Dan Kemp is the Chief Investment Officer for Morningstar Investment Management in the Europe, Middle East, and Africa region. Below is an excerpt of a presentation he gave on the economic impacts and outlooks in a Covid-19 world.
It goes without saying that we live in extraordinary times. We’ve never before had a deliberate stop on the economy in peacetime. And it’s not surprising that we witnessed a very sharp fall in asset prices in February and March 2020. Living through these periods can be unsettling, but I think we need to remember that market crashes are a feature and not a bug of investing. Crashes reset valuations and provide the opportunity for investors to improve their portfolios–and particularly to improve the expected returns of those portfolios long into the future.
To use an agricultural analogy, we can think of crashes as providing the fertile soil into which we sow the seeds of future returns. Unfortunately, unlike the turning of the seasons, the precise timing of crashes is unpredictable. You don’t know when they’re going to occur. Moreover, you can only sow seeds into ground that is cleared of the last harvest. Investors who left the previous crop in the ground too long hoping for a bigger harvest were poorly prepared for a crash and face the problem of trying to decide what to plant and what to harvest at the same time.
Now, we at Morningstar Investment Management, like anyone else, don’t know when a crash is coming, but the investment team spends a lot of time thinking about whether the current environment is favourable for investors and whether our focus should be on planting or harvesting. And as prices of some equity markets became very stretched over the past couple of years, we’ve generally taken a little bit less risk in portfolios, so we were reasonably well prepared for what happened in February and March.
Providing you’re not caught with your harvest rotting in the fields, investing during a crash is pretty straightforward. You simply buy more as prices fall and the margin of safety for future returns looks better and better. The questions become: what you buy, how much you buy, and how quickly you buy. We responded to those falls in February and March by rebalancing portfolios. That’s the first and most efficient step. Then, toward the end of that March period, we added more equity risk.
The current situation is now much more difficult. The opportunities we saw a month ago have declined. U.S. equities in particular have risen sharply, and simply adding more risk is less attractive than it was. Now we are much more focused as an investment team on finding the best opportunities. We’re especially interested right now in sectors that have been hit the hardest during the downturn–for example, global energy and high-yield bonds. We’ve been adding those positions to the portfolios.
We’re also seeing opportunities in markets that fell sharply but haven’t really participated in the recovery. U.K. equities are a good example of that, and some emerging-market bonds have become relatively more attractive as well. Of course, all these decisions are being underpinned by the deep fundamental research that’s the hallmark of our investment management team.
Another challenge faced by investors in volatile times is that they tend to look at the path behind them and use that as a guide to the future in front them. We can think of this a little bit like driving a car just using the rearview mirror or plowing a field (to stick with the agricultural analogy) just looking behind you. We know that leads to poor outcomes. You see that when people talk about the fact that we are past the worst, or that asset prices have risen too quickly–that indicates the path behind them is influencing the way ahead. The truth is that, frankly, we don’t know what the near-term future holds. So, our portfolios have to be prepared for a range of possible outcomes. We also have to prepare our clients, as we can only empower their success if they stay invested.
I’ve learned some things that may help you as you think about long-term investing, or for advisors who are asked questions by others. The first is that we have to acknowledge people’s concerns. We need to listen to them before they’ll listen to us. There’s no point just brushing past their concerns. We need to take those concerns seriously. Second, we need to understand that different people need different responses. Some clients need reassurance. Others will need evidence or data to help them make their own decisions. Some groups will need to be challenged out of wrong ideas or bad ways of thinking. Third, we need to focus on price/fair value and not on those past returns. By looking only at near-term returns, we can get the completely wrong idea. If you want to see how this works, I’d recommend going to the home page of Morningstar Direct and looking at the difference in the way that you feel when you look at year-to-date returns, which are a sea of red, versus the valuation lens, which shows a much more gentle blue (meaning that many assets are currently undervalued).
And then fourth–and most importantly–we need to focus on goals. The question is not how much is in your portfolio, but whether you’re on track to meet your goals. An investor who has clear goals and a portfolio that’s matched to those goals is likely to be more empowered and therefore successful.
Kyle Cox, Investment Analyst, EMEA
Dan Kemp, Chief Investment Officer, EMEA
With the Trump administration starting a purported trade war with China on July 5, questions have
grown into fears over how tariffs may affect the global economy. However, we offer a more nuanced
response to the question, posed in the title, which is on many investors’ minds today: We do think U.S.
stocks are overpriced now and believe selling overpriced assets is a good discipline. But selling should
not be driven by fears, macro events, and the like. In fact, over the long run, investors usually perform
better when they ignore these market tremors and stay focused on their financial goals.
A Nasty Trade War Is Possible, But How Likely?
Investors seem spooked by the recently announced tariffs and the possibility that all of this may lead to
an ugly trade war. The subject has clearly grabbed attention and headlines. As illustrated in the exhibit
below, Google searches in the U.S. for “trade war” and “tariffs” spiked in recent months as the Trump
administration began an effort to renegotiate terms with its trade partners, starting with tariffs on steel
and aluminum announced in March. That move was aimed at China, but also impacted many other
Unsurprisingly, China prepared countermeasures by proposing tariffs on imports of American soybeans,
sending commodity prices tumbling. Mexico and Canada faced challenges as the U.S. administration
sought to renegotiate the North American Free Trade Agreement. European countries confronted the
U.S. over tariff threats on autos. Retaliatory measures from all sides raised the probability of an
extended conflict that may hamper global economic growth.
We don’t believe that the announced tariffs present a major threat to global economies. The proposed
tariffs are significant and would affect 23% of U.S. imports, primarily hitting auto imports. However, we
believe the U.S. economy, in particular, is large enough and domestically oriented enough to not feel too
much pain from current measures.
Of course, trade tensions and tariffs could become more severe and, at worst, tip the global economy
toward a recession. But getting too focused on a worst-case scenario ignores the possibility that
tensions cool, compromise is reached, and investors go back to focusing on strong earnings. It wasn’t
too long ago that presumed nuclear conflict on the Korean peninsula sent tremors through global
markets, but that seems to have been laid to rest for now.
Should Investors React?
The short answer: no. We focus on long-term valuations—the true and durable value of an asset class,
rather than its market price. Having a long-term perspective makes the next turn in the trade spat less
concerning to us. Instead, we ask, “How might this affect fundamentals over the next several years?”
Investors who trade on emotion and market reactions are more likely to sell when markets are low and
buy when they’re high. We seek to do the opposite, in part by sticking to our principled approach to
investing, which is designed to keep us rational in a sometimes irrational world.
Because we’re defensive now, we are prepared to be buyers if this or other concerns provide an
attractive buying opportunity. That point isn’t here yet. The effects of trade-war fears on U.S. stocks
have been minimal to date, with the post-crisis rally still up 15.3% on average for each of the last eight
This long bull run has made U.S. stocks pricey, we believe, so we’re expecting below-average returns
from U.S. stocks over the next five to 10 years. But that does not mean we would ever sell stocks—or
any asset—based solely on newspaper headlines, the macro view, or fears. In fact, if anything, fearbased
price declines alert us to possible buying opportunities.
What Should Investors Do About Macro Events?
Perhaps the easiest thing to do is to do nothing. Ignore the headlines and stay focused on the long term.
But really the best investment advice is saving advice: develop a plan to reach your financial goals, then
stick to it. When you get an itch to do something different, try saving more—that’s probably the best
move to improve the chances of an investor reaching their goals.