Coordinator: Welcome to The Center for Investment Excellence, a production of JPMorgan Asset Management. The Center for Investment Excellence is an audio podcast that provides educational insights across asset classes and investment teams.

Jennifer Archer: Welcome, everyone. Thank you for taking the time to join us today. My name is Jen Archer, and I run the Institutional Defined Contribution Business at JPMorgan Asset Management, North America. In covering their defined contribution business, many of our clients are spending a lot of time thinking about the shift in consumer behavior for both themselves and their participants.

Many are working from home and learning to adapt to online tools and platforms. So I'm pleased to be joined by my colleague, Shane Duffy, International Equity Portfolio Manager, and Mark Ferguson, Global Head of Research for Equity, who recently launched a white paper on the changing consumer preferences due to COVID-19.

Shane has been at the firm for over 20 years, first as an analyst covering the global consumer sector, and then as a portfolio manager, managing international equity strategies, principally in international growth and international focus. Mark has also been at the firm for over 20 years, always in research. He was a financial analyst in Europe, Asia, and EM, and was head of emerging market research for almost 10 years, and is now the Global Head of Research.

Shane and Mark, thank you so much for joining me today. Let's get started, Mark, let's begin the conversation with you. Talk to us for a few minutes about the goal of the paper and some of the high-level themes that emerge.

Mark Ferguson: Thank you, Jen. Good morning, everyone. Maybe if I can start just by giving some very brief backgrounds. So as many of you are hopefully aware, we have a large team of fundamental analysts in the equity business here at JPMorgan Asset Management. So if you look at emerging markets plus developed markets combined, we have 90 analysts covering around 2,500, so 17 years average industry experience. And I think importantly for this purpose, we very much promote global collaboration amongst these analysts, and we have 17 global sector groups.

So as the COVID crisis has hit over the last few months, I would say the team of analysts had two names. The first one is what I would call the (unintelligible) aspects of the crisis i.e. trying to get all these numbers up to date, inclusive of possible stress testing balance sheet, trying to understand (unintelligible), who is going to have the right equity, et cetera. So that's obviously an important part of the analyst role at a time like this.

But then also I think very important and more the subject is important that we try to get the analysts within that sector to really think about the longer term implications of COVID, i.e. what trends change, which trends don't change, et cetera. So that's the topic maybe for this call.

And I would say, if there's one overriding theme that comes out through all of this, is really an acceleration of existing trends. So the most quotes from a historian you all know (unintelligible) about how pandemics press the fast forward button on history.

And I think that's what we see across a lot of the examples that we'll get to. We do see, rather than those new trends emerging, we see existing trends that have really been accelerated by everything that's happened. Now, if you try and bucket the trends, I think you can (unintelligible) in three categories. There's ones related to consumer trends. There’s ones related to corporate behavior or business resilience. And then there's ones related more to government society in general, in particular ESG.

So we thought the best way to pass all this, given it's quite a big topic, would be to have three separate papers and three separate calls over the next few weeks going through each of these. So this one in particular, we're going to focus on the consumer preferences side. So within that, I would highlight three main themes that we talked about in the report.

The first is around working from home, and I think we've seen sufficient evidence to be pretty convinced that at least publicly, we won't go back to the offices, but certainly (unintelligible) instances of remote learning will certainly go up, we feel on a more permanent basis, and in terms of what's already in place, but certainly will be accelerated by this.

We quoted the Gartner CFO Survey in the face of that (unintelligible). But I would say also just the corporate interactions that we have, I think are very clear and send this message as well. so for example, if we're talking to some of the most high tech semiconductor companies or IT-savvy companies with extremely large workforces globally, or even our own business, these are all examples I think of businesses where actually they managed to retool to be able to work and service their customers remotely more quickly and seamlessly than many people would have thought, and in many cases, without hitting their loss in customer service.

So I think clearly we will not go fully back to where we were before in that case. So that's the first overall theme. And that obviously has a lot of implications, which we can get into more detail as we go through, but it's positive for broadband providers, positive for public cloud adoption. It’s positive for potentially home improvement, residential construction over time.

But then there are losers as well. The office REITs, commercial construction, business travel, business fashion, even work clothes, et cetera. So we do see a lot of different impacts on different industries as a result of this working from home thing. And I think Shane and I can get into that in a bit more detail as we go through.

