The word impulse has several meanings. It can be defined as a sudden, strong and unreflective urge to act. For example, I had an almost irresistible impulse to giggle. Or - for those last minute present-buyers caught with the news non-essential retail outlets were about to be shut just ahead of Christmas – I had an impulse to shop. It can also be used to describe something that might happen more quickly; the decision added impulse to the work that had to be done. In the world of biology, the word is used in the context of an electrical signal transmitted from the brain to a muscle; a nerve impulse. Finally, physicists use the word impulse to describe a force acting briefly on an object with mass that produces a finite change in momentum; airbags in cars are designed using impulse principles.
Exploring this example further, the impulse experienced by an object is always equal to the change in its momentum; in other words, an object with 100 units of momentum must experience 100 units of impulse to be brought to a stop. Moreover, any combination of force and time could be used to produce the 100 units of impulse necessary to stop an object with 100 units of momentum.
Airbags save lives because they are able to minimise the effect of the force on occupants, when a vehicle is involved in a collision. They accomplish this by extending the time required to stop the momentum of, say, the driver and passenger. Instead of hitting the windscreen, they hit the air bag and the time duration of the impact is increased. With modern airbags, this time duration might be increased by a factor of 100. Thanks to impulse principles, the bigger the T (time) the smaller the F (force).
Financial markets, impulse and momentum change
On 19 February 2020, the S&P 500 index reached its highest level (3386) since the bull market began from the Global Financial Crisis-low (676) of 9 March 2009. Few of us will need reminding that by 23 March 2020 it had fallen by 34% – the fastest fall of this magnitude in the history of the index. This precipitous decline was replicated across many stock markets around the world, as the Covid-19 health crisis plunged the global economy into its deepest recession in modern times. This rapid change in momentum would take some reversing and it took intervention on a massive scale and in very short order, by central banks and governments, to achieve this. To steal the impulse principles outlined earlier, it took a very large F – in the form of QE and fiscal stimulus – firstly discussed by policymakers, then finalised and subsequently implemented, over a very small T. As we know, for countries that implemented this response, it proved hugely successful in providing a financial bridge to the other side of the pandemic – whenever that might be – and asset prices responded accordingly.
The other side of the pandemic consequently came into view on 9 November 2020, when Pfizer announced their vaccine was more than 90% effective in preventing Covid-19 infections. This then triggered a huge momentum shift in market leadership as investors rotated out of so-called quality growth/safe companies, in favour of the equity and credit of those businesses and sectors that had been meaningfully impaired by pandemic mitigation efforts through lockdowns.
Growth/safe versus value/cyclical assets
This chart provides a powerful representation of the magnitude of this shift into previously unloved value/cyclical assets. The global banking sector and the price of oil, which were down between 30% and 40% in the year to 9 November, were up c.20% from that date to 27 November (when this chart was prepared). According to Goldman Sachs, this relative move was 2.3x the highest move seen in the prior 22 years; an astonishing 11 standard deviation event.
So, where are we now?
The latest wave of the pandemic across the northern hemisphere and the resultant circuit breakers introduced by governments is expected to hinder the economic recovery into at least the first quarter of 2021. The emergence of new, more infectious, variants of the virus – coupled with the logistical challenge of vaccine roll-out – are adding to uncertainties and the demand for quality growth/safe equities has not gone away. At the same time, investors are awash with cash and as lockdowns are lifted, vaccinations accelerate and social distancing restrictions are eased, previously distressed sectors are already attracting capital on the expectation of a cyclical recovery.
Meanwhile, mania fuelled by the digitisation of everything – including online trading – has made owning shares even more effortless. Over US$18 trillion of client assets are estimated to be held at the leading online brokerage companies; with many of these assets chasing the ‘hot’ growth names higher and higher, with little or no regard for valuations. Irrational exuberance is increasingly evident in the IPO (Initial Public Offering) market. There were 447 new offerings in 2020 worth US$165 billion; a figure eerily similar to the 1999 bubble number of 547, which raised US$167 billion. The average IPO in December soared 87% on its first day of trading, something we also last saw in early 2000. Airbnb climbed 113% – a home-rental company with close to a US$100 billion market cap, which is yet to post a yearly profit. Speculative investing abounds and where the ‘thundering herd’ is defining share prices, caution is warranted. As one of our long/short tech managers recently wrote ‘Popularity is not synonymous with fiduciary responsibility’.
Implications for portfolios
Notwithstanding the message above, the very same manager (Mark Hawtin, GAM Investments) also stated in his piece; ‘In more than 25 years investing for clients in this part of the market, we have never seen such dispersion in valuations and expectations’. Followed by an upbeat conclusion that ‘the current landscape could well prove to be a significant one for alpha generation over the next 12 months’. Admittedly, this is very tech sector specific, but suggests there could be some very big winners, alongside some very big losers. Net/net, the underlying index might not move much, but this will mask a very challenging environment for investors.
We suspect rotations, volatility and regular changes in momentum will be a feature of financial markets in the year ahead and have been positioning portfolios in anticipation of this. Committing capital to portfolio managers that can; invest both long and short; or are extremely nimble; or have a track record of capturing idiosyncratic returns; or harvest profits through a focus on relative value, has been a feature of our recent asset allocation decisions.
After all, our investment process is purposely designed to help us avoid any impulse which might be defined as an unreflective urge to act.
Please do contact us with any questions.
