For many people, 2020 is certainly shaping up as a year they would rather forget – both in terms of health and wealth – and this is despite significant signs of financial improvement in the second quarter.
Indeed, we have witnessed two of the more extraordinary periods an investor can face: the first three months of the year saw record falls, with share markets purportedly having their worst first quarter since the Great Depression in 1933. Then the second quarter saw one of the fastest market recoveries since at least 1983, notwithstanding that this mellowed in June as fears of a second wave of infection grew.
As a result, we have been receiving a lot of questions about the market rebound and whether it has gone up too quickly. As you may have read, major US stock indexes are near to or in positive territory for 2020, sparking media coverage and investor concern. This seems to have some substance, given the dire economic news we continue to see.
For most investors, the net result has been a modestly negative year-to-date performance – yet, peculiarly, this is no different from what one might expect in a typical six-monthly period. Technology and so-called ‘new economy’ stocks continued to outperform as they thrived in the work-from-home environment and, while these tech stocks are popular, for obvious reasons, popular stocks are more sensitive to missed earnings.
Contrarian opportunity
Indeed, several studies show that unpopular stocks can do even better than popular stocks due to being more attractively priced. It is much harder to sell high if you do not buy low. This contrasts with some long-established businesses, whose stocks are struggling despite decades of delivering positive cashflows for investors. The performance gap – embodied by growth and value stocks – has stretched to the bounds of extremity, which would appear to offer a contrarian opportunity.
Bond markets have moved strikingly too, with liquidity now moving freely and conditions largely settling. As an example, we saw strong performance from riskier bond markets – as might be expected in such a speedy market recovery – with most of the earlier losses overturned.
In fact, corporate bond yields are now back towards the record lows of late 2019, especially among higher-rated issuance, which seemed unfathomable to some just months ago. These represent big rear-view moves that change the forward-looking landscape, with a dim assessment of prospective returns on offer.
Second wave
Moreover, as the risk of a so-called second wave of coronavirus infection increases, the validity of the overall market rebound is being questioned. Indeed, we live in a challenging period, arguably with higher uncertainty than any period since World War II. We have, for example, clear demand shocks to contend with – including everything from suppressed household spending to a lack of corporate investment. We have supply chain issues too, which would all be exacerbated if we saw another spike in coronavirus cases.
Here, we are seeing conflicting developments. On one hand, the economy and many companies are still hurting. On the other, liquidity is flowing freely and interest rates are supportive. In such an environment, sentiment changes quickly. These shifts are also sensitive to news coverage, which is the hardest of all to understand, as an investment trades at whatever the next willing buyer thinks it is worth.
Lessons to learn
So what lessons might we learn from this? Perhaps it is best to acknowledge three things; herd behaviour, policy response influence, and the opportunity to buy at low prices. The second quarter rebound highlighted the ever-important balance between return generation and risk management, re-emphasising why an investor can do well by staying emotionally grounded and smartly diversifying into attractively priced assets.
Where we go from here is the question everyone wants answered but, with uncertainty rife, we encourage investors to focus on what they can control – saving more, reviewing financial goals, and keeping their sights focused on the long term.
To navigate this perceived randomness and the popularity conundrum, we strongly encourage investors to follow a time-tested and robust philosophy – invest regularly, offset risks, be smart about minimising costs, and let the power of compounding carry you. Importantly, this approach is not time-bound. It works in “normal” times, but it is especially useful when we are in uncharted waters like today. We can anchor on this.
To validate this message, it is crucial to remember a portfolio is designed for one’s goals. It is diversified, with offsetting influences, including different stocks and bonds. As such, you do not need to have a positive/negative view on the short-term economy to be positive about one’s portfolio.
Emma Morgan is a portfolio manager at Morningstar Investment Management Europe
