The article below is from our BRIEFINGS newsletter of 26 May 2020
As one of the longest-tenured CEOs on Wall Street, Jefferies Financial Group CEO Rich Handler says the current crisis is unlike any he’s ever seen and will have profound effects on the economy, consumer behavior and the future of work. Speaking at a virtual Goldman Sachs Asset Management (GSAM) Forum event, Handler shared his thoughts with Katie Koch, co-head of GSAM’s Fundamental Equity business.
Katie Koch: Given your long tenure on Wall Street, how does this crisis compare with all the previous ones you have managed through? What will the eventual economic recovery look like in terms of timing and velocity?
Rich Handler: What makes this crisis so dramatic is the health component. After past crises, we were able to go back out in the world, whereas the health risks of this virus adds a complexity that is rattling everyone. On top of that, this crisis affects everyone. Even the companies that appear to be resilient, such as enterprise software companies, are affected because their clients are in a lot of pain and are focused on reducing costs due to disruptions to their business models. This will filter through the entire world in terms of corporate earnings power and economies.
But compared with prior crisis—which, with the exception of 9/11, were preceded by rumblings of problems—the economy was in solid shape going into it. Unemployment, inflation and interest rates were all low, the economy was strong, liquidity was great and banks were in a good position. The fact that the economy was in a strong position going into this will make it easier to pull ourselves out.
That said, if I were to assign a letter to the shape of the recovery, it would be an “X”—no one knows what the recovery will look like as there are so many unknown variables about the virus. The issue is that you need a recovery in demand for the economy to recover. Just because the government opens up cities again doesn’t mean the economy is open again. We will be open again when people feel safe and that will take time. The demand side of the equation will take time to come back.
Katie Koch: At GSAM, while we acknowledge the sheer magnitude of policy support, we still have been somewhat surprised by the resilience of equity markets in the face of what is likely to be the worst economic contraction in almost a century. What is your take on this?
Rich Handler: Many market indices are performing well due to the performance of large technology companies, which make up a significant portion of these indices. However, when you take a closer look at the individual names in the indices, you will find stocks that are disproportionally beaten up and reflect the reality of the moment better than some of these larger tech companies. This bodes well for the approach of active management versus passive management over the next two to five years.
Katie Koch: At Jefferies Financial Group, you and the team specialize in companies from $2bn to $10bn of market cap. Do you expect to see consolidation in this part of the market as a result of some of the stresses these companies are facing? What do you think about small cap stocks as an investment opportunity at this point in the cycle?
Rich Handler: It depends on your duration of capital. If you are looking at this over a long-term investment horizon, the valuations in small- to mid-cap companies are very good relative to large cap. Earlier in the year, we saw a lot of strategic offensive deals occurring across every industry—most of these are on hold now. Now, most of the activity we’re seeing is along the lines of capital market arbitrage. The smartest companies and CEOs right now are focused on extending their runway to get through this given the duration is unknown. This differentiates management teams that are being proactive from those that are in denial about the shape and speed of the recovery. The companies that are going to make it will be the ones that are focused on extending their runway and being proactive rather than the ones that are waiting around for government aid they may not receive.
Katie Koch: At GSAM, we are spending a lot of time debating the legacies of the COVID-19 crisis. When you look out over the next few years do you expect regulatory change, such as restrictions on capital allocation in certain industries? What changes to consumer behavior do you and the team anticipate?
Rich Handler: Unlike the global financial crisis, no one is at fault here so there shouldn’t be as much regulatory change as there was after 2008. That said, it all depends on what happens with the US presidential election in November. In the meantime, we are likely to see a further widening between the “haves” and “have-nots” as the parts of the economy that aren’t able to work from home are more likely to suffer from the disease and experience a loss of income. This will be a very divisive event to happen in times of political change from a regulatory perspective.
The way consumers behave coming out of this crisis will depend on the medical solution. For example, if we can develop solutions that decrease fatality rates or therapies that keep ICU admissions low, we could see people returning to many of their pre-crisis behaviors, but even then, the world will be different. The crisis, will have many ramifications on the future of work: we won’t need as much real estate; our people will have a better quality of life; and we should see more opportunities for women raising families as companies can no longer argue that workplace flexibility is a limiting factor.
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Date of first use: May 26, 2020