Investment Matters

The market: where to from here?

Recent events

The market is racked with uncertainty. While it has reacted to uncertainty in short term earnings, we continue to look through short term risks. Our focus is on the long-term value of companies.

We do not know when the market as a whole will reach its low - it is impossible to time such an event in our opinion. We are sticking with the clear strategy we outlined to you over the last 8 months.

We constructed your portfolios with 4 clear objectives;

  • To hold significant cash reserves in the event of a market sell-off
  • To purchase good quality stocks that are ‘on sale,’ progressively adding to positions as the market falls.
  • To constantly monitor changes in conditions of companies we own, and those which we would like to own at better prices
  • To invest with a 3-5-year time horizon in mind

We are not selling.

In periods of stress, institutional strength, leadership, and commitment to process is critical, at all levels. When institutions are strong, good long-term decision making emerges, when they are weak or compromised, problems compound. 

Politics and COVID-19

We started the week identifying political risk at home and abroad as critical. We needed to see definitive, sensible and effective action in both Australia and the US.  Creating the right “fiscal response” and health response will likely drive market movements. 

We think Australia has succeeded in its initial responses, and in turn has presented a strong road map of sensible policy that will build a base from which to invest your cash into in this downturn.

Fiscal programs which support cash flows of employing businesses, provide incentives for ongoing investment, provide income support for those at risk, and build strength in an already fabulous health care system has been a point of genuine global differentiation for Australia this week.

Winston Churchill is said to have quipped, “you can always count on the Americans to do the right thing after they have tried everything else.”  I am sure the quote didn’t relate to global pandemics, but the sentiment captured perfectly a perhaps unique feature of American life, and one highly relevant today.

They haven’t yet done the right thing, and the longer this takes, the higher the short-term risks will be.

Whilst Australian markets tend to follow global markets and their indexes such as the US Dow Jones, there can also be periods in which the fundamentals of the companies and economies diverge by critical levels. 

We see that there is considerably more uncertainty for the US economy, where the public health and fiscal response has been underwhelming, than for our economy.

The willingness to act, and fiscal measures we have seen implemented by our government provides greater certainty.

Thus, in our view, there is a dislocation between the potential impact in Australia and what has been extrapolated from the US market.

Recent market volatility has provided the opportunity to add to a number of existing positions, as well as introduced several new names to your Australian Equities Portfolio.

In adding these names, we see that on a portfolio level we have achieved three aims:

  1. Significantly strengthen the portfolio’s expected return
  2. Improved the diversification of the portfolio: adding to its breadth - more names, that achieve a more diversified exposure
  3. Increase the quality and size of our positions, particularly our exposure to larger companies (+$1bn in size).

We are excited to now share some of these names with you and the rationale behind some of these investments (below). While we have invested a portion of the portfolio’s cash holding, we re-iterate that we are aware of the potential for market conditions to remain volatile and thus are adding to positions in a measured manner. Your portfolio continues to hold a significant portion of cash.

In brief, we have:

  • Added new high quality and often fast-growing stocks that have previous been too expensive.

  • Diversified our exposure to resource companies

  • Improved the dividend yield of the portfolio

 

-          Craig Shepherd

 

Putting recent events in context

Since 1980, there have been over 8 incidences where the market has corrected more than 10% in a single month. That equates to roughly once every five years. While the magnitude and speed of the recent sell off has been more pronounced than this, in each instance the market has gone on to reach higher highs.

The pullback we have seen in markets this week, while confronting, was not in our view as unwarranted or as unlikely as the market may have implied. We have seen valuations in the market over the past few years as demanding.

In the moment, these pullbacks can cause significant discomfort and concern. It can be difficult to see the market move significantly and retrace several months or years of gains. However, it is at this point, where uncertainty is high and fear appears to be gripping the market that the best opportunities often present.

It is easy to quote adages such as:

“Be fearful when others are greedy and be greedy when others are fearful”.

This is easier said than done. Investing appears simple in hindsight, when we can detach ourselves from the emotion of weeks such as these. However, this is what we must do.

As seen below, some of the highest future returns over a five-year period have been achieved after significant market pullbacks.

 WM 13.03.20

                                                 Source: First Samuel, IRESS

The graph illustrates a simple idea which is obvious but can elude us at times like these: when companies become cheaper, future expected returns rise.

The blue line represents the value of the All Ordinaries Index (logged, to provide a better representation of price moves). The orange line represents the annual return you would have achieved for the next 5 years if you had invested in the market at this point.

Three previous shocks that have occurred in the past that are highlighted in blue (in order): Black Monday (1987 stock crash), the Recession we “had to have” (1991) and the Global Financial Crisis (2008).

What the graph shows is, leading up to market peaks, future 5-year returns are at their lowest as subsequent market declines eroded capital value.  However, it also shows that as markets correct, future 5-year returns begin to rise as companies become cheap again.

This is why we chose to hold higher levels of cash. Given our cash weighting, we have been able to purchase companies, at prices we see will prove to be cheap in the longer term (discussed below): we have not been held captive to the falling market. 

For us, this is not a time to panic. It is time for us to take stock, seize on opportunities and take advantage of this period to position your portfolios for long term success.

 

-          Paul Grace