is considered as a defensive stock, and is less sensitive to the performance of the economy. 

We have recently tested the performance of cyclical and non-cyclical stocks on the Maltese market. This was done by creating two segregated portfolios of the securities listed on the MSE each of which composed exclusively of either cyclicals and non-cyclicals securities. We have noticed that in the last five years up till the third quarter of 2019 the cyclical portfolio outperformed the non-cyclical securities. This reflects the strong economic momentum of the Maltese economy in this timespan. 

 

So shifting between equities within different sectors, which might have different behaviours is an important consideration in the risk management framework of investors. Sometimes, local investors tend to invest in those equities which have an inclination to distribute dividends, with little consideration to the different sectorial exposures that one might be building up in the process. Although it is important that equity investors seek companies that provide shareholders’ returns, given the extraordinary period we are living at the moment, dividends are not the ultimate objective that we should invest in equities. One of the key concepts in the management of mutual funds is to ensure that a portfolio is adequately diversified and taking such economic factors into consideration, for the benefit of ultimate beneficiary shareholder. This will also protect investors should a particular sectorial downturn occurs.