Chris Horwood, MBA, CFA is an investment counsellor at Orbis Investments and is responsible for the firm’s institutional business in Canada.
Investing in stocks comes with few certainties, but the global market environment today is more uncertain than at any time in recent memory. As turbulent as markets have been in recent months, it has been a healthy reminder that investment decisions are best made with the head rather than the heart.
When the pandemic first began, it was natural to assume the worst from both a public health and economic perspective. The Saudi-Russia oil price war added further fuel to the fire, at one point sending oil futures into negative territory for the first time in history. Volatility surged and high yield spreads jumped. The fear was palpable.
Governments and central banks acted quickly and forcefully in response, infusing the global economy with a truly unprecedented amount of capital in an effort to calm markets and prevent severe long-term damage. At a minimum, this seems to have bought us some time. Many parts of the world are now slowly re-opening, energy markets are a bit more stable, and at least some progress has been made toward controlling and treating the disease.
As encouraging as this may be, plenty of uncertainty remains. We still have no clue about the long-term social and economic impacts of the pandemic, the timing and efficacy of a vaccine, and the severity of a second wave of infections. On top of that, already tense relations between the US and China have worsened significantly in recent months, and widespread protests and social unrest mean the US elections in November are shaping up to be even more contentious than expected.
As an equity investor, extreme volatility and uncertainty can be overwhelming. Here are a few tips that may help you navigate the current environment and the “unknown unknowns” that lie ahead.
Forget about forecasts. It is incredibly hard (if not impossible) to predict the outcomes of socioeconomic, geopolitical or macroeconomic events in a “normal” environment and the current environment is anything but normal. Even if you manage to get a few of the variables right, the interrelationships between all of them are infinitely more complex. And even then, there is plenty of research to show that accurate macroeconomic forecasts don’t necessarily translate into winning investment ideas.
Be selective. The speed and magnitude of the market rebound has left many investors wondering if the opportunity to act has passed. But dig a little deeper and it is clear there is still a lot of pain—and possibly, opportunity—out there. As at 25 June, 24% of the stocks in the MSCI All Country World Index were down more than 30% from their Q1 peaks, while 45% of the index was down at least 20%. Nevertheless, you need to be highly selective. Certain businesses, especially some brick-and-mortar retailers and heavily leveraged energy players, may be permanently impaired. At times like this, it pays to “think like a lender”. Ensure the company has the balance sheet and liquidity to survive if things get worse before they get better.
Focus on valuation. More than anything else, it is the price you pay for an investment that makes the difference between winning and losing. The pandemic hasn’t changed the deeper problem that investors faced heading into 2020 with global equity markets, notably the US, appearing richly priced. Indeed, in spite of all of the chaos in the world today, earlier this month the S&P 500 Index was trading at 30 times cyclically adjusted earnings—right back at levels last seen in December! Do not lose sight of valuation. Consider a wide range of metrics, compare them to peers and historical norms, and understand the expectations embedded within them. An important lesson from history is that even the most fundamentally sound businesses can be terrible investments if the price you pay is too high.
Expect the unexpected. Great investors have both the courage to challenge consensus and the humility to know the limitations of their analytical powers. The latter is especially important at a time when the likelihood of unpleasant surprises is well above normal. Apply a healthier discount than you normally would to whatever you think will happen and place greater emphasis on whatever you think is less likely to occur. Expect the unexpected and build in a large margin of safety to guard against the chance of permanent capital loss when you get it wrong.
While there are reasons to be cautiously optimistic that we are through the worst of the pandemic, there is still enormous uncertainty facing investors. These four tips won’t guarantee success, but when coupled with an ever-critical long-term perspective, they may help avoid some of the big mistakes that come with emotional decisions.