As 2021 roars into action, Harbour Asset Management porfolio manager, Shane Solly, reflects on the timeless investment lessons of the previous 12 months…
Covid-19 made 2020 a challenging investment environment. But active investors were able to navigate through the chaos with a focus on people, process and patience.
Stock markets will likely remain more volatile in the year ahead as economies reopen, accelerating growth and a possible rotation between sectors that are, or are not, sensitive to the changing backdrop.
In this environment sticking to investment processes that have been tested through many cycles will matter more than ever with patient stock selection remaining a key influence on outcomes.
If 2020 was a tough year, though, it was also an important (but painful) ‘teacher’. The year taught investors, or reminded them, of five crucial investment lessons:
- The importance of being active;
- Equity markets are not a mirror of economies;
- Businesses are pretty good at adapting;
- Structural trends can last for a long time; and,
- Why patience matters in investing.
In the short-term equity markets oscillate but over the long run they tend to go up, driven by GDP plus earnings growth. Often at points of uncertainty equity markets act more like a voting machine (reflecting sentiment) than a weighing machine (based on actual data) – it is at this point when deep fundamental research and active decision-making adds the most future value.
Being active, undertaking in-depth research and then investing in stocks based on that analysis when uncertainty is high is often an effective way to enhance returns over time. In 2020, investors were able to boost returns by allocating more to good stocks with a strong track record or the potential to grow earnings through cycles in weak markets.
While economics influences company earnings and stock valuations, equity markets do not simply mirror GDP. Equity markets have a different composition from underlying economies: for example, the NZ equity market has low sensitivity to domestic GDP with a bias to defensive utilities and secular growth stocks whose earnings are less influenced by local economic activity.
In 2020 equity market earnings and returns outperformed broader economic measures, with Covid highlighting the exposure to cyclical and ‘old’ economy sectors in the wider world.
Businesses are pretty good at adapting to adversity. Often uncertainty and innovation are best friends. The Covid-19 pandemic has proven to be an accelerant for technology-based innovation across many sectors and may drive customer-acquisition for stronger business models.
Covid-19 has forced businesses to restructure and take on new operating models to get costs down and efficiency up.
In Harbour’s view as long as businesses have cut ‘fat’ and not ‘muscle’, the earnings’ growth of some businesses will benefit over the medium-term from this forced accelerated change. Overall, 2020 highlighted the need for businesses to have the management philosophies and financial strength to navigate and grow through uncertainty.
Structural trends can last for a long time. Key structural change keeps working through all economic environments – not all the time, but over time. Pandemics and dislocations strengthen, not weaken, growth and structural thematics. The increased adoption of technology in 2020 sped up the evolution of the information age, not just for technology companies but for all companies. Other structural trends such as demographic change and sustainability will steadily reassert themselves through coming years, underpinning returns regardless of short-term economic forces
Most importantly, 2020 reminded investors of the need for patience. We look forward to 2021 with the hope that the Covid pandemic is behind us sooner rather than later. But we should expect surprises and learn from the lessons of 2020.
Equity markets are forward-looking and anticipate the impact of change – sometimes too fast, sometimes too slow. As Investors we all need to maintain a focus on factual data, investment goals and asset allocation while ignoring market noise.
When the market ‘noise’ is loud and uncertainty is high investors should seek professional advice – but stick to their investment plans. We need to learn from 2020 but focus on the long run.
In the immortal words of Fleetwood Mac “don’t stop thinking about tomorrow, don’t stop it’ll soon be here, it’ll be better than before, yesterday’s gone’’ (with apologies to Christine McVie and Lindsey Buckingham from Fleetwood Mac).
Buckingham, it seems, has followed that advice after selling his song publishing rights last week in a canny move to capitalise on investor craving for yield amid an ultra-low interest rate environment.
Similarly, investment success depends on balancing long-term goals through constant short-term market volatility; some choose to blindly follow the crowds but you can go your own way.
Shane Solly is Harbour Asset Management director and portfolio manager.
This article is not intended to constitute advice to any person. To the extent that any such information, analysis, opinions or views constitutes advice, it does not consider any person’s particular financial situation or goals and, accordingly, does not constitute personalised advice under the Financial Advisers Act 2008.