The long term remains attractive but investors should stay alert
Markets have bounced back but the scars of Covid will be deep and lasting
Many investors are still heaving a giant sigh of relief, having come out of 2020 not only unscathed but in reasonably good shape. If, in March last year when the market was down 30%, you had offered to take their assets off them at a 15% discount, they would have bitten your hand off. In fact, many ended the year with their losses erased and sizeable gains to boot.
Although not all, much of the pretty remarkable performance of 2020 had more to do with being in the right place at the wrong time. Investors had been buying Amazon, Apple and Netflix for all sorts of valid reasons, but not because they thought there was a pandemic in the offing – one which would exponentialise their earnings. Of course there’s nothing wrong with being lucky and smart but it is hard to repeat. Investors, therefore, would be wise to avoid complacency.
And markets do look a little complacent at this point. They are effectively writing off earnings for 2020 and most of 2021 and looking beyond to a brighter future – a future where things will be okay in the long run, either because of effective vaccines and treatments or because society just finds a way to live with Covid. Add to this historically low interest rates and even distant earnings have real value.
What’s concerning in the meantime is the real economy continuing to be seriously scarred in a number of ways: rising unemployment, increasing levels of corporate debt, delinquencies and bankruptcies, unfathomable levels of public debt and future tax increases. These – for now – are being digested but they will leave deep scars that will eventually come back and bite in ways we have yet to fully understand.
There’s political risk too. Voters are far from pleased with governments’ handling of the pandemic. In Europe especially, this weakens the union even further and opens the door to further fragmentation.
Low interest rates are enabling businesses to refinance themselves more easily than would otherwise have been possible. The result, though, is that businesses that should be are not going bust. While that’s good in the short term, zombie companies are hardly a base for future prosperity. ‘Japan Inc’ is the textbook case and a salutary lesson.
The threat of rising interest rates and inflation is of course is another concern. Ever since the financial crisis, governments have been able to borrow at almost zero rates. Recent rises in bond yields, however, indicate that investors are now rightly worried that a cocktail of stimulus, demand normalisation and contraction in supply will inevitably increase inflation. This would prompt central banks to either raise interest rates, stemming the flow of free money that has buoyed markets for so long or – even worse – not raise rates and undermine their credibility.
Overall, we are in a much better position than we were a year ago. Improved confidence is not unwarranted and there remain tremendous opportunities out there for serious investors with long-term horizons. However, a little caution now until a clearer picture emerges might be just the thing.
Graham Wainer is CEO and Head of Investments at Stonehage Fleming Investment Management. He is also Chairman of the CIO Group.
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