Most of us trust what we are told. Since COVID-19, we have been constantly informed that we are in the worst crisis ever and that life will never be the same again. Studies have quantified the immense damage. On a daily basis, we are being confronted with stories of human tragedies.
It’s no wonder that so many investors are still loaded with cash today. A lot of it. On average, cash represents one-third of the typical investor’s portfolio. Ironically, the market has quickly dismissed this challenging news and recorded a tremendous rebound since the lows of September, with stocks up between 50-60 per cent on key stock market benchmarks like the US S&P500 and the MSCI World indices.
What should investors still sitting on cash (and having missed the boat) do today? Is it too late to buy?
No, it is not too late. In my view, you should still buy at today’s level. Or maybe the best wording is ‘accumulate’ (e.g. buy in stages). But continuing to keep cash should not be a strategy, otherwise it means you continue to suffer a mathematical loss after taking into account inflation (and eventually taxes).
Buying today is not difficult to do, but it’s crucial to avoid a few mistakes:
Mistake #1: Having too short a time horizon
Don’t judge your success in a matter of days/weeks (as only luck matters here) but in terms of years. For any trade, no time horizon should be shorter than 1 year. Longer time horizons allow you to put things into perspective.
Mistake #2: Fearing an all-time high
For whatever reason, most people get scared when the market reaches an all-time high, and (wrongly) assume that a correction (a drop of at least 10 per cent in the price) is around the corner. In reality, hitting a new high is a sign of particularly strong momentum and most of the time the market continues to rise afterwards (up 8.3 per cent after 12 months, on average). Technical analysis considers hitting an all-time high as a signal to buy, so don’t be surprised if market benchmarks follow the same path.
Mistake #3: Having an “all or nothing” approach
If you hold 30 per cent of your portfolio in cash today, nobody should force you to invest everything in one shot. But you can start by investing 5 per cent, then reassess, then repeat.
It is about managing your risks through a staggered approach. Should the market fall, you still will have 25 per cent cash to invest at better levels. If the market continues rising, at least you benefit from that.
Most importantly, you will need to continue to invest at even higher prices than today. Why? We are in a secular bull trend (markets that have been consistently rising for years) that started in May 2013. If history is to offer any guidance, we may still have 10 years of rising markets - the two previous secular bull markets happened from 1950-1966 and 1982-2000 – and, in my opinion, it would be a shame to miss out.
Mistake #4: Waiting for a 5-10 per cent correction before buying
This only looks good on paper. In practice, it never works.
This is because if buying when the market rises is difficult (“the market is too high”), buying when the market falls is almost impossible (“it’s the beginning of a crash – the market will collapse”). The issue here is that financial channels (newspapers, TV, internet, analysts) make their living by explaining why the market is correcting, and even if there is nothing new, they will find ways to scare investors (implying more potential downsides) so that you will never buy at the bottom.
The narrative about what’s going on systematically worsens with any correction, and your stance becomes “let’s wait for the dust to settle” or “let’s remain on the sidelines for a while”. Obviously, the market anticipates everything, and once the narrative has improved the market will already have rebounded.
Mistake #5: Confusing the markets and the real economy
The markets and real economy are not the same. What happens in the real economy is not systematically reflected in the stock market. For instance, these factors must be taken into account:
• Timing disconnection: The real economy shows you what is happening now. The financial markets discount what will happen in the future.
• Structural disconnection: The real economy is mostly made of very small companies. The market (main indices) show you the performance of the mega caps (blue-chip stocks). They are not the same thing and don’t suffer the same from COVID-19.
In the long term, they tend to move in the same direction. Shorter term, they can behave differently, and this is perfectly fine.
Mistake #6: Undervaluing the action of central banks and governments
Central banks, and especially the US Federal Reserve, have been extremely proactive at cutting rates and creating new liquidity (quantitative easing), but they get a lot of criticism in terms of impact on the real economy. In addition, governments have been quick to support their economies. Combined, these define the Modern Monetary Theory (MMT).
History will tell whether all these interventions were positive or not. In the meantime, the market does not care where the money or the stimulus comes from, it just celebrates. The beauty, in my view, is that such interventions will last for a while, supporting the markets for a long time.
Mistake #7: Not buying when the market is expensive
It is a fact that the market is expensive. But the problem is that the market is always expensive: financial statistics show that the market is more expensive 90 per cent of the time.
“It is not a question of ‘this time is different’. It is just mathematics, pure and simple.”
Alternatively, waiting for the market to be cheap, means that you might wait for a very long time. Think about ‘Mistake #4’: when the market gets cheap, it is because it is crashing and nobody wants to buy.
The game changers here are rock-bottom interest rates, which influence valuations as follows: Mathematically, discounting future cash flows at 5 per cent or at 0.5 per cent makes a world of difference. Stated differently, with lower rates, future cash flows, when discounted to present value, are worth much more. This means that stocks and bonds should be trading at higher multiples with lower interest rates.
It is not a question of “this time is different”. It is just mathematics, pure and simple.
Many variables go into estimating those cash flows, but among the most important are the company's future sales growth and profit margins. When predicting a company's revenue growth, it's important to consider a variety of factors, including industry trends, economic data, and a company's competitive advantages. A company with strong competitive advantages may grow faster than its competitors if it is stealing market share.
How to position yourself?
So how should investors position themselves in these turbulent times? I’d like to conclude with three final recommendations:
1. Focus on secular trends (IT, healthcare, industrials) - ones that are likely to continue moving in the same direction for the foreseeable future. Even if your timing is wrong, you can still sleep well at night because these companies will not run out of business.
2. European equities underperform as these indices are full of banks, energy, and carmakers. In the long-term, they will continue to underperform.
3. Growth style investments remains superior to value style investments for the time being. This may change the day the first vaccine against COVID-19 is approved, but we are not there yet.
Diego Wuergler is Head of Investment Advisory at Julius Baer