The first half of 2020 has been anything but ordinary. We went from forest fires, to the threat of a new world war to total economic lockdowns. But what has remained constant during this period is the unrelenting march of the stock market. Upwards and onwards.
The US indices in particular have shrugged of any curveballs thrown at them this year and have exploded higher. By some estimates, US stocks are now in bubble territory. By others, we are just getting started.
The company’s that have done well and profited enormously from the lockdown are those that have captured the shift to online. Amazon, Apple, Alphabet (Google), Facebook, Microsoft, Mastercard, Netflix, Paypal, Shopify, Zoom. The list goes on and on. US indices are dominated by these so called new economy stocks. No wonder US markets have done well.
Across the Atlantic, the UK based indices have done less well over the first six months of the year. The FTSE 100 is down 16.9%, the FTSE 250 midcap index is down 21.9% and the AIM 100 is down 8.4%.
Many are speculating that UK based indices, now at bargain basement prices, should recover to their pre-Covid levels and therefore represent extraordinary value for investors. While this may be the case for some companies within the indices, there seems to be good reason for the atrocious performance of indices as a whole.
To keep it short, UK indices are full of old economy stocks. Cyclical companies with levered balance sheets and poor pricing power. Companies that have failed to adapt to changing customer expectations and whose growth and profitability are structurally challenged. The kind of companies that will do badly in the economic environment we’re experiencing.
For UK focussed investor, now is a good a time as any to be choosy. I don’t want to be stuck in bad businesses via my index fund exposure. That is why I don’t invest in UK indexes such as the FTSE 100. I dislike the composition. On the other hand, I would be more than happy to be invested in the S&P500.
It is a shame that the UK has a limited selection on these so called new economy stocks. Software is eating the world. As Satya Nadella of Microsoft put it “ we have seen two years’ worth of digital transformation in two months….in a world of remote everything. There is both immediate surge demand and systemic structural changes across all of our solution areas that will define the way we live and work going forward.”
Going forward, all companies will have to become technology companies. Businesses will have to accelerate the resilience, flexibility and capacity of their technology infrastructure. If the new normal is here to stay, those that play by the rules of the old world will soon disappear.
The problem with buying into the so called new economy stocks right is that I feel like I’ve missed the boat. These stocks are trading at mind boggling valuations. A lot has to go right over the next several years to justify today’s prices. Take the dotcom craze as an example. Investors were predicting that the internet would become this huge all encompassing thing. Whilst that certainly turned out to be true, many investors actually lost money in dotcom stocks due to the excessive valuations stocks were trading at. So valuation certainly matters.
Having said that, I have shares in companies such as Paypal who’s valuation seems excessive at present. But I would not sell the stock at present even though it is trading way above my intrinsic value calculation. Why is it so much easier to hold an overvalued stock than to buy one? I wish I had an answer to that.
Investors need to be extra cautious when navigating the markets in these testing times. One needs to buy into companies that are not cyclically challenged, over leveraged and going in the way of technological obsolesce, all at a reasonable valuation.
It becomes increasingly tricky once you impose these stringent criteria on any new purchases. But this is really important considering the unpredictable times we are in. Rather be safe than sorry. As Buffett says “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”
For the month of June, I only invested in one company, PZ Cussons. Consumer staple companies are exactly the time of businesses I want to be in now. Their demand is consistent regardless of the state of the economy. They have very low capital expenditure. They have high pricing power. And they produce torrents of free cash flow which they use to reinvest in the business as well as shower on shareholders.
I bought shares 250 shares in PZC at a price of £1.72 each. For this purchase, I am expected to receive dividends of £20 per year. Looking at my portfolio as a whole, it is now expected to generate £3,740 in annual dividend income.
Looking ahead, we as investors need to keep our eyes wide open. We need to recognise that, post this crisis, the world may not be quite the same. Attitudes about health, contagion, assemblage, consumerism, debt and savings will no doubt be different for some period of time, resulting perhaps in a tamer form of capitalism, characterised by less tolerance for unpreparedness, leverage and complexity and greater emphasis on safety and transparency. On balance, such a shift will be beneficial for everybody. We also need to be prepared for any fiscal shocks that come our way. For we will have to pay for all the ‘free money’ that has come our way. And what better way to do so from a government standpoint then by increased taxes.