Why previous market corrections prove the value of due diligence
For investors, there is optimism. But previous market corrections prove the value of due diligence
It was John Maynard Keynes who introduced ‘animal spirits’ to the world, coining the phrase to describe the range of emotions, human impulses, enthusiasms and misperceptions that drive economies – and sometimes unravel them. .
The phrase came to mind when I read in a recent Bank of America report that investors had invested $ 602 billion in global equity funds in the five months ending in late March 2021. , up from a total of $ 452 billion over the previous 12 years combined.
At the end of April, global stock markets were up 90% since Covid’s first initial lows and average equity allocations were reaching record highs of 63%. How rational is this enthusiastic attitude?
In countries like the United States and the United Kingdom, the pandemic is receding, their economies are reopening, and growth is accelerating, with the United States leading the charge. If you live in London or New York, you too may feel more optimistic as everyday life begins to become more normal.
However, governments around the world continue to warn their citizens that they are not out of the woods yet. As I write, new tragedies are unfolding. At Berkshire Hathaway’s annual investor meeting, Warren Buffett warned when urging investors to note that while the recovery was “hot” and the business “really, really good”, there were warning signs of “very substantial inflation” and excessive exuberance. .
If, like me, you find yourself weighing the mixture of headwinds and tailwinds, you can reasonably wonder if the fruit at hand has already been plucked. If so, does a full equity allocation still make sense?
It is true that monetary policies are fueling the recovery of both the economy and financial markets with ultra-low interest rates and billions in new spending. The world is inundated with money and doesn’t know where to put it.
The Federal Reserve has announced that US household net wealth has just hit a record $ 130.2 trillion. But are we missing something? After all, we live in a world of contrasts, and Covid-19 has been the great inequalizer. The World Bank estimates that more than 100 million people fell back into extreme poverty in 2020.
Millions of businesses are still closed or operating at reduced capacity. The cost of Covid has resulted in record levels of public debt, which will have to be paid, at least in part, by higher taxes.
The rise in growth is accompanied by a rise in inflation. And, to top it off, even more sinister new variants of the virus could still emerge.
In their book Ten global trends every smart person should knowRon Bailey and Marian Tupy point out that most of the time the world doesn’t get worse, even though polls measuring global public opinion indicate people tend to believe it.
The authors argue that the world’s population will peak at 8-9 billion before the end of this century, as the global fertility rate continues to decline from six children per woman in 1960 to the current rate of 2.4. The global absolute poverty rate has fallen from 42% in 1981 to 8.6% today.
Satellite data show that the forest area has been expanding since 1982. Natural resources are less and less expensive and more and more abundant. Since 1900, the average life expectancy has more than doubled. Of course, major concerns are still present, but many are already in the process of improvement.
So if an investor wary of a pandemic hangover can also identify positive global trends, backed by science and reason, can they have their cake and eat it? Is it possible to play both offensive and defensive?
Richard Urwin, CIO of private investment firm Saranac Partners, reminded me recently that for such a strategy to be successful, it is not enough to identify sectors and themes for the future.
After all, many investors correctly identified a positive secular trend in tech in the late 1990s, but failed to identify sustainable stocks; those who have become tech titans, like Apple and Amazon.
So what is the key to success? Richard believes that it remains more important than ever to examine the health of individual businesses, focusing on key metrics such as price-to-sales ratios as well as the age-old themes that determine their performance. His advice to investors seduced by the animal spirit that drives profitless stocks in hot sectors is that themes can be dangerous.
I agree with him. The same goes for Alliance Bernstein analysts who looked at unprofitable 50-year tech stocks with price-to-sell ratios above 15. They conclude that the worst results tend to be in the highest-valued tech stocks; these stocks lost 18% on average over three years and 28% over five years.
When animal spirits drive the markets and trust is high, investors are prone to saving money and not doing due diligence. But once the cracks start to appear, they can spread quickly – just as fast as an infectious disease.
Annamaria Koerling is Managing Partner of Delfin Private Office
Image: Olivier Le Moal / Shutterstock
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