Dear Reader,
This week was all about the end of the pandemic. Which hasn’t happened yet. But markets, being forward-looking, suddenly decided to price in a vaccine that works and a return to normality.
Stocks that boomed thanks to COVID-19 suddenly got smacked. Stocks that languished during lockdowns boomed.
Zoom crumbled, airlines went ballistic, for example.
It’s all very intense. Imagine a world where you can travel again. Where lockdowns don’t threaten you. And going to get a haircut doesn’t feel risky.
Sounds great, right?
I’m in Japan, where life continues normally, but with a lot more masks. A friend escaped the UK lockdown for Sweden, where life continues normally without masks, until 10pm at least, when the bars close…
But today, we look at the big events from an investor only point of view. Because the key questions facing investors are very different to what you experience in the real world.
First of all, the question isn’t: ‘how the pandemic has changed the world?’ It is ‘by how much?’ And the all-important: ‘compared to how much the market is expecting?’
For example, if the market is pricing in a return to normality by January under a Pfizer vaccine, it’s likely to get disappointed. As good as the return to normality may be, if it’s later than the market expects, the market will fall.
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If the market is predicting the work from home lifestyle will be permanent, it’s likely that Zoom stock remains a sell as some people go back to work.
More on these scenarios shortly. For now, they’re just illustrating the broader point I’m trying to make.
When making investment decisions, being able to predict the future is only half the game. You also need to figure out what future the market is pricing in.
And that’s a question very few investors ever bother with. They think a prediction about the future is good enough. But it isn’t. You have to be a step ahead of what the market is expecting too. If the market is already pricing in the future you see coming, your investments won’t outperform.
The good news is, you can outsmart the market in many ways. Or, at least, try to.
You could try to be first — before the market figures something out. An early adopter of bitcoin, perhaps. Or you could’ve listened to early warnings about COVID-19 from inside China.
Another option is to figure out when the market is simply wrong. The sub-prime crisis began in 2006 or even 2005 by some measures. The market didn’t figure out how bad it would be until 2008. There were plenty of people who warned about it in the meantime.
Regular investors probably shouldn’t try to outrun the market. You’d be competing with some rather impressive machinery, which is located a lot closer to the exchanges than you are.
The point is, there are ways to identify where you can do better than the market at being right about the future. And that’s where investment gains come from.
So, today, we try to prod and poke at what our future might look like. And whether the market is pricing it in or not.
Working from home?
I’ve stopped and started working from home many times in my career.
Hayfever kicked me in the face for four years before I finally left our Melbourne office and moved back to tropical and unseasonal Queensland, working from home. Then I worked from the UK office in London for a few months because working from home had made me too lazy.
After a break working as a trapeze artist in Thailand, I went back to working from home in Perth. Then I returned to the London office once more, intending that to be permanent. The pandemic had other ideas…
I feel I’m uniquely qualified to tell you that the working from home trend is permanent, but incredibly complex and messy. Simply buying stocks that you think will benefit from it will prove a challenging strategy.
And, more importantly, it’s a boom that may have surpassed us already. The market priced in a long pandemic with a series of lockdowns and working from home thereafter. We’re likely to see the working from home trend go the other way after the pandemic opens up.
That’s why pandemic-booming stocks fell on Monday as the Pfizer vaccine news broke.
Unlocking the global economy
One argument is that a return to normality could happen remarkably quickly. For any reason. If you can lockdown an economy, you can unlock it too.
The market action this week displayed the potential returns nicely. Airline stocks were the best example.
A vaccine, even if it doesn’t work, might be all we need to give politicians an excuse to open up the global economy. Tourism, travel and leisure could boom.
Here in Japan, people are going to theme parks and queuing like sardines. I’ve had to watch them and hear them scream from my lockdown window…
While some people in Australia were banned from travelling interstate, the Japanese people have been subsidising such travel within Japan to boost internal tourism.
While some people in the UK cannot go to restaurants, the Japanese government subsidises them to do so…
But what is the market pricing in? Such a return to normality?
I don’t think so. Airline stocks are still deeply depressed from their levels earlier this year, for example.
Opportunity?
Perhaps…
The debt crisis is deferred, not defeated
But what about all that debt? All the mortgages which are deferred, government supported loans to businesses that’ve gone bust, government debt itself?
Has the market priced in the defaults and foreclosures coming the moment we try and open up the economy again?
I don’t think so. The bond market certainly hasn’t. Some of Greece’s government bonds have a negative yield, for example.
A debt crisis, just when the market is expecting a recovery, would be quite a shock. The key thing to remember about them is that they take time to play out. Especially when the government is using a pandemic as a reason to defer the fallout.
A return to normality in the debt markets could expose something very ugly the market isn’t pricing in.
Gold, either way
The interesting thing about gold is that it can benefit from both a crisis and a boom if that boom is inflationary.
The irony being that the gold price tumbles at the onset of both these scenarios.
At the beginning of a crisis, the gold price falls alongside everything else. Why? It is a long story involving the investment banks involved in the gold market and their other positions.
But, as the government and central bank responses to the crisis begin, and as investors seek safe havens, the gold price tends to outperform in a crisis thereafter. Including the COVID-19 shock and 2008.
This is an easy market mispricing you can take advantage of in a crisis. Buy the dip.
This week, the gold price got smacked despite the narrative being a sudden recovery under a vaccine. This seems unfair at first. If gold takes a hit during the onset of a crisis, surely it should go up at the onset of a sudden recovery from a pandemic?
But no, that’s not how it works.
If a global boom is on, safe haven gold looks like the wrong bet. And so the gold price fell on the pandemic news. Dramatically so.
However, and this is the key to gold’s medium-term future, it seems to me that interest rates will lag behind the global boom, if we do get one coming out of this pandemic. There is simply too much debt to raise rates on, as just described.
This in turn means that monetary policy will be one step behind inflation. And that’s the most important influence on the gold price there is. Inflation ahead of interest rates makes gold go up.
As I see it, the recent gold slump is a buy either way. One way you can get ahead of the market and profit from it being wrong too.
Is the pandemic even over?
Earlier I suggested some things about the pandemic that I’m not convinced of. Basically, that it’s over or wasn’t particularly dangerous to begin with.
Next we consider the reverse, which I’m not convinced of either. But you might believe it and it illustrates my point today well.
The virus could mutate. Or it could break out in Australia before the vaccination arrives. That’s what has happened to many other nations, which escaped earlier outbreaks.
These things are not priced in and would likely trigger another downturn in stocks.
Never mind whether you agree with these different predictions and scenarios. Instead, take away my real message. Whatever future you see coming, don’t forget to consider whether the market has already priced it in.
Until next time,
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Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend
PS: Australia’s Great COVID Recession — Learn which investments to accumulate and which ones to avoid in order to give you the best chance of preserving your wealth during the recession. Click here to learn more.
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