Avoid investing for cyclical recovery

While Covid-19 gave markets a massive shock last year, the carpet was not pulled out from under the global economy the way it was during the 2007-2008 Global Financial Crisis – everything was just shut down.

As a result, economies around the world should be able to recover a lot quicker than before. In fact, by the end of the year US GDP could be back to where it was before the virus crisis.

The stock market discounts what it expects to happen, not what is happening now. While there appears to be opportunity in companies like airlines, hotels or restaurants, the good news might already be priced into those shares. If you invest for a cyclical recovery, then you must invest early, and sell early. While we are not saying the buying opportunity is over yet, we are uncertain about the level of sustainable economic growth.

Once the global economy has recovered, the growth path from there is likely to be quite pedestrian because of the levels of debt being carried due to stimulus efforts. In fact, it could be quite difficult for many companies to achieve good top-line growth. As always, the challenge for investment managers is to identify those that can.

Which brings me back to the point that investing for cyclical recovery is risky as you are buying with the intention of selling before the cyclical recovery matures, and it is very difficult to get your timing right.

In addition, inflation needs to be factored in. Many investors fear that the high levels of debt globally will lead to high inflation later. However, the same issue was raised during the Global Financial Crisis and inflation did not become much of a problem after the crisis passed.

There are two main factors mitigating against high inflation in the current environment. The first is the improvements in productivity that technology continues to bring, and the second is the structurally lower cost of energy, specifically oil. These factors will, in our view, continue to keep inflation in check.

What could be another issue is employment, as inflation is also driven by employment costs. While governments have and are continuing to prop up consumption with stimulus efforts, these will eventually end. Will everyone go back to the jobs they left in the crisis? During the past year, companies have become very effective in managing with less manpower during a crisis and are unlikely to re-employ everyone.

Investors want to believe that once the pandemic is over, everything will go back to the old normal. However, we believe that instead, we will return to a different kind of normal. Everything evolves including what is ‘normal’ and the pandemic has accelerated that evolution.

Instead of looking at shares that will benefit from a cyclical recovery, rather consider longer term candidates. Some of the themes we see are technology, health care and luxury goods. Technology has become the main driver of the global economy, and given the pandemic, people have become even more conscious of their health.

Why luxury goods will benefit is less obvious. Because of rolling lockdowns, consumers have become more conscious of getting out and appreciating their loved ones and the good things in life, and luxury companies are doing exceedingly well. This is also being supported by the growing wealth being enjoyed by many people in, for example, Asia, specifically China.

Investing successfully is about identifying something that is sustainable, that will not change from quarter to quarter or year to year – something that compounds. That is the difference between strategic investing and tactical, cyclical investing.