So that's the first big theme. The second big theme is what we just call increased adoption of online services. And this covers a very wide fleet of industries. So the traditional e-commerce, the obvious beneficiaries like the Amazons of this world. But I think we found also Omnichannel retailers who have a good online (footprint) have really seen a big acceleration and adoption during this period.

Some more nascent areas like food delivery have really seen very large entry drivers. And then I think one of the interesting features is the data that we're seeing. The real-time data suggests quite a degree of stickiness of economy has opened up again. We continue to see large rises in e-commerce type spending.

But I think online alternatives also is much broader. It can include streaming. It can include online learning, online healthcare, online gaming, online banking, different ways of doing payments, et cetera. So I think again it's a broad team that's covered a great deal of industries and a great deal of potential investment opportunities. And so we'll get into that again in much more detail.

So that's the second big thing, increased adoption of online services. The third one that we mentioned is also potentially how big is the (unintelligible), I'd say is one we probably have slightly less conviction about how it will play out. So that's just around risk aversion and higher savings, right? So again, we can come back and talk about that one in more detail.

There are other things as well that we can come back to, but those are the three that we thought were particularly worth highlighting. So I'll stop there and maybe Shane can get into some more detail around examples for (unintelligible).

Jennifer Archer: That's incredibly helpful. and I think the first thing that you mentioned around working from home, that's obviously going to have a large impact on many of these aspects of our daily lives, from things like (unintelligible) invitations, to, as you mentioned, business attire and business travel and everyday commuting. Shane, could you maybe spend a few minutes on the impact, particularly on the energy and transportation sectors?

Shane Duffy: Yes, sure. I think Mark set things up pretty well there. I think the key issue really when you think about energy in the first instance, is the impact of working from home. We look at the US energy picture, we break down the demand for oil by sort of end usage, and around a third of the demand for oil in the US relates to commuting, and around a third relates to shopping.

So already, around half of energy demand is related to activities which are going to be quite seriously impacted, certainly in the shorter term, and possibly longer term, by the trends with working from home. The reduced levels of activity really are a challenge for the energy and oil demand picture. But of course in effect (unintelligible) there were some really unpredictable supply-side issues. And the timing of the Saudi Russia debacle back in March couldn't have been worse.

And we've seen potentially some slight surge in oil released into the market at a time when demand is under pressure. Consequently, energy prices have come under quite a lot of near term pressure. There was obviously (unintelligible) self-correcting mechanisms within the energy market (unintelligible) will be shut in and constrained it starts to normalize supplies a bit.

But it does mean that our longer-term view on energy prices is lower than it would have been pre-COVID. And I think some of these trends are just bringing forth longer-term demand disruption for energy, and the adoption, as well as accelerated activities, start to think about the (unintelligible) that one might sort of see in the Russian government policy. I think Europe is going to seek to accelerate green initiatives and the adoption of renewable energy sources.

So to some extent, I think the impact on the energy sector here are very long term, and it's just a reminder really of the unpredictability of the sector and the difficult economics for the industry. So we've seen the major oil companies slashing CapEx. They're also slashing dividends. So lower returns for shareholders.

And also yesterday, we saw some fairly big write-downs on BP and Shell's asset base as well, reflecting a fair value of some of these projects and investments that have been made historically. So a pretty tough impact in an already difficult sector of today's energy. On transport, it's a little bit more nuanced. You know, when we think about travel as an industry and transportation, it has been travel by the growth industry in recent years, traffic growing at a multiple of GDP.

So it had been an attraction here for investors to try and invest around the travel and transportation theme. And in previous crises, we've seen travel rebound actually pretty quickly post-recessions. Normally it takes around two years to get back to pre-crisis levels of demand. But leisure, in particular, is (unintelligible).

But I think there's reason to be a little bit more cautious here. I think even as the economies open up, we're seeing hesitance from consumers around travel. We’re also seeing a shift in business trends. We can do more via telephone and via Zoom and other services like that. So maybe the market business travel starts to come under medium-term pressure as well and we don't see that initial snapback.

But as we looked at it, we feel that the hotel industry is probably in a better position than the airline industry right now. I think it's easier to be in the hotel industry (unintelligible) and manage some of the challenges. We also expect local demand to recover more quickly than sort of international travel, and that will help the hotel industry over the air travel industry.

And of course, airlines really struggled with low load factors because if we park the airplanes, the economics suddenly look pretty bad. So we've remained pretty cautious on the airline industry in terms of they have some structural challenges around overcapacity anyway. And it also makes us think about the knock-on on effect to the aerospace sector, where and to the earlier comment, (unintelligible) traffic has been a growth industry.

