As 2020 fades into history, it will not be a year that is soon forgotten. It will be remembered for many things, of course the pandemic of COVID 19 being the most obvious, but really the impacts of this globally shared crisis are the most noteworthy.
Employment, and remote working or working from home are likely changed forever – unemployment and devastation of certain industries, at least for a period of time, such as travel, airlines, hospitality, events, restaurants and bars, movie theaters, oil and gas and of course commercial real estate to name a few will struggle to recover in many cases for a long time.
Of course the flip side of that are the parts of the economy that have exploded with the benefits that quarantining and confinement have bestowed – starting with residential real estate, home improvements, online shopping, home deliveries, packaged meal home deliveries, technology and services. Also equipment demand to supply working from home needs, demand for used cars, demand for services, telecommunication services, and of course biotech and drug companies have surged as they have sought to solve the COVID mystery – through designing tests, seeking therapies and of course the “cure” of a vaccine. However, what has really driven the global economy is the collective efforts of governments around the world to overturn and hold back the tide of shutdowns by loosening credit, lowering interest rates and flooding the markets with liquidity by printing money and buying bonds to forestall economic disaster.
Things will be forever changed – but one thing will remain a constant – greed and excess will end badly for many.
So how does this impact the way we manage your portfolios?
Despite the challenges of 2020 Claret has seen the year as an opportunity to change and adapt to our clients’ needs for 2021 and beyond.
We organized in March to allow for all employees to work remotely, either to accommodate their need to do so or their wish to do so, so as to allow for seamless client service. We have completed conversions of several technology systems including our portfolio reporting system, which you will see for our year-end reporting. We have changed the supplier of our online client portals, which will be introduced in January, where you will be able to view all your quarterly report going back as far as 2010, or whenever you joined us as a client since then. Additionally, the client portal will include your client documents going forward, and tax slips as soon as they are available. We will have detailed instructions for your easy access to the portals shortly. We are hopeful that each of you will elect to receive your quarterly reports in this manner in the future for three main reasons: security of your data (avoiding the mail service for confidential financial details), speed of access (we will be able to post it to the portal sooner than we can print and mail it) and of course the storage of all relevant documents in one easy-to-access secure location.
We have improved our website and we will be posting videos, newsletters and articles we think will be of interest to you. We continuously upgrade our software through our office services provider Microsoft, who also supplies our cloud services for storage of data and back-up systems availability. Additionally, and perhaps most importantly to you our client, we also continuously upgrade our cybersecurity with the most recent software and security techniques. Confidentiality and privacy of your data is of utmost importance to us, just as it is for you.
The “bright sides” of COVID 19
I know we are all suffering from COVID fatigue and can’t wait for the vaccine to be delivered to all of us tomorrow, but this pandemic also reveals how resourceful the human kind is under pressure, thanks to science and technology:
- Innovation acceleration: Vaccines typically require years of research and testing before reaching the clinic but in 2020, scientists embarked on a race to produce safe and effective coronavirus vaccines in clinical trials on humans in record time. Currently researchers are testing 64 vaccines in clinical trials on humans, and 19 have reached the final stages of testing. While in Britain, 3 have been approved for emergency use, in Canada, 2 have been approved and a third is about to be approved. Furthermore, at least 85 preclinical vaccines are under active investigation and testing in animals.
- Technology adoption rate: The pandemic has shown us that the old way of working is not necessarily the best for all. We suddenly became aware of the amount of time we wasted commuting between our home and the office, the fast food we grabbed in the food court everyday versus the healthy lunch we make now, let alone the difference in costs. Technology has changed that. Group and in-person meetings were quickly replaced with Zoom meetings, done from your house. Suddenly, we have a new normal. Lots of workers understand the benefits of eliminating the commute to work: many more housing options – larger homes further away from city centers, more space and more time with family – all that for probably lower costs.
Looking at 2020 from the financial markets point of view, with hindsight….
2020 was a year of extremes: we experienced the fastest bear market in history followed by the fastest recovery in history. While the recovery has been imbalanced, favoring large growth stocks the likes of FANMAG (Facebook, Apple, Netflix, Microsoft, Amazon and Google) at the beginning, it has broadened to smaller companies since September.
Having said that, there seems to be a serious disconnect between the markets and how the real economy is performing right now. We can come up with many plausible explanations, but worldwide central banks’ money printing policies combined with government spending largesse are pretty tough to beat.
