Market powers on despite uncertain times
Over the last 12 months, markets have produced strong returns. This has been achieved in an investment environment that remains highly uncertain.
The internet continues to enable new e-commerce businesses that are impacting a wide range of traditional business models, from retail (Amazon, Alibaba), to banking and finance (PayPal, Afterpay), travel and leisure (Priceline, Airbnb, Uber), and media (Google, Facebook, TikTok, Tencent). The biotech revolution promises to make similar far-reaching changes to all the component parts of our healthcare system in the years ahead. There is also the rising urgency for the world to deal with climate change, which is redirecting investment globally toward reducing carbon emissions and away from fossil fuels.
Additionally, the global political environment continues to be problematic, with tensions between China and the West remaining at high levels. A raft of regulatory changes over the last year in China have caused uncertainty across a range of industries, including e-commerce and property development, both important drivers of economic growth.
Of course, one cannot fail to mention the uncertainty for businesses and consumers induced by the COVID-19 pandemic and the waves of infections that have spread across the world. With this, there have also been extraordinary levels of government spending and money printing in response to the crisis, particularly in the US, resulting not only in dramatic increases in indebtedness in the major economies, but also the highest rates of inflation that have been seen, in some cases, for decades.
All this has occurred at a time when investors can earn minuscule rates of interest on their bank deposits and fixed interest investments.
If one was to describe this highly uncertain environment to investors of a decade ago, who had not experienced the intervening 10 years, it is likely that they would have assumed a highly depressed stock market trading on crisis-level valuations.
Instead, we have one of the most exciting bull markets with some of the most extraordinary valuations seen in history, at least in some segments of the market.
One could readily explain the phenomenon to a degree. Investors, pushed into the market by low interest rates on their savings, decided to back the companies that were winners in this environment, whether that be the fast-growing e-commerce, payments, and software companies, or in biotech companies revolutionising healthcare and helping to fight COVID-19. Alternatively, investors sought out highly defensive businesses selling consumer staples, such as household products and food and beverages. Investors, naturally, avoided anything exposed to the wild swings in the global economy, or potentially impacted by the tensions between China and the US.
This all makes intuitive sense. Unfortunately, it misses the most critical variable in investing, and that is, the return you receive in the long run will be determined by the price you pay for your investment and the future earnings or cashflows that it produces. Today, the prices being paid for the obvious beneficiaries of the current environment are high by any standard of history, even when adjusted for today’s low interest rates. Perhaps more importantly, there are risks for today’s market darlings that are possibly not given enough attention by investors.
One risk is the potential for higher interest rates if inflation remains more persistent than otherwise expected. Another risk is the extraordinary sums of capital being attracted into these fast-growing areas, setting the scene for a more competitive environment in the future. Netflix faces numerous new players in video streaming, as does Afterpay in the buy now, pay later (BNPL) sector. Facebook now has to share user’s attention with TikTok. It is not unusual for disruptors in fast-growing sectors to be disrupted! Finally, there is the attention of the competition authorities around the world, that are carefully examining the business practices of the largest e-commerce players.
Does the rapid change in technology the world is experiencing, together with permanently low interest rates, mean that “this time is different”? Or is it just like any other bull market in history, where excess liquidity and a good story propel prices ever higher? Only time will tell, but the one feature of the investing landscape that is likely to remain permanent, is the role of human psychology.
Investors’ intuitive responses, driven by their cognitive biases, lead them to be systematically overly optimistic when times are good, and similarly overly pessimistic when they are not. These biases are at the core of Platinum’s investment approach of looking amongst the out-of-favour stocks for opportunities and avoiding the popular stocks. As such, our conclusion is that it is likely that we are in a traditional bull market, that will end at some point, with painful consequences for those who remain invested in the hottest parts of the market when the music stops.
It is highly likely that over the next 12 months, as progress is made in vaccinating large portions of the populations in the major economies, that the world will continue to progress toward a full reopening. This should underwrite ongoing improvements in economic activity. Whether this translates into good performance for stock markets is far from clear, given the many uncertainties outlined earlier. Nevertheless, it is a market environment that we would expect will provide many opportunities to investors. The investment team is focused on ensuring our funds are well positioned to take advantage of such opportunities as they arise.
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Andrew joined Platinum as a founding member in 1994 in the capacity of director and Deputy Chief Investment Officer. Previously he was a Vice President of Bankers Trust Australia covering Asian equities and managing the BT Select Market Trust -...