There's also been potentially quite a bit of growth in the civil aerospace sector and demand for new planes. Of course the outlook (unintelligible) by Boeing and Airbus. So clearly these airlines are under financial pressure that potentially puts new plane orders under pressure and some negative consequences for those businesses.

So that's one area where I'd say we were historically more optimistic on the medium to long-term growth outlook. We’ll probably be a little bit more cautious now in the wake of COVID and some of these effects starting to linger around.

Jennifer Archer: Thanks. If we move on to the second term, the acceleration of online alternatives, Shane, what were some of the trends that you saw before COVID-19, and do you see those changing as you look towards the future?

Shane Duffy: Yes, I mean online term is a very broad label and covers a lot of industry. And the facts are that while some parts of the online space have done very well on the back of the COVID pandemic, and we've seen an acceleration in trends, that's not true universally. I'd say that the three areas where we've been most enthusiastic has been retail, food delivery, and entertainment. And each of those three areas has seen positive acceleration in trends around COVID pandemic.

So if you take retail, for example, Amazon reported very strong numbers in Q2, beating expectations. We've seen some of the e-commerce businesses operating in single verticals, like clothing retail in Europe performed very well as well. So as consumers have stayed home, it's obviously been much easier to order and all get to be delivered straight to the home.

And this has really brought forward we think e-commerce conversation quite dramatically. So when we look at the US for example, e-commerce penetration jumped by around six to eight percentage points in April and May alone. So we think the US is probably on track for e-commerce sales to be around 30% of retail sales by 2024. That’s about three years ahead of where we might have expected the US to hit prior to this pandemic.

But to Mark's earlier point, we're seeing retail accelerate, but we're also seeing real stickiness around these pages, that businesses are sort of flashing the pan where we think consumers are going to go back to a traditional retail model, seen as (unintelligible) maybe comes back to reality. I think this is going to really cement some of these trends and structurally move economies by the US, but even more established online economies like the UK or Korea, higher around the adoption penetration code.

Food delivery like I mentioned, many of the companies in that space have seen a real acceleration in order volumes on the back of it. And again, the interesting thing there we think is that many of these customers and businesses that relies on a customer acquisition cost, and then the lifetime value of the customer.

But many customers come to these platforms almost voluntarily in this process. They haven't been expensively acquired, with obviously good incentives and promotions. So the economics of getting these customers (unintelligible) is actually tremendously positive as well. And so we expect that to really come through in the results these companies are reporting.

Certainly on entertainment, the streaming area that Mark mentioned has been really positive, really strong. We’ve seen record subscriber additions for Netflix in Q2. We’ve seen strong acceleration in businesses like Spotify. So it really is starting to accelerate some of these trends, which were strongly in place already, but just moving them onto a stronger footing and further up the adoption curve.

As I mentioned, it's not universal. There are some online platforms which are struggling and seeing trends interrupted through this process. If you think about the ride sharing space, Uber for example, ride options are down 8% in April, down 17% in May. and even in markets where we've seen a return to more normal levels of activity, ride sharing, ride hailing, outsourcing activity only really back to around 8% of pre-COVID levels.

So again, it goes back to that point. There is hesitance from consumers and caution as they emerge from this. So some of these areas which have been seeing strong growth, might be waiting a little bit longer to get back on to that growth trajectory.

Jennifer Archer: Okay, thanks. One of the interesting things that I've seen over the past few months is that if you look at US household savings rate, they all increased significantly to 13% in March, and then 33% in April. Mark, what does this tell you all about human behavior going forward? Do you think that there will be a permanent shift in the savings rate?

Mark Ferguson: Yes, that's a difficult question. So in the white paper, we showed the longer-term chart of going back to 1980. And we've chosen the areas where there were recessions in the past. And I think in general, I would say, you pretty much always see a temporary freeze in savings during a recession i.e. see some risk aversions going off, at least on a temporary basis.

However, if you see the ones in the comparatively mild recessions for example in the early '90s and early 2000s, they didn't actually break the structured trend at the time of reduced overall savings. The global financial crisis hit, because obviously in a sense a deeper recession for many people, a much (bigger upheaval). And so that point, it was coming from a point where savings rates had got to an extremely low sense.