Shades of 1999
Which brings me back to 1999… after the financial crisis sparked by the Russian default which put the whole US banking system in a bind, the Federal Reserve (the Fed) dropped interest rates to historic lows. Combined with worries regarding the potential deflationary impact of the Y2K bug, the Fed allowed the money supply to expand, i.e., printing money.
For those who are unfamiliar with the term Y2K, it stands for Year 2000. As we moved to a new century, there was a scare that all computers would stop working since they were built to use only 2 digits, i.e., 1998 becomes 98, 1999 becomes 99 but 2000 would be 00 as is 1900… The world spent an estimated 400 to 600 Billion dollars to fix the bug.
All the money was pumped into the economy and found its way to the stock market, especially the dot com companies. They had futuristic business models. Some of them were visionary, think Amazon, but sometimes ahead of their time, think the early cloud computing companies, while others varied from irrational to outright delusional. As examples, for those who are interested in a little history, there was a company called “Webvan”, in grocery delivery service. Another one was called “Pets.com”, in pet supplies online…
Of course, technology and biotech companies were the most attractive vehicles for high speculation thanks to the possibility of the outsized return potential. It was actually better to not have earnings so “investors” and “analysts” could forecast pie-in-the-sky scenarios to justify any stock price.
Unbeknownst to the speculating crowd, the Fed started to raise interest rates as they feared inflationary pressures. The party finally ended in 2000 with many of the dot com companies eventually losing 90% of their value. Some survived and thrived (think Amazon again) but most have become a footnote in financial history.
If any of you see a parallel here, you will understand why we think caution is warranted. Regardless of whether you believe fundamentals will ever matter again is irrelevant. What is essential is that period of excess speculation always ends the same way.
If you are one of our younger clients, who have never been through a “bear market”, I understand if you find it hard to believe what I am telling you. However, a bear market will happen. I just don’t know when. It will be an unexpected, exogenous event that triggers the selling… as it always is…
What our experience has taught us…
Market timing is an impossible endeavour historically, at best underperforming and at worst an unprofitable strategy. One particular JP Morgan study shows that in the 20 years from December 1998 to December 2018, if an investor were to miss the 10 best days in the market, his return would have been less than half that of the S&P 500 index and if he were to miss the 20 best days, his return would have been negative while the S&P 500 returned approximately 5.6% compounded. Other studies show similar results. Only to say that it takes a very small miss (10 days to 20 days in 2 decades) to end up with a nasty result.
We also know that companies with strong balance sheets, fairly predictable and positive free cash flow, and good management that has integrity are likely to survive and thrive under any economic conditions. Moreover, they probably would take advantage of a crisis to expand their moat and their businesses.
What we don’t know….
We have no idea when the next bear market will be, only that there will be one…
- Be cautious but remain invested;
- Be disciplined and discriminating in your security selections;
- Be diversified;
- Beware of the songs of the Sirens: social media, financial media, many financial institutions etc. – remember they likely are selling something…
- Have liquidity to take advantage of upcoming opportunities – there will ALWAYS be opportunities –
As we march on to 2021, we would like to reprint some of J.K Galbraith’s writings – especially the ones extracted from his many books regarding financial history and financial euphoria:
- “…I review the great speculative episodes of the past – of the last three centuries. As already observed, common features recur. This is of no slight practical importance; recognizing them, the sensible person or institution is or should be warned. And perhaps some will be. But as the previous chapter indicates, the chances are not great, for built into the speculative episode is the euphoria, the mass escape from reality, that excludes any serious contemplation of the true nature of what is taking place…”
- “…There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.”
- “All financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy by real assets… All crises have involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment.”
To conclude with the well known and brilliant Canadian economist, Galbraith reportedly said many years ago: “the old generation must die off so a new set of idiots can make the same mistakes all over again”.
For 2021 we will continue to invest mainly in well-run high-quality companies, that have great business models and that often present overlooked opportunities. We like to focus on free cash flow and growing businesses where the leadership has money invested – skin-in-the-game – alongside the investors. And we will endeavor not to miss the 10 or 20 best days in the market over the next 20 years by trying to time the dips – just as we have for the last 20 years, investing alongside our clients.
Most importantly, after a very difficult year for most people, we would like to thank all our clients for their ongoing support. We know that you have many options, and we recognize that by choosing to stay with Claret, you are showing trust and enduring loyalty which often requires patience and thoughtful consideration. The confidence you have shown in us is not taken lightly and is the cornerstone of our success.
Chief Investment Officer
For the Claret Team