The epidemic significantly impacted the markets and the state of the nation. We think this presents a different opportunity set than the one that dominated the previous ten years and a half for equities investors; one that favors alpha (excess return) over beta (market return).
Key Takeaways
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Easy money is no more in style. With more difference between individual equities, the post-pandemic era is likely to be more erratic.
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When a rising tide lifts all the boats, beta—or market return—is enough. Alpha resides in the middle of the more conventional investing environment now developing.
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Skilled stock pickers have a chance to outperform a more discriminating market pricing stocks on their underlying fundamentals.
Including the crisis reaction and aftermath, the epidemic period created fundamentally different conditions under which the economy and markets are developing their base. We think this regime transition presents a different opportunity set for equities investors than the one that dominated the last ten years and a half; one that favors alpha (excess return) over beta (market return).
The Conclusion And Starting Point Of An Era
Establishing the core of the new market system calls for background knowledge and analysis of the dynamics existing before the present. The years following the Global Financial Crisis (GFC) were defined by 1) fragility and 2) unheard-of accommodation. Recovering from a severe recession and consequences from corporate and financial collapses were households and companies. The Federal Reserve (Fed) initially launched quantitative easing and lowered rates to almost zero in order to boost the economy and assist firms and consumers in healing, therefore supporting markets.
Forward to 2020 and the COVID-19 dilemma. Though the previous crisis caused a more strong shock to GDP, it was a moment defined by a worldwide economic shutdown and restart and an unparalleled mix of monetary and fiscal support significantly more than witnessed during the GFC. Stimulus money filled consumer pockets; demand for commodities was strong; yet, supply was constrained because to pandemic-related closures.
The crisis set off supply-side inflation, which was then supported by fiscal and monetary stimulus; conflict in Ukraine compounded this effect. To lower skyrocketing prices, central banks aggressively hiked rates. Although inflation is starting to reduce, sticky aspects like salaries are proving more difficult to lower, which sets the ground for longer-term higher inflation and interest rates just as stock valuations also are higher.
Implications For Investments: An Alpha Imperative
We think the post-pandemic investment environment marked by increasing inflation, rates and valuations will call for a fresh approach to equities investment. This new background implies lower market return, or beta, meaning that more stock portfolio gains will have to come from alpha, or excess return.
Returns to beta were abnormally high over the twelve years following the GFC as values shifted from extremely low to normal and the difference in returns across individual equities was limited. Investors purchased the declines, so the drawdowns were quite shallow and brief. In the case of any wobbles, the Fed also was ready to step in to save things. Beta was king as well-supported markets yielded remarkable performance that resulted in an average yearly S&P 500 return of 15% for calendar years 2010 to 2021.
By comparison, the period preceding the GFC showed longer and deeper equity market drawdowns, as seen below, implying higher volatility as well as more chance for competent stock selecting to yield above-market returns (or alpha). This dynamic is returning, and the view of alpha is growing more favorable. You may also read this: Why Saving Money is Important
Five Elements Leaning Toward Stock Selection
Although markets are famously erratic and there are no crystal balls in investing, we observe many market trends developing that favor an alpha-centric strategy to equities investment:
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More likely to rise than to fall in the equity market is volatility
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Stock dispersion standardizing from low levels, separating winners from losses
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Factors less important than stock characteristics in determining return dispersion
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Currently limited market breadth ready to expand artificial intelligence generating opportunity and disruption
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We investigate every one of these in the complete report.
The Comeback Of Varying Returns
Stock values, inflation, and interest rates are all higher in the regime presently developing—the post-pandemic age. Demographic trends—aging populations and fewer workers—as well as decarbonization and deglobalization—all of which are inflationary as businesses pay to adapt—are restricting supply. A less advantageous situation for financial markets, the Fed is more likely going ahead to be in a position of having to battle inflation rather than boost the economy.
Over the long run, equities have always been the asset class with the best return; we see nothing to change that trend. Higher stock values than at the beginning of the previous government with higher interest rates suggest, however, less return from markets generally (beta). Earnings estimates, valuations, stock returns show higher dispersion, which points to more possibility for experienced active managers to create more alpha. Consequently, in our opinion, active return will become more important component of investors' whole return profiles in the next years.
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