The current Covid-19 wave reminds us that we’re not out of the grip of the pandemic just yet.  The Canadian Government projects that by early fall most of our adult population will be vaccinated. Perhaps by then we will begin to learn what the post-Covid “new normal” will look like.

In this quarter’s feature article, we discuss how we are investing our clients’ savings as we look ahead to a post-Covid world. 

There are many questions about life after the pandemic:

• How quickly will we (or will we ever) resume past vacation and travel patterns?
• How much of our online retail shopping due to the pandemic will revert to in-store purchasing?
• How much remote-from-home work will return to the office?
• Will businesses reconsider the technological alternatives to past spending levels on office space, travel, in-person meetings and conferences?

From a macro-economic perspective:

• How will government borrowing taken on during the pandemic affect future economic growth, taxation and interest rates?
• Will infrastructure spending accelerate a shift away from fossil fuels to a greener economy?
• Will the migration over the past few decades to global trade and open borders give way to nationalist protectionism?
• How long will interest rates remain at near-historic lows?

As investment managers we consider past history but also the impact of the unknowns on capital markets and our investment strategies.  Starting with recent history, does anything over the past year change our investing beliefs and practices? 

A Quick Look Back

Let’s remind ourselves of some of the key themes that impacted both stock and bond markets in 2020: 

• More work from home than in offices
• Workers commuting less and businesses requiring less commercial space
• Technology became more highly leveraged by businesses and consumers
•  A reduction in business and personal travel
• On-line shopping became more widely adopted
• The closure of national borders
•  An increase in healthcare spending

Many of these trends have been emerging for years, but out of necessity, the pandemic accelerated the pace of change.

Meanwhile, governments implemented large stimulus programs and central banks lowered interest rates to record lows.  The US Federal Reserve has commented that it is willing to allow inflation to exist at higher levels for an extended period of time in its pursuit of full employment.  The future path of inflation and interest rates is something we are watching very carefully.  In the meantime, we need to consider the implications of near-zero interest rates on our clients, particularly for those who have capital preservation as their primary objective.

Valuation of Securities Still Matters

During the pandemic there were many examples of dramatic stock price performance from some newer, less-proven businesses.  Some names seemed to advance almost every day without any fundamental reason.  Some made headlines, and with so much capital on the sidelines, certain segments of the stock market enjoyed valuation escalations based mainly on the momentum of investor sentiment and speculation.

Some of this ‘speculative excess’ has quickly unwound in 2021 and some of the same stocks that produced remarkable gains last year have seen dramatic declines as the market reassessed the fundamental developments (or lack thereof) at the company level.  Reality sets in eventually.  Profitability, growing revenue and the price you pay for a company continue to be important for long-term success.

Warren Buffett, paraphrasing Benjamin Graham (his mentor/teacher), wrote in his 1993 annual letter to shareholders:   

“In the short run, the market is a voting machine – reflecting a voter-registration test that requires only money, not intelligence or emotional stability - but in the long run, the market is a weighing machine.”  

It seems every generation has a different way of learning this same lesson.

It is still, and will always be, prudent to spend time researching company fundamentals and to assess future prospects.  We also believe that paying a reasonable price for a business rewards investors over the long term.

Maintaining Our Investment Philosophies While Adjusting for the Future

We are generally considered to be “value” managers, meaning that we invest in companies with established track records and strong balance sheets positioned to weather unpredictable events.  With a few exceptions, these stalwarts did not catch investors’ attention during the market rebound in the last three quarters of 2020.  Nevertheless, we remain confident in our strategy and believe these companies will provide favorable returns for our clients over the long term.  In the past two quarters (see the “Value vs Growth” chart) there has been a cyclical rotation between the value and growth investment styles.

We have not been tempted to join the rush to invest in companies whose valuations are predicated on sustaining extremely high growth rates for many years into the future – growth rates that we believe are highly unlikely ever to be achieved.  In the past few months, we have seen some of these valuations pull back – whereas long-established companies such as Canadian banks, Berkshire Hathaway and Diageo have in many cases beat earnings expectations, translating into healthy price gains.

At IAIC, we feel that it is prudent to consider what the economy will look like in the future while not getting caught up in current “noise” or short-term market trends. As always, there are consequential headwinds and tailwinds for investors in both equity and fixed income that we consider carefully when making tactical adjustments to our investing strategy.  As a result, we have begun making tactical changes to our clients’ portfolios (changes will vary based on each client’s specific circumstances) in several areas including: 

•  Increasing exposure to technology given continued world demand
• Increasing our consumer sector holdings, given continued consumer confidence and strong household balance sheets
•  Increasing exposure to healthcare
• Reducing direct exposure to fossil fuels
• Increasing the use of passive investments to further complement our value style
• Increasing US equity weightings, as there is more opportunity in the US markets
• Increasing our use of ESG (Environmental, Social, and Governance) metrics in our investment theses
• Given the interest rate environment, seeking additional income yield when warranted by the risk-reward tradeoff between bonds and other asset classes    

Tactical adjustments are always made to adapt to the environment we are in and align with future expectations for the economy.  We do not chase yesterday’s winners or speculate on which sector will be the next to heat up beyond any reasonable rationale.  Instead, we continue to emphasize diversification in our clients’ portfolios in order to navigate the uncertainties of the future.  In all cases, we take each client’s personal objectives and comfort with market volatility into account when selecting the appropriate investments for the client.