Annus Horribilis - Q1 2021 Investing Outlook
2020 is a year few of us will ever forget. The Covid-19 pandemic shook every aspect of our lives. Against this difficult backdrop, Northland’s client portfolios performed well.
Three key investment recommendations drove outperformance:
Private debt: We have focused on this asset class for much of the past decade given industry leading returns relative to risks taken. Institutional class funds allow us to significantly reduce fees and deep industry relationships provide access to managers unavailable to many other advisors.
Private equity secondary funds: Secondaries provide a lower risk method of gaining private equity (PE) exposure since these funds buy existing PE funds at a substantial discount to NAV, have superior cashflow characteristics relative to the underlying funds and provide immediate diversification.
Bitcoin: We began investing in bitcoin in 2019 and it has increased in value by more than 400%. While we believe in the long-term technological and economic value of Bitcoin, we are currently reducing our overweight exposures to rebalance and to redeploy capital into assets which exhibit less volatility.
Covid-19 vaccines will unlock substantial pent-up demand. There will be a burst of economic activity once effective vaccines allow people to return to normal life.
In many ways, the Covid-19 crisis is like a natural disaster and historically, the impact of these types of crises on the underlying economy has always been “transitory”. This time should prove no different. The speed of the economic rebound since April has been rapid and surprised many investors. Retail sales in the U.S. and Europe for instance have not only clawed back all their lost ground but have made new highs.
Coronavirus cases and deaths have declined significantly since their January peaks. Data out of Israel, which leads the world with 47% of its population vaccinated, is particularly encouraging. And for the first time since the crisis started excess deaths in the U.S. are below trend.
Unfortunately for many of us, Canada is trailing behind some of the more economically powerful nations given its lack of a homegrown vaccine. Regardless, consumption in many large, developed countries is likely to return to normality in the second half of this year.
But that doesn’t mean that central banks and fiscal authorities will take their feet off of the gas pedal. In the US, the Biden administration has proposed an additional $1.9 trillion package, which will bring total fiscal stimulus over the past year to 25% of GDP if passed, more than five times the size of stimulus during the 2008-10 recession. Central banks have also done their part, promising to keep policy settings easy as far as the eye can see.
Accelerating growth with increasing fiscal spending and ample liquidity provides a fertile environment for creating asset bubbles. Signs of froth in late January mean markets are getting increasingly treacherous and a correction would not be unlikely.
With so much liquidity sloshing around, it is hardly surprising that it is winding up in unexpected places. I personally know someone of modest means that bought a Tesla car with her ‘winnings’ from a bet on Tesla stock (TSLA-US) that she bought because her nine-year-old son likes their cars.
Rampant speculation means the odds of a shakeout in risky assets are high. However, we doubt that a correction will represent the end of the economic cycle. As such, pullbacks should be viewed as buying opportunities.
What to Buy?
Rather than chasing the latest fad hyped on the Internet, we prefer to invest using tried-and true principles based upon undervalued assets with superior cash flows.
Every decade is defined by a major theme. Get it right and you are “laughing all the way to the bank”. Get it wrong and you are “carried out in a stretcher”. The 1970s was all about gold. In the 1980s it was Japan. The 1990s was driven by Tech. In the 2000s it was China and commodities. Then last decade it was the FAANGS (Facebook, Amazon, Apple, Netflix and Alphabet (formerly known as Google)).
But leadership never repeats in the following decade because after ten years the story is so well-known and the asset so overvalued that there are few buyers remaining. Instead, new leaders tend to be born from unloved sectors and deep undervaluation. Finding the big winners requires long-term vision, a deeply contrarian spirit and a steady hand to stay the course when all those around you disagree.
It is from this perspective that we have developed our major themes for this decade, namely:
Favour alternative assets: Private loans and equity remain inexpensive compared to their public peers because of the liquidity discount. Unlike in public markets, successful private managers tend to continue outperforming due to an information advantage. The odds of the massive pool of U.S. retirement savings (IRAs, Social Security etc.) opening to private assets is becoming increasingly likely.
$US dollar weakness: The USD is quite overvalued. Beyond a short-term bounce on rising risk aversion, relatively high levels of fiscal and monetary excesses suggest the path of least resistance is down.
Favour emerging markets: EM underperformed over the past decade resulting in cheap valuations. Relatively limited excesses suggest a stronger growth profile going forward, which should support outperformance.
Favour value vs. growth: Over the past century value (stocks that have significant assets, or trade close to their book value) have never underperformed growth (fast growing companies) by as much as it currently has. Consequently, relative valuations are extreme.
An improving economic outlook suggests that investors do not need to pay as much for fast growers, which should support value plays. At present we are particularly enthusiastic about distressed plays in the hospitality sector, but only with world-class real estate managers that Northland has access to.
If you have any questions or comments, please do not hesitate to contact your Portfolio Manager, or myself.
All the best,
Co-Chief Investment Officer
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