A Force of Nature

By March 24, 2020 Insights

The Prof G Show with Scott Galloway

Investing in the time of corona

Last week Professor Scott Galloway of the NYU Stern School of Business launched a podcast called “The Prof G Show,” with special guest, fellow Professor of Finance at NYU, Aswath Damodaran.  Professor Damodaran is ranked among the world’s top business school professors and is known as the “Dean of Valuation.”  Galloway asked him how he viewed “investing in the time of corona.”  His response resonated with us: “Think of investing like you’re sitting at the beach and watching the waves roll in and then roll out.  Right now, the waves are rolling out, but they will eventually come back in.”

Like waves, or seasons

That’s been our investment philosophy since our inception.  We view the business cycle and the economy like waves, or seasons.  The Great Recession was a long winter that gave way to the “green shoots” of spring and the full blown bull market of summer.  Sure enough, we have recently re-entered a significant downturn as markets (and likely the economy) will lead us back to winter.   And just as every season is different, we must invest slightly differently to ensure we are protecting and optimizing our portfolios.

Food for the survivors

In a recession, we want to emphasize sectors that are more defensive in nature, those that represent companies with excellent balance sheets, lots of cash, and therefore financial flexibility.  “Prof G” referred to these – to stretch the metaphor – as “the species that will thrive after they cull the herd.  Fewer animals mean that, after the rains come, there will be more food for the survivors.”  In other words, those companies with the margins and financial buffers to emerge stronger than before will devour the weaker competition.  (An example of this includes our exposure to large technology companies through VGT, the Vanguard Info Tech ETF which owns Apple, Microsoft, and Salesforce.)

Objects in motion..

Isaac Newton’s First Law of Motion.

Of course, as Isaac Newton said, “an object in motion, stays in motion.”  This current market decline could last for longer.  While every bear market we’ve experienced in the past four decades has been precipitated by something different, this one was not caused by a weak economy.  Yes, economic signals were beginning to break down late last year, and market valuations were at the high end of historical ranges, but there weren’t undue speculative excesses like we saw in 1999 or 2007.  What gives us confidence that this market will recover faster than past declines is precisely because we weren’t in bad economic shape going into this downturn, which began a short four weeks ago.

Following China and South Korea

Michael Cembalest, Chairman of Market and Investment Strategy for J.P.Morgan Asset & Wealth Management

No one knows how long the economy will remain at a standstill due to the forced “shelter-in-place” orders that nearly 25% of Americans are currently following.  If China and South Korea are a guide, we could see the COVID-19 infection rate flatten by the end of May.  J.P.Morgan’s Investment Committee Chairman, Michael Cembalest has done extensive analysis of both the science of the virus and the historical economic implications of pandemics.  Among his conclusions is that markets recover at about the time the virus spread has plateaued.  There is no guarantee that this will be the case with COVID-19, but as Cembalest points out, there has never been a point in history where we have had today’s advanced technologies such as artificial intelligence, genomics, and supercomputing contributing to the discovery of new medical treatments.  He notes that currently, there are over 30 such vaccines, anti-virals and immunomodulators underdevelopment by major organizations around the world.  There’s a decent probability that at least one will be successful.

Our knowledge and experience guide us in ensuring we help our clients navigate the current challenges through broad diversification. This is the time-tested way to wait out the tide.

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