LEVATUS Investments | Simple Truths About Financial Markets
A confluence of new dynamics has burst onto the scene since the beginning of the year. Changing long-term cyclical and secular trends are likely at the heart of it.
Photo by Markus Spiske on Unsplash
Many, if not most, financial assets are mean reverting. All this means is that over time the price of an asset tends to move up, beyond the average, and subsequently trends back down and below the average. Repeat. The length of time this cycle takes may be different, but the pattern is the same. Importantly sometimes the long-term average line is upward sloping and sometimes it is not. Paying attention to this is important. What does this mean in the context of market performance this year?
We wrote to our clients recently about growth opportunities in the coming decade and where to find them. Our analysis speaks to the changing trends we see in front of us. Some of the dynamics of these past months look like the leading edge of what we believe represents significant long term opportunity.
Image by Tamas Tuzes-Kata
Growth Stocks
Growth stocks outperformed the equity universe by a lot in 2020. Apple, as an example, was up over 80% in 2020. Growth assets have outperformed by a lot for the past 5 years. NASDAQ outperformed the S&P 500 by over 90% from 2016 to 2020. It is not surprising to see growth companies pause relative to companies with different attributes that had lagged for many years. While there have been many explanations tossed around for this year’s divergences, we believe this simple explanation has the most merit. The fundamentals of Apple are good. Apple is a great company. The price got a bit ahead of itself relative to other assets.
2. Interest rates
Interest rates have been on a 40-year downward trajectory, which has now basically ended at zero. Yes, rates can go somewhat negative in absolute and real terms for a time. This has already happened in parts of the world. From a big picture perspective, however, absolute rates have basically met their lower bound. Therefore, it is not alarming or a reason to panic if interest rates are rising. In fact, if economic growth is picking up it is logical that rates should rise. There would be more red flags if interest rates were not rising.
3. small and mid cap stocks
The world’s largest companies (‘mega caps’) have wielded their technological and financial might for the past decade, dramatically outpacing their smaller rivals. Now, equalizers such as Shopify and Paypal have helped small companies to harness Amazon like powers, regulators are more acutely aware of anti-competitive practices and the tides are shifting. This does not make the larger companies bad; it just means that the scales are tipping back in the favor of smaller companies. Investors who continue on with the theme of large cap dominance may be missing important mean reverting shifts.
Image by Ben White
4. inflation
The price of imports coming from Asia has gone down every year for the past 20 years, but now, for the first time in a long time, import prices are starting to rise. This presents a hint of inflation, which has been mostly benign for a long time. It is not surprising that we have begun to see the end of the downward price push from globalization, as many emerging countries are no longer willing to produce products for near zero labor costs. In addition, commodity prices appear to be turning the corner after a twenty-year period of underperformance relative to equity prices. In the context of these two shifts, an uptick in inflation is not surprising. It also does not mean we are heading for runaway inflation. Historically, equities have been a good place to invest during periods of moderate inflation.
Image by Alex Knight
5. technology
We have been in a world where technology has ruled for several decades. Now, companies that employ technology are moving into the driver’s seat. The output that technology companies produce is not yet a commodity, but that is what the future holds. Figuring out ways to use technology for drug development, automated manufacturing, driverless vehicles, secure payments processing, is the wave of the next decade. The supply chain chaos of the past year will only accelerate this trend. We see nontechnology companies beginning to shine in a world that for many years only had eyes for technology companies.
Connecting investment cycles and investment process
Market rotation and mean reversion are not surprising; sometimes, however, trends that are in place for multiple decades lull market participants into a false sense of security and misplaced confidence in the continuation of a long-standing pattern . Historically significant volatility emerges when trajectories begin to change. An investment process that is rigorous, guards against clinging to trends that are in the rear-view mirror and recognizes the new emerging long-term opportunities that arise as directions shift, is key to meaningful success. Often when markets become volatile investors dive down into the details of aging trends for explanations, when really the explanation is much clearer when one steps back and views cycles from a higher vantage point.
Aligning long term capital with long term opportunities
The LEVATUS Approach to Investment Management
