It’s a Topsy-Turvy Year: Investing During COVID

Putting aside the health aspects of COVID,¹ it has also been an odd year for investors. The year started on a good footing. Then, as COVID-driven lockdowns occurred, we had the quickest surge in unemployment ever and a recession that turned out to be the steepest decline and most abrupt recovery ever. In a predictable fashion (ironically, as the market is rarely predictable), the equity market had its most abrupt plunge ever,² followed by the most rapid recovery ever. One might say, it was quite a topsy-turvy year.

“Topsy-Turvy” was a musical drama, released in 1999. It was a dramatisation of the famous partnership between playwright William Gilbert and composer Arthur Sullivan. Set in the Victorian 1880’s, this duo collaborated with good-natured opposing views and creative conflict to produce several operas, including “The Mikado”. But the origin of the term goes back centuries before that:

“They say that… they see the houses turne topsy turuye, and men to walke with theyr heeles vpwarde.” Richard Eden’s The decades of the newe worlde, written in 1555 and itself a translation of an earlier work written in Latin by Peter Martyr d’Anghiera (1457–1526), about the then “new world” of Asia and the Americas.

Well, that kind of captures 2020 as well, it seems! Even behind the headline GDP and market moves, the topsy-turvy aspects of 2020 go deeper still. Who would ever have thought, that in a recession with elevated unemployment and huge uncertainty, we would see personal incomes increase (due to generous government handouts), home prices increase, consumers pay down debt, bankruptcy filings fall, interest rate plumb their lowest levels and all the principal U.S. equity indices reach record highs?

As an investment manager, the above is weird. But when it comes to individual companies and sectors of the market, it has been even stranger. There are some stocks that typically perform better than the market average in a difficult economic environment. One such group is dividend-oriented equities. This is because these stocks are typically larger, profitable companies with well-established competitive positions, so they can survive a recession. Also, they typically trade at reasonable valuations, which provides superior downside protection in uncertain times. Not so in 2020. As an example, the S&P Dividend Aristocrats, which are the stocks in the S&P 500 that have an unbroken track record of paying dividends without a cut for at least a quarter-century, have, as a group, trailed the overall S&P 500 this year by the widest margin since 2007 – by about 11 percentage points to the end of September.³ Another category of good quality, but staid, stocks is the U.S. utility sector. These companies generate electricity, and distribute electricity and natural gas, in the most uneventful way in good times and bad. Well in Q2 of this year, they lived up to their reputation. The utilities sector was the only one (of 11) in the U.S. stock market that actually increased the sector’s corporate earnings year-over-year. So, how about the Utility sector’s stock market return? They walked with their heels upwards… with a -11% return for June 30^th year-to-date, the Utility sector’s return was well below the overall S&P 500’s -3% return. Only 3 sectors, Energy, Financials and Industrials, had returns that were worse than Utilities. Who would have expected that?

For an explanation, let’s go back to COVID. Investors were cooped up at home, many working remotely. All were concerned about the economy and all were keen for good news stories. Cue the growth stocks – everybody uses Zoom, everybody loves their Peloton bike, eCommerce is going to the moon (Amazon, Shopify), I need a Tesla, and so on. These, and many other growth stocks, are doing superbly well in the stock market. The entire group of growth stocks has beaten the value stocks this year and, at October 31^st for the year-to-date, was ahead by 32.8 percentage points.⁴

For investors, these are the COVID winners and losers. Looking back at the longer track record, growth stocks and value stocks have taken turns outperforming each other for periods of time. As is usually the case with equity markets, these periods and the leader are clear in retrospect, but looking forward it’s largely unpredictable. Which one leads, when, for how long and by how much? It may seem a slam dunk that growth stocks will win over the long term. After all, they tend to be new economy stocks with the advantage of better growth. The complication is that, ultimately, for a stock to have a good long-term return, the company needs to generate a reliable profit stream and investors shouldn’t pay more today than that future profit stream is worth. The reality is that optimistic investors frequently overestimate and overpay for this future profit stream. For these growth darlings, with high growth comes more competition. With more competition comes less-than-hoped-for profitability. The valuation of a stock – what the investor pays relative to what he gets – matters. Not all the time and not now, but eventually. Over the long term, it’s actually the value stocks that have performed better. The value investor is still 4.3 times as wealthy as the growth investor over the period from July 1963 through June 2020.⁵ This outperformance by value is simply the flip side of the coin – if there tends to be too much investor optimism with growth stocks, so, too, is there typically too much pessimism for value stocks. Investors, in general, assess these slow, established economy stocks and their outlooks pessimistically, such that the stock may well be “good value” and many deliver a better profit stream than expected.

Returning for a moment to Gilbert & Sullivan’s Topsy-Turvy travails with the creation of “The Mikado”. It turned out that The Mikado was the start of Gilbert & Sullivan’s long road to fame and riches. Let’s hope that the topsy-turvy world of 2020 is the start of a more profitable streak for investment strategies with a quality and value orientation.