Paulo Bilezikjian: Is there nowhere to hide?
"In the European context in particular, in spite of record low interest rates, capital often does not arrive where it is needed."
The next many years look quite promising but challenges abound.
What does that mean in practical terms? Essentially a jump in productivity in years to come. Productivity gains are by far the most important driver of change in living standards as long as its fruits are also shared by most.
What I described above, however, does not justify a Panglossian view of the world. Far from that, the challenges investment managers had before COVID-19 have only increased in scope and size. In a very simplistic way we are living in a world with very expensive fixed income assets and very expensive equities. Some would argue there is nowhere to hide. Even other asset classes such as Real Estate, Alternatives or even Art do not look attractive. When rates are very low for a reasonably long period of time, as has been the case, the price of all assets become distorted. If rates are well below inflation, as for example, the 10 year bond of any Euro member country, asset prices can become even more so.
It might sound contradictory, but markets where capital flows more easily tend to amplify price excesses. Behavioural Finance has shown time and again that we are much less rational than we think. Herd behaviour for example has been fostered by social media and by very easy access to “free” brokerage accounts with the possibility of using leverage. Another symptom of an exuberant equity market is the creation of weekly expiration option contracts. The only purpose they seem to serve is to strengthen the notion that the stock market is a casino. We see these elements much more prevalent in the United States. In Europe, for better or worse, this is much less so.
From an investment standpoint we should look at promising sectors where capital is scarce.
Is there nowhere to hide? I don’t believe so. Actually, there are always pockets of undervaluation or even severe undervaluation even in the middle of seemingly excessive prices worldwide. In the European context in particular, in spite of record low interest rates, capital often does not arrive where it is needed. For example: small and medium European technology company stocks, and especially European private technology companies are priced on average much cheaper than their American counterparts. There are several pockets of serious innovation in Europe that do not reach its full potential because of a lack of capital and very importantly, entrepreneurial know-how. This gap is filled partially by Private Equity and Venture Capital firms which might be one way to access these investments. A similar situation exists in the Financial Services industry where a lot of innovation and probably better regulation is needed.
I must say I didn’t expect the COVID-19 situation to last this long and I understand how people are worn by it but as the English historian and theologian Thomas Fuller wrote: “It is said that the darkest hour of the night comes just before the dawn.
In spite of a certain degree of pessimism because of market valuations, there are always interesting investment opportunities. The current technological revolution will impact us quite positively in years to come. European tech might be an interesting investment theme.
Dealing with uncertainty is inevitable. Technological development and innovation will accelerate.
"It’s difficult to make predictions, especially about the future."
The often used quote, variously attributed to Mark Twain, Niels Bohr or Yogi Berra among others, has a bit of irony and a lot of truth. But we have no choice when taking investment decisions. Understanding the limitations of forecasting is essential. With that caveat conveniently established, I will address a number of issues that I deem worth exploring when we look at the years ahead.
In spite of all the gloom and doom about the economic perspectives after COVID-19, the important challenges that existed even before the current health crisis and that have been exacerbated by it, we have a lot to be optimistic about.
We are at about the one year mark from the start of the more strict measures against COVID-19. In this rather short period of time we have been able to develop, test and vaccinate hundreds of millions of people using at least five different products with more on the way. This is nothing short of impressive, previously vaccines took several years even a decade to be developed. But this is just the beginning: according to the McKinsey Global Institute in a May 2020 report “45 percent of the global disease burden could be addressed with capabilities that are scientifically conceivable today”.
In addition, there are advances in many other areas as well. Tremendous progress is also taking place in transportation especially in autonomous trucks. Ships and cars will follow. In October 2020 for example, Waymo launched a fully driverless taxi service in Phoenix.
Obviously many of these innovations that we have seen and will see, have been in development before the current health crisis. But need drives humans to make them faster and more efficiently. As Microsoft CEO Satya Nadella put it in April 2020: “we’ve seen two years’ worth of digital transformation in two months.”
One of the most important effects of COVID-19 is the acceleration and widening of the technological revolution, which started with the increased connectivity and ability to cheaply process colossal amounts of data that began in the late 20th century. We are in the first innings of this process