Even for those of us who have been working in investment markets for decades, the first half of 2020 delivered unprecedented circumstances.
These times have tested the resiliency of the global markets, specifically, as well as society at large more broadly. We are all still adapting to new norms brought on by the COVID-19 pandemic, and seeking to understand what the future will look like.
As investors, an important part of this has been what an eventual recovery will look like. Indeed, a common debate in recent months has been the shape the recovery is likely to take — V-shaped or some other letter ranging from a W to an L, an M, an N, or the trademarked (but non-letter) “swoosh”.
Oblivious to letter preferences, the markets have simply gone up. In the past six or so months, global central banks have rolled out their own alphabet soups, consisting of letter-laden fiscal and monetary interventions, yielding several key events that led to questions ranging from whether this is actually possible to why is this happening now?
Some of the more unusual events in recent months include:
- In April, the price of front month oil futures on the Chicago Mercantile Exchange traded with a negative price;
- Just as global economies were shutting down en masse, the number of people suddenly interested in day trading (due to boredom or newfound analytical skills) hit an all-time high. This latest cohort of day traders represent a new generation of speculators, whose mantra can be summarised by “stocks only go up”;
- Coinciding with the rise of the new generation of ‘traders’, global car hire company Hertz not only filed for bankruptcy during the quarter, but was the first company in our collective memories that attempted to issue equity knowing the shares were worthless! The US Securities and Exchange Commission (SEC) ultimately shut the offering down; and
- A certain German payments processor suddenly found itself ‘missing’ €1.9 billion ($3.1 billion) in cash as at 18 June, 2020. For a company whose business model is predicated upon tracking other people’s cash, to the nth decimal, how they couldn’t keep track of their own cash is quite extraordinary.
These — and other — events have all been astounding, but what gives us concern is something different: the sustainability of price movements for those areas of the market where fundamentals remain quite weak.
After all, we still believe fundamentals drive stock prices over the long term. But when an ex post narrative becomes the justification for current prices, a pause is needed.
For example, many companies across the hospitality space — including cruise lines, airlines, restaurants, and car hire companies — saw strong price appreciation during the quarter. We agree with consensus that not every company in those industries is going bankrupt, but it’s generally going to be a long slog back to ‘normalcy’ across those areas.
Based on that logic, we have put many of the aforementioned industries in the ‘avoid’ bucket. We believe that it’s quite difficult to get high visibility on earnings for many of the companies in the hospitality space, so we would rather wait for the fundamental data to confirm the price than the price to be justification of the fundamentals. We believe it’s preferable to react to data rather than try to predict events and we’re comfortable with this trade-off.
Like most things in life, whether that’s investing or capital allocation, trade-offs exist. In the world of statistics and data science, there’s generally a trade-off between ‘bias’ and ‘variance’ In economics, it is about consumption today versus tomorrow (although we’re venturing more and more into “I’ll gladly pay you Tuesday for a hamburger today” territory). And in investing, there’s generally a trade-off between returns and volatility (though not always), as well as quality and price.
We’re asked quite often these days how we are thinking about valuations. There’s no doubt that prices in aggregate are higher today than they were in the past. While this is a function of a series of variables, we still believe we can find compelling risk-adjusted opportunities around the globe.
Rather than simply asking what the price is, the real question should be what you are getting for the price you are paying. On this basis, we believe there are still good opportunities for investors in the current market.
So while the global investing landscape may be at fever pitch in terms of uncertainty, we think the long-term growth potential of our portfolio companies is less so.
We believe that high growth with high uncertainty yields a margin of error for the future that is too small and this high uncertainty has traditionally been a pitfall for growth-oriented managers over time.
Among the many takeaways we have had from this year, the first six months of 2020 have reinforced our belief, as mentioned above, that we are far better off reacting to the changing market environment than trying to predict the future.
As we move into the second half of the year, we’re not deluding ourselves into thinking that the intersection of COVID-19, global political tensions, government and central bank actions, and a US presidential election are going to have a calming effect on global markets.
Regardless, we believe our focus on fundamentals, particularly earnings and earnings stability, will provide direction as we look to compound our clients’ capital.
Rajiv Jain is chief investment officer at GQG Partners.