So we can see that (unintelligible) we have seen move us from around 2% to around 8% (unintelligible) in the US. And then obviously for specific reasons, we've seen this spike over the last couple of months. So in a sense, in this scenario, we have a big picture in terms of calling what happens in the secular level. And we've seen a deep aversion (unintelligible) short term spike.

My personal view is that due to the (unintelligible) recession similar to 2008, probably the secular trend of increased savings I think has more likely than not perhaps a more secular nature to it this time around, which will obviously improve with implications to various parts of consumers industries, including our own industry as well.

But as I said at the outset, that's one that we thought was worth flagging, but I wouldn't say it's one that we have very high conviction, that we know the right answer in terms of what happens next.

Jennifer Archer: Okay, great. So with that, I want to ask you both one more question about the trends you've discussed. There could be a pretty significant impact on long-term investment implications. Keeping that in mind, do you have - so ranging from public pensions to corporations, endowment and foundations, healthcare companies, and some folks and partners on the line today, what are some of the investment implications that they should be aware of?

Mark Ferguson: Maybe I'll start and Shane can continue on that. I mean, I think in a sense, my answer will sound rather self-serving, but I think in a sense that the crisis does highlight the importance for fundamental research, because I think there's a lot of micro-level complexity to what's going on. So there are these big secular trends, some of which we're pretty confident in, some of which we're less sure about.

At the same time, there is a lot of market dissipation that we've seen in the last several months. There's a lot of near term stress, a lot of earning pressure varying less from industry to industry and from geography to geography. So in a sense, it's very hard to generalize, I think about, you know, you should borrow (unintelligible) necessarily because in some cases (unintelligible) haven't (unintelligible) by those stocks of value, stocks, et cetera.

So I think in a sense, the answer is very micro, and I think that really having that individual understanding of all the different companies in all the different sectors and geographies, I do think is very important to navigating the times. And from a reverse perspective, the way we try to think about, we ask our analysts to think first of all, around corporate quality.

(Inaudible) kind of a structured process for thinking about that, and this obviously ties in a lot to the secular themes, who are the winners and losers. But then within that, we also have an emphasis on the common valuation process, which the team is relatively long term horizon five years. But nevertheless, it gives the opportunity for us to understand in which cases the winners are a bit overhyped, and which cases the relative losers.

A good example we can talk about a lot recent here is European banks. And so I think those put in a structural winner category. So we do think they are a lot more resilient than they were in previous crises, and we do think the valuations are very cheap. But to say the general approach I think for investing, you have to be very micro.

You have to combine assessments of corporate quality with a fairly disciplined valuation framework. So that would be my answer on the research side. I'm sure Shane probably wants to add some comments on the outcome.

Shane Duffy: Thanks, Mark. I think you're actually right. I think it does remind you when you go through one of these crises, the importance of corporate quality, the profitability of the franchise and market position the company occupies, intelligence of the management team, the resilience of the business.

And so having a framework around that and being able to sort of hold your nerves and keep phasing the best quality businesses through what is generally a tough time present one, I think is critical. And in each in every crisis that I’ve invested through, we’ve seen the good companies get even better on the way out.

So whilst the temptation can be sometimes acute and how quickly explore the recovery and (unintelligible) more leverage for that and for normalization, I think in reality, the better long term approaches to stay with the structural winners, and then a structural advantage, well managed, profitable company you can find.

(Unintelligible). And thinking more big picture and from an asset allocation point of view, I guess the big question is around the health of sovereign balance sheet at the end of all this, and we’ve got used to massive amounts of monetary intervention, but we haven't yet seen that combined (routine amounts) of fiscal stimulus.

So we're about to see what that does. The big debate I suppose is around what does lead into longer-term inflation on here and market leadership. And that’s sort of often beyond the (unintelligible) of an equity portfolio manager. But I would say that our fundamental ability goes back to the idea that the best companies will prosper, whatever the environment unless we see some short term uptick in inflation on the back of fiscal stimulus and so on.

But be it that might short term give a bit of a boost some of those more inflation sensitive sectors. But that’s the long term boost to overall economic growth and demand and most companies will benefit from these position companies will benefit disproportionately over the longer investment horizon.

So we think based on some of these issues and worry about the implications of changes in government policy, but from a micro perspective, it will come back to exactly what Mark is saying. You identify the better-positioned companies and best around over the long term.

Jennifer Archer: Thanks so much. Mark and Shane, thank you so much for your insights.

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