Right now, the future impact of Covid-19 and its effects on global markets is superlatively important but largely unknowable for investors. This uncertainty may drive some to wish to pull out of markets – however, take a moment to reflect over the past 100 years.
In that time, we have been through two world wars, more than a dozen recessions, a financial crisis and a Great Depression – to highlight just a few events. Each of these had unique features and high levels of uncertainty at the time, but each also had things in common with the current crisis – devastating economic impact, global scale and political upheaval.
While we do not know how the pandemic will play out, we have seen one of the largest and fastest government policy responses and this has made dire economic outcomes much less likely than in the past. Knowledge about pandemics is also much better.
As we navigate the tumultuous present, however, we continue to hear investors ask why the market rebounded so strongly given how bad the economy is, and whether we will see the lows of March retested.
Of course, markets are unpredictable in the short term, yet there seems to be no end to the appetite for predictions from investment managers. But it’s not just investing. Anyone who watches sports on television fully knows that a) the unpredictable seems to happen a lot, b) humans’ ability to predict any short-term outcome is very limited, and c) we still love to hear and make predictions.
This too will pass
A lot may be said about predictions, but my point is that markets’ future may be blurry in the short term but, in some respects, becomes less so over the long run. Generally speaking, economies recover, markets recover and, in the case of today, the coronavirus will eventually end.
Through market environments, market prices will depart from market fundamentals, or the aggregate cashflows produced by companies. When prices are below what we think a stock or market is worth – all else being equal – we will typically find that to be an attractive investment. This does not require accurate short-term predictions because, again, eventually assets will be priced fairly, meaning overpriced assets will fall and underpriced ones will rise.
Some of the sectors and investments where we see value today remain much the same as they were prior to this bout of coronavirus-related volatility – albeit with greater dispersion between the best and the worst. As examples, we are still seeing opportunities in the UK, Europe and some emerging markets equities. Newer opportunities include energy companies and high-yield and investment grade bonds, all of which sold off heavily in March.
Know your universe
The second point is that it is important to understand what is within an index, or ‘the market’, before you talk about it or invest in it. Popular indexes such as the S&P 500, for example, do not tell the full story about the investable universe.
This ‘market’ has well outpaced most other developed-market stocks over the past decade. It has also become increasingly dominated by companies that are doing well in the current environment because they benefit from work-from-home consumers or are internet-related, have strong balance sheets, benefit from globally diversified revenues, or their businesses are defensive by nature. In other words, demand for their products is less dependent on the strength of the economy.
These points are even more true about the Nasdaq, which is loaded with technology and growth-style US businesses. In fact, if we were to characterise these ‘big tech’ firms themselves as a ‘market’ – so Amazon, Apple, Facebook, Google (Alphabet), Microsoft and Netflix – we would see that much of the growth of the entire US stockmarket since the global financial crisis has been thanks to the success of this handful of stocks.
The big question for investors is whether a rosy future for these stocks is already priced in or whether these companies can do even better in the future than the past and therefore justify a further re-rating. For many of these market darlings a lot of very good news is already in the price and the scope for disappointment is high.
To conclude, while we do not know when markets will regain their highs, or if markets will retest their lows, over the long term, companies – and the consumers that buy from them – will adapt and find ways to deliver value.
We also believe that prices will inevitably follow the underlying cashflows of the investment in question. Therefore, we have an anchor we can trust to determine fair value – that is, fundamentals – and need the fortitude to sit patiently until prices reflect these underlying cashflows.
Mike Coop is head of multi-asset portfolio management (EMEA) at Morningstar Investment Management
