Hangover

The hangover of the pandemic will last longer than the pandemic itself.

Stock markets exploded with euphoria on the dosage of US presidential election results and positive news on the coronavirus vaccine. Both Pfizer and Moderna have likely found effective vaccines – fuelling hopes that an end to pandemic is within reach. The markets are celebrating, but we remain cautious, given the regulatory approval and the vaccine distribution are still far away.

As we exit the COVID-19 recession, we expect to live in an economic reality that will be much different than the one we are used to. Like the 2008 Global Financial Crisis, we believe the financial markets will be fundamentally changed in the aftermath of COVID-19. In the months ahead, investors will face some short term and medium-term challenges, but it is critical to look beyond the end of the recession and consider the long-term implications for portfolios. 

We are constantly evaluating what will continue to work well and what may not work as well in the next decade. The coronavirus hangover will be unique and possibly last longer than the pandemic itself. The actions taken by the global economy to battle the virus in the form of social distancing, digitisation, change in consumer behaviour and monetary & fiscal stimulus will likely evolve a new economic reality for investors in the next decade.

Historically, recessions have been more destructive for high paying jobs in comparison to the lower end of town. COVID-19 has been a recession like no other and has disproportionately struck the lower paying jobs.

A market is a sponge that absorbs millions of datasets and spits out real outcomes.

We were already living in a world that closely followed the Pareto principle which means 80% of the consequences come from the 20% of the causes and this explains the concentration of wealth in the largest companies in the world. COVID-19 accelerated this trend and now markets reckon there is an asymmetric benefit to the upside to the companies that are too big to fail.

 “There are decades where nothing happens; and there are weeks where decades happen.” - Vladimir Lenin

COVID has further accelerated this trend as the decades happened within weeks. Last Week, at Sohn’s Hearts & Minds Conference, Scott Galloway, a famous professor at New York University highlighted pre-Covid online sales as a proportion of the overall retail market was growing at a rate of 1% p.a.; within 8 weeks it grew by 28% which is 28 years’ worth of growth. It took Apple 42 years to reach a market cap of $1 Trillion and only 6 months to gain the next $1 Trillion in market cap.

Looking ahead, we expect slower economic growth in a post pandemic world, driven by the trends in deglobalisation, disruptions accelerated by the virus and changes in the consumer behaviour. The slow economic growth will also likely reflect in the share market returns. To understand the expected market returns, we need to break down the components of revenue growth for businesses:

1.     Growth in the overall economy

2.     Taking market share

 In a low growth world, only superior businesses will be able to grow their market share while average quality businesses will be heavily reliant on the economic growth. We believe the reasons behind this disparity are technology-based disruption in human capital markets, high debt levels, rising wealth inequality and ageing population in the developed economies. That is the reason we don’t buy markets, we buy businesses.

Moving on to politics, a major political hurdle of US election is behind us and a democratic victory without senate control is a cheerful moment for investors. We also find comfort in this political outcome but also believe that Presidents often get too much blame when things go wrong and far too much credit when things go well. Most of the performance in the stock market depends on where we are in the cycle when they take office. “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” ― Benjamin Graham “

 Portfolio Positioning

This section translates our macro views into executable micro level investments across your portfolios.

Healthcare

The pandemic has brought a revolution in healthcare, as investors realise the importance of investing in this sector. Healthcare is supported by long term demographic trends like ageing population and fundamentals. We consider it as “defensive growth” for the resilience in demand and its significance to the communities. Meanwhile, healthcare is also bolstered by growth from innovation trends and amplified research & development.

We continue to maintain our exposure to this sector by holding on to our preferred long-term positions and have recently increased our exposure to the global healthcare sector. .

Small and Mid-Cap companies

Investors have enjoyed exceptional share market returns in the decade following the GFC and most of these returns were simply achievable by holding large cap equities. The next 10 years are going to be different than the last 10 and we need more diverse sources of return in investment portfolios; not only to diversify the risk but also to access returns while we enter an extended phase of low growth and low interest rates. By holding quality small and mid-cap global investments, we gain access to an outlier opportunity set. The sector and investment allocation of our preferred small cap fund is materially different from its benchmark.

Bottom Line

Increasing our exposure to the defensive growth healthcare sector and investing across small and mid-cap quality investments in a highly uncertain economic environment, amplifies the overall diversity of our model portfolios by avoiding investments which are cyclical in nature and are predominantly driven by the macroeconomic factors.