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The long game

  • Financial Analyst
  • Blog post submitted on 16th November 2020
Injection

It feels like yesterday that back in March, as news flowed about a serious “flu-like” virus that was spreading in China that I jumped in on a conference call with an epidemiologist who was closely following developments. His language was stern and his warning stark. And how right he was.

Fast forward to today and what a ride it has been. Post financial crisis, most of the news flow was largely insignificant comparably, and equity markets slowly but surely edged higher, with a gentle tailwind of accommodative monetary policy also tightening spreads. I suspect we’ll return to that state, albeit not for a short while longer.

Last week there was a ground-breaking announcement, which in the future I am sure we will look back on as the turning point in this pandemic saga. Naturally, I am referring to the announcement of the successful clinical trials of the vaccine against Covid-19.

Over the weekend, the creator of the vaccine made a bold statement that by next winter, life as we knew it would return to normal. I cannot underline more the significance of that statement in terms of life general, but specifically my focus, which is financial markets.

Its significance lies most in that it removes the hugely disruptive “U-word”, uncertainty. Investors can deal with bad news; they realign themselves and move on, but uncertainty stops the economic wheel in its tracks as it saps both business and consumer confidence. Businesses and by extension financial markets like predictability, because it gives comfort that investors can measure the effect of variables when making an investment decision; albeit this on many occasions can be a false sense of security.

From here on out, for the different businesses which investors may analyse, they can reliably measure the pain that was inflicted throughout 2020, and make a reliable assumption of the end, which should be in the second half of 2021.

Remember that the definition of a stock is the summation of the future income, or by proxy dividends (when appropriate) in perpetuity. This future income is “discounted” to today for the risk that these income flows will not materialise, also known as an equity risk premium. More certainty, means less risk that these cashflows will not materialise, therefore the value of the several future income streams appreciates and the stock value rises.

A key point is the value of a stock is in perpetuity, which is a hell of a long time. If you had to carve out the pandemic inflicted pain, which is now measurable, the residual value is what is important. You need to play the long game, in the sense that the value of a stock is only partially affected by present; it is the future, and what factors will shape potential cashflows long term that is important.

Similarly, for fixed income investors the elements are the largely the same, although the question which is being asked is different. Their concern is whether the company can generate enough cashflow to service its debt obligations, irrespective of distributable profits. The question here is one of survival. For both types of investors, it is key to have a long terms perspective and not be influenced excessively by short-term “noise”.

A quick word on the trend we have witnessed this week, whereby investors have been switching out from industries that have benefitted from the pandemic short term. These include technology companies involved in teleworking and online shopping which have declined, versus the large upswing in the more fundamental sectors such as industrials and banks. This move is in line with the expectation of a gradual return to pre-covid activity levels in the western world, as is already happening in China, backed by reported economic data.

Make no mistake, we are not out of the woods yet. In Europe and the US several countries are still in lockdown or have restrictions in place due to increasing numbers of cases that have stretched healthcare systems beyond their tipping point.

This however should not dissuade you from having the confidence to take the right decisions in the marketplace. There are several positives to revolve your investment thesis around, include the monetary support of central banks, fiscal support from governments and large savings rate increases over the pandemic period which when unwound will give consumption a boost.

In terms of timing, it would be ideal to take advantage of any weakness in sentiment in the marketplace to add exposure to risk assets. There is light at the end of the tunnel, and with history as our witness, it has proven smart to bet on humanity prevailing through hard times.

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