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9 minute read Tue, April 13, 2021
The fragility of financial forecasts
This time a year ago, 2020’s experience would have seemed unthinkable. Who would not agree that 2020 was a year of unforeseen events. A global pandemic forced lockdowns in most of the world. Markets fell 40% regaining their losses in the space of six months. Rocketing unemployment and double-digit economic losses coincided with some equity markets approaching record highs.
Similar to the Global Financial Crisis of 2008, the current Covid-19 crisis challenged economic and financial forecasts in every way. Forecasts again proved too fragile to be reliable, which makes us think harder about the longer term and sustainable investment drivers that offer portfolios some resilience when they hit headwinds.
This is also why we want to look beyond Covid-19’s immediate impact and challenges, so that we can avoid the danger that obscures some of the more profound and longer-term changes already under way.
Support will fade and investors will have to work much harder for their return.
Pandemic response
The response to the pandemic – massive central bank monetary stimulus and fiscal spending from governments - was strong and coordinated, triggering a shot of confidence to global markets. Central bank and government support, together with the progress in Covid vaccinations, will continue to dominate asset price movements in the near term. But once the stimulus has put economies back on track, support will fade and investors will have to work much harder for their returns as the fundamentals of low growth and low interest rates underlying our economies have not altered.
The risks
While remaining positive on risk assets for the coming year, we cannot disregard that valuations of equities and bond investments are somewhat exhausted. Equity markets, for example, have already priced in the end of the pandemic with the arrival of working vaccines. Some big technology stock valuations have priced in low rates, increasing sales and successful vaccination programmes to perfection. In fact, the danger is that stock valuations are getting ahead of themselves and may be setting up investors for disappointment down the road.
The current technological evolution is similar in importance to the introduction of electricity
Looking forward
Looking beyond the technological advances in home-working or e-commerce, for example, we believe that our economies are at the beginning of far more fundamental changes in the years ahead. Artificial intelligence, genomics, big data, robotics, cybersecurity and blockchain are just a few examples of technological innovations with powerful promise to touch every aspect of our lives.
The current technological evolution is similar in importance to the introduction of electricity in the late nineteenth century, or the arrival of computing power in the 1960’s. And like both electrical power and computing, none of these technologies are an end in themselves. Instead, they are disrupters of traditional business models as we know them.
We are still in the early stages. Every equity investor knows that technology names already dominate many stock indices. Even the largest traditional companies, such as Exxon Mobil, have been ousted. Or that new tech firms, like Tesla, boast market values far beyond their long-established rivals.
Yet much of their promise is still unrealised. Electric vehicles are an obvious example of a tipping point. Today they account for fewer than 3% of new car sales. But once battery efficiencies make e-vehicles cheaper, the transition away from internal combustion engines will accelerate rapidly.
Healthcare offers other examples. Covid vaccines were developed remarkably fast while medicine is turning predictive using AI, genomics, and big data for example. Healthcare is becoming highly tailored with smarter devices that make sense of a body’s every pulse and alert a doctor to problems before you know you are ill. And in public health, Google can already localise disease outbreaks, based on internet searches, days before hospitals see a rise in patients.
Capturing growth
If investors want to capture growth opportunities in portfolios, relying on traditional regional or sectoral allocations in public market assets will not be enough. The greatest changes from this year’s pandemic are just becoming visible. Sectors from airlines and hospitality to office real estate may not recover if they put their faith in 2019’s business models. At the same time, innovative companies involved in the development of disruptive technologies are moving ahead at eye-popping speed. Sectors such as robotics, cloud computing, autonomous driving, or e-commerce, to name just a few, have returned over 30% in 2020. Far from being stretched, they are at the early stages of their evolution.
Apart from the listed companies broadly available to investors, many still-private firms with innovative businesses are open to savvy investors. They dig into disruptive business models at the stage where most value is created; before companies are public. Private markets can therefore nurture value in early-stage firms experiencing exponential growth, while open to only a small number of investors. Some of these companies will deliver fundamental change to the economy. In the process they will displace older and soon-obsolete companies.
This search for creative and disruptive business models drives our investment philosophy and search for alternative and long-term sources of return, both public or private.
Participating in the technological evolution demands a dynamic and decisive commitment to a different investment approach. Understanding the implications for obsolete industries or dying investment models will set up portfolios for returns in the years ahead. 2020 inflicted a terrible virus. But all this transformation may be a once-in-a-generation catalyst for radical change.
