When the pandemic started in North America last year, the global financial markets started to slide into a rapid downfall and thus the chaos began. CH identified the four stages of 2020 in our February Portfolio Minute, which can be read here. The third stage of 2020 was the Early Rally, which occurred from April to October. A very small number of equities rallied mostly during this time, with the six largest companies in the world finishing the year representing over 25% of the entire New York stock market. So, why did this happen? Clients flocked to the certainty of mega-cap company’s stocks (companies with a market cap typically over $200 billion), whose stock prices recovered more rapidly as more and more of them were being traded. These stocks were and continue to be severely overpriced (P/E ratios nearing or above 100), so is the cost of certainty worth it?
Being Drawn to Certainty Isn’t New
The pandemic has been a unique and interesting time, to say the least, but investors being drawn to certainty is not. This happened in 1999 when the internet was going to change the world, leading to an extremely overvalued tech sector. Again, we can also look back to between 1973-1974 labeled as the “Nifty 50” craze, where a group of 50 companies became the “must-have” stocks to own. And yes, you guessed it- their stock prices skyrocketed to very high valuations. Investors justified paying whatever they needed to join the crowd despite market timing not being in their favor.
What Certainty Does Look Like?
Below is a table from EdgePoint that illustrates some of the “great” mega-cap stocks that were labeled as “must-own.” These companies reached at least a 3% weighting in the S&P 500 index and were all admired for the past successes, leaving investors certain this would turn into future gains. Investors paid the cost of certainty to own these companies, with the result being lackluster performance over 5 and 10 years.
The Certainty of Uncertainty
Our portfolio managers crave uncertainty. This allows them to have views about a business that their competitors do not. If every investor shared the same views, the market would achieve perfect certainty. There would be no undervalued stocks available to purchase, leaving no surprises and no positive outcomes. The market would simply produce a risk-free rate of return for every investor. What would this look like? A Canadian 10-year government bond is considered one of the safest investments, which is currently hovering around 1.50%. Now imagine this was your risk-free rate of return in our perfect market scenario. This doesn’t get an investor very far ahead, let alone break even if the rate of return can’t keep up with inflation.
When it comes to finances, our human nature draws us towards certainty. Who doesn’t want to have that level of comfort when they are about to retire, purchase a first home or start a family? When it comes to investing, CH believes uncertainty is not something to shy away from but an opportunity. As with all of our Portfolio Minutes, we welcome any questions or comments you may have.
All the best,
Devin Gorgchuck, Wealth Advisor
& Your CH Financial Team