<![CDATA[Coronavirus crash: for value investors, Covid-19 can be a crisis and an opportunity]>
This is the fifth time this has happened over the past 100 years: the Roaring Twenties, Nifty Fifty, Dotcom, Global Financial Crisis, and now the FANGs (Facebook, Amazon, Netflix and Google) and Unicorn bubble.
As the saying goes, history repeats itself, and for equity investors who were heavily influenced by the overall positive market sentiment, rational thought and valuations once again went out the window. At any time, buying shares without paying close attention to valuations makes little sense to value investors.
After all, when we buy other things, like tangible goods and services, we engage in a "value for money" consideration before buying. We don't punt on a fridge, guess the value of a car and just pay for it, or book an unfamiliar hotel without taking a close look at reviews and prices online.
People walk past a board showing the Hong Kong share index on April 14, 2020. Photo: AP
An abundance of positive sentiment drives bubbles as markets become crowded with like-minded investors. We vividly remember the Dotcom bubble, which ran from 1994 with the founding of Amazon, to the peak in 2000, with United States vs Microsoft in federal court and the collapse of Lehman Brothers, which led to the global financial crisis.
Dotcom was a perfect example of value being brushed aside during a growth bubble. As the spotlight shone brightly on companies that were often nothing more than airy ideas, investors chased the hype and this led to bizarre valuation practices such as "price-to-revenue ratios" to justify investing in a company that had no profits.
The subsequent crash led to a period where value investors succeeded as growth investors licked their wounds. What followed was a period during which good valuation practices produced solid returns and it has only been in the past four or five years that we have seen a pronounced shift away from value and back to growth.
Since 2016, investors in growth have been crowding into expensively priced stocks in the belief that massive earnings growth by these companies in an ultra-low or negative interest rate environment will be the most logical outcome, and source of outperformance.
Negative market forces over the past few years, such as trade wars, Brexit and sabre-rattling in North Asia, did not manage to disrupt the Unicorn narrative. It is the disruption caused by the coronavirus which now makes the earnings growth outlook opaque, and the most common refrain in upcoming announcements from all corners of the globe will be profit warnings.
A recounting of the last century's bubbles and busts is instructive. The "Roaring Twenties" left a trail of massive uncovered debt as interest rates were jacked up, and ended in the 1929 crash and the Great Depression. Afterwards, value investing outperformed well into the 1940s.
Then in the 1960s and 1970s, investors, buoyed by seemingly endless positive market sentiment, bought the top 50 American blue-chip stocks " the long-term holds " and ignored fundamental stock valuation metrics.
The subsequent crash of the "Nifty Fifty", arguably the result of skyrocketing oil prices, Watergate and rising inflation and interest rates, led to a period where value again outperformed into the 1980s. That lasted until the cycle was repeated about seven years later with the Black Monday crash in October 1987, following the attack on oil tankers in the Persian Gulf.
During these periods of overheated economies, easy money and prolific stock speculation, the valuation metrics which form the basis of good fundamental analysis " studiously learned when entering the financial industry " are forgotten or ignored until the supply of "greater fools" runs out.
Graphic: SCMP
The question we face today as the coronavirus crash of 2020unfolds (aside from whether we will survive) is: are we approaching a turning point where value once again becomes an investment proposition that outstrips what growth has to offer? If this is the case, it would suggest the start of another cycle in which we should seek shares in solid businesses that pay good dividends and can afford to reward their shareholders.
Or is the flight to bonds, gold and safe-haven currencies temporary? Perhaps by the end of the summer the coronavirus dies off and investors pile back in.
The latter scenario is becoming increasingly unlikely, as this market shakeout is turning out to be not just a "correction" but potentially a transitional shift, driven by panic. The impact of the global financial crisis, which the coronavirus is likely to match, wiped about 50 per cent off share prices, a fall that we are close to seeing again.
Pandemics and epidemics will always be with us, they are part of an evolutionary arms race between the human immune system and mutating bacteria and viruses. However, coronavirus disruptions could now become an annual event with the first sneeze of winter. There have been 11 coronavirus outbreaks over the past 20 years, and several known coronaviruses that have yet to infect humans are present in animal populations.
People queue in front of a public bank to receive government assistance in Brazil. Photo: Reuters
This year's Covid-19 experience will lead to long-term changes in the way we live, work, interact and travel; just as the September 11 terrorist attacks changed our perception of safety. Similarly, the impact on companies this year is not going to be just a short-term disruption of revenues, but long-term changes in the way they operate, employ, source and distribute.
Reliance on concentrated supply chains is now too risky. Dependence on a single manufacturer for key components means the entire product is at risk in the event of a new bug. No one can any longer guarantee a workforce that can reliably commute and turn up and work together. The risk of doing nothing and just carrying on as before is becoming too great. Change is likely to be a costly and lengthy process, suggesting a return to a scenario where investors require more than simply a stab at future earnings, but rather an assessment of value and the cost of changing the operations of running businesses.
In a crash, all stocks go down and valuations are reset. Markets tend to overreact to bad news, but where there is a crisis, there is an opportunity. What happens next is key. History suggests that a market shock of this magnitude will justify the patience value investors have shown. ■
Neil Newman is a thematic portfolio strategist focused on pan-Asian equity markets.
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This article originally appeared on the South China Morning Post (SCMP).
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