Andy Gardner, investment manager in AMP Capital’s global equities team, shares his thoughts on 2020, and the current state of play in global markets after a monumental 12 months.
What has driven the remarkable resurgence in equities markets in 2020 - particularly in the US?
We’re dealing with one of the largest intra-year rallies in S&P history, following close on the heels of the most significant economic downturn of the post-war period. It’s a strange juxtaposition, and one that’s actually quite difficult to comprehend unless you view it through the lens of drastic policy action. During the peak panic phase of the crisis, the Federal Reserve was buying more than US$1 million in financial assets per second.1 And just as important as the magnitude was the speed of the response, by far the fastest ever in an economic downturn.
Fast-forward nine months, and while markets are out of the woods it has become a little hard to square the rally with the economic and corporate fallout, which is proving to be quite large. A transition to a sustainable demand recovery from this point will be dependent upon health solutions rather than just fiscal and monetary policy.
In a market teeming with uncertainty and enthusiasm, what characteristics will determine whether a company lives up to today’s high expectations?
Winners in this environment need to first survive the current crisis and then thrive in the aftermath.
Surviving requires a strong balance sheet and the ability to earn positive cash flows to avoid depleting capital in a very challenging and highly-restricted demand environment. Low return, highly-levered companies are much more exposed to these risks, particularly where demand for their products and services is more discretionary and cyclical in nature.
Those that thrive longer term are likely to be the companies able to expand their cashflows even in a background of impaired economic growth and with predictable sources of new demand that are supported by structural rather than cyclical shifts.
Many mature cyclical sectors face structural challenges, low returns, and higher-than -average debt levels, and are consequently more exposed to the risks of recapitalisation and capital erosion. The costs of pivoting to address structural change – for example, taking an ‘old economy’ company online- can be enormous. Assets like these rarely offer more than a temporary home for capital, and investors should instead seek out the relative safety and support of long-term structural trends that allow highly profitable companies to compound their cash flows at above average rates over the long run, regardless of the economic climate.
Which investment strategies are best suited to the world of 2020?
Major 'one time' events like COVID-19 or progressive structural changes like technological disruption - both of which we have witnessed in 2020 – not only widen the gap between new trends and old practices, they also increase the disparity between good business models and bad ones, and it is crucial to understand how they play out between various sector and from company to company.
We believe the growing gulf between winners and losers favours a targeted and active approach. One thing that the experience of 2020 has taught us is that individual company fundamentals matter more than the index, classification, or label that a company has been assigned.
Passive investing via a benchmark is a questionable proposition at the best of times, effectively assuming that all the constituents and their weighting within the benchmark are entirely appropriate for meeting the end investor’s specific needs, regardless of risk tolerances, return requirements and timeframes. At times like the present, when the effect on the pandemic on cashflows within and between sectors has been so divergent, a passive approach effectively ignores the growing distinctions which will determine future profitability.
What are the most important lessons we’ve learned this year?
Given the sheer variety and complexity of challenges being thrown at investors in 2020, it is valuable to have been reminded that uncertainty and disruption are not the exception but the rule when it comes to economics and markets.
While 2020 has been remarkable and devastating on many levels, it is the latest in a long line of crises that investors have had to contend with over time. So while we all look forward to a return to normal life, from an investment standpoint it is prudent to assume that we need to build sustainable and resilient portfolios that can withstand the vast majority of shocks, particularly given we never know ahead of time what the next one might be.
1. Bank of America Global Research; https://www.bofaml.com/content/dam/boamlimages/documents/articles/ID20_0467/the_world_after_covid.pdf
Subscribe below to Market watch to receive my latest articlesAndy Gardner, CFA | Investment Manager Global Equities
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