At the risk of sounding insensitive to the suffering and pain caused by Covid 19, I admit to not being an expert of Pandemics and therefore will stick to what I know, portfolio management. Today I aim to highlight for all investors, panvestors and their portfolios, one very important risk of Covid 19, is you yourself. If you can read through the rest of this piece without having to look at your phone, your insta, twitter or FB, then you are half-way there in protecting your portfolio and its future returns.
Too Many Happy Chemicals 😊
Given, Covid 19 and its ongoing panic, you might not be feeling too happy. Lets not forget that like different crises before we will pull through this. With an cautiously optimistic approach let me introduce you to your happy chemicals that determine how you behave and act, especially when making important decisions;
Dopamine – One more, one more please
Endorphin - No pain
Serotonin – Loyalty and allegiance
Oxytocin - Intimacy and safety with team mates or tribe
The first two, Dopamine and Endorphin are often referred to as the “Selfish” chemicals as they come with self-preservation and gratification. The latter two, Serotonin and Oxytocin are seen as the “Selfless” chemicals only released for our enjoyment when engaged for or with others. Personally, I am especially fond of the latter two.
Amongst these four, Dopamine has been much talked about especially in regards to the relationship between us and our social media intake. What is not talked about is the fact that the same dopamine hit has been received by us all through returns on our portfolios over the last decade. It has created many equity market dopamine addicts over the years.
Up until recently most stock markets, especially US have had us enjoying the dopamine kick year in year out. So much so that as of late last year, the 10 year average total return from S&P500 was running at >15% pa. The last time we saw same kind of returns were in 2000, 1990, 1960 and 1930. Unfortunately COVID 19 and its impact has inconveniently disrupted this equity return driven dopamine hit.
The chart below shows the move in Nasdaq, S&P500 and Dow Jones indices over the last 10 years. How does it make you feel?
Almost everyone I have met in the last few weeks is licking their lips and wanting to buy. Buy US, buy tech, buy gold, buy Facebook, Apple, Amazon, Netflix and Google, the famous FAANG. We have or will have buyers for almost all assets which had shown positive momentum over the last few years.
Is the recent fall making you want to buy?
This otherwise happy chemical, Dopamine, is currently appealing to two of our most powerful emotions, Greed and Fear. In my 25 years of investing both of these emotions have been behind some of my worst investment mistakes.
With the last 10 years of Dopamine addiction, the risk we run now is that we remain greedy for that same stock hit, wanting our stocks to reach the old highs and make new ones even if we cannot see where and how the post Covid 19 world will be. Our addiction is screaming out “one more, one more please”. The other side of Dopamine is creating the fear of missing out (FOMO), in case we missed the party and now believe like the current resident of the White House that “miraculously” Covid 19 will disappear in April. Our greed and fear needs to be tempered with patience and good judgement, backed by due diligence and analysis.
Data Over Dopamine
This is not the time to blindly go where the crowd has been before. It is the time to buy those businesses that you have looked at, understood and always wanted but were not willing to pay the hefty prices. As an example, many investors are looking to jump into the US equity market on every down day. Without even claiming to know how Covid 19 will impact US economy, I believe that there are some facts that must be considered.
US stocks have seriously outperformed global peers, especially eclipsing their European counterparts over the last decade
2. This has been justified given the massive profit margin improvement in the US versus global peers
3. Productivity aside, US companies effective tax rate is at all time lows
4. And their share of US GDP is at all-time high
5. US companies Pre and Post-Tax Profit exposure to the globe is also at all-time highs (non-crises period) of 45% further bringing into question the US earnings exposure to global growth
6. US stock (S&P500) earnings growth already stalled in 2019 as shown below and yet the party continued with high hopes for 2020. Human nature being what it is, we start high on our estimates and then downgrade as reality sinks in and often over estimate on the downside as well. Are some of the companies already priced for a worst case earnings impact?
Charts courtesy of Minack Advisors – March 2020
The point of the above exercise is not to provide some definitive claim for or against US equities but to highlight that data can show how much has changed even in the last 10 years and how it may change in the coming years. Can US profit margins continue to delink from global peers? How many more tax cuts can corporate US expect (other than the currently proposed short term payroll tax relief)? Will foreign tax loops become harder to navigate, as countries need taxes to fund what will be a fiscal solution to the current economic problem? Given 45% of US profits are from offshore, are investors prepared for their new found global sensitivity? Will PE re-rating sustain another year of no earnings growth? These are some questions that will need to be answered before one bets on their next dopamine hit without getting duped by it.
At Panarchy Partners understanding our portfolio companies outlook in a prolonged Covid 19 world is our first priority, with data and discipline not dopamine driving our decisions.
I wish everyone a safe and healthy period ahead. Also a special thanks to my dear friend and very well informed global strategist Gerard Minack, for always looking at facts from a different prism. Over the years we have agreed on much and agreed to disagree on some, but data is data and we both tend not to let Dopamine win over Data.