Despite the plethora of asset classes in this world, investing boils down to one simple concept, according to Robert Almeida Jr, MFS global investment strategist – and it’s getting simpler.
In a short paper released last week, Almeida says “ultimately there is only one asset class: volatility”.
And while investors historically benefited from taking positions either side of volatility trades depending on underlying market conditions, even that distinction is fading.
“Most financial assets are effectively short volatility, as they benefit when markets anticipate increasing certainty and stability. Conversely, they suffer when conditions deteriorate.
Assets such as US Treasuries or gold, on the other hand, are effectively long volatility and benefit from greater uncertainty,” Almeida says.
“But lately, as policymakers have injected capital into financial markets to fund operating losses and suppress the cost of risk, the correlation between short and long volatility assets has gone from negative to positive. Today, everything is rising in value because there is excess capital chasing too few opportunities. Is that the role of financial markets? Capital should be allocated more responsibly than that.”
He says amid a rapidly deteriorating economy, implied revenue growth in 2021 based on current share market levels relies on “fuzzy earnings math”.
“Absent revenue growth that is materially better than it was 2019, I honestly cannot make the earnings math work,” Almeida says.
The US economy contracted by about a third in the June quarter, he says, as bankruptcies rose to levels not seen since the peak global financial crisis (GFC).
However, unlike the GFC, which was triggered by on over-leveraged financial sector, this time the debt burden weighs across the wider corporate world.
Following the GFC, easy money allowed weaker firms to “substitute borrowed cash flows for operating cash flows”, the paper says.
But even prior to the COVID-19 crisis, the monetary drug was beginning to lose effectiveness.
“The pandemic is the excuse often used for weak financial results, while the cause was soft demand heading into 2020, balance sheet fragility and financial engineering,” Almeida says.
“As a result, I expect more bankruptcies during this recession and a weaker-than-normal recovery in overall profitability.”
He says prudent investors have to exercise the traditional virtues of patience and “skilled security selection… as the outlook for future cash flow deteriorates”.
The financial services industry might have evolved considerably over the last 100 years, Almeida says, but its core purpose to swap present capital for future cash flows remains in situ.
He says the latest paper is an attempt to draw on that central insight to examine what the current price of risk indicates about future earnings.
“… though at this point it’s questionable whether the average investor even cares,” Almeida says.
Founded in 1924, the Boston-based MFS is one of the world’s oldest fund managers with a mainly institutional presence in Australasia.
MFS has several large mandates in NZ including with the country’s largest non-government fund manager, ANZ Investments. Financial advisers can also access MFS through several channels such as via the Clarity Global Shares Fund.