CIO Insights: Disruption and Transition in the Cycle

Hi everyone

I hope this finds you well in what continues to be an amazing time in history. Surely this period will be used in future Economics and Business Studies curriculums across schools and universities.

Did you watch the Ray Dalio video I shared in last months insights? For anyone interested in better understanding market cycles, I encourage you to invest the 43 minutes to view this easy-to-watch, animated and enjoyable clip. Market cycles do repeat. All.The.Time.

In good times, everyone has more patience. There’s even an Australian phrase for it – “She’ll be right, mate”. People are happy to wait longer if they don’t get the outcome they are looking/hoping for straight away, and this is particularly so with investing.

Disruptive technology stocks, by definition, don’t expect to make money for the first few (or more) years of their existence. Indeed, many fail because they run out of capital before their idea comes to fruition. In good times, investors are more patient and willing to invest/reinvest in companies they think will be the next Amazon or Google, even though they won’t be profitable until (call it) 2025 and beyond. This is why disruptive technology stocks, in particular, fared so well until the start of this year. Investors were more patient, and weren’t too fussed that the companies would make losses for the next few years, because they hoped they would make up for it afterwards with supernormal profits. It worked for Amazon and many others, and buyers believed they had found the next Amazon. Some of the current disruptive tech stocks will become highly profitable and successful companies. And some won’t.

We saw a similar cycle in 1999-2000, where many, let’s call them ‘concept’ companies (with no earnings, and large up-front losses) saw huge share price appreciation. One of them was actually Amazon.

Then the Dotcom bubble burst.

Amazon fell from $91 to $7. Like many others it was reporting current losses, but promising future year profits. Investors gave up on them, or their patience disappeared, whatever you want to call it (ps. we all know Amazon eventually recovered, but it took many years).

The first thing to evaporate when bad times hit is patience. We saw it back then, and we’ve seen it again this year. Pandemics, supply chain disruptions, inflation, and rising interest rates all frighten investors, and rightly so. It represents a change in the market cycle. And the first thing investors have looked at this year when deciding what to hold and what to sell, has been current earnings. Not 2028 forecast earnings, but 2022-23 earnings. Stocks that don’t have current earnings have seen their share prices fall far further than profitable stocks. Patience disappeared.

The market cycle turned very quickly. Even the Central Banks around the world didn’t see it coming, and the consequence of that has been larger and more frequent interest rate rises, in an attempt to stymie the prolonged inflation that no one really believed would continue. Many investors didn’t see it coming either, so when it became apparent that things were worse than feared, patience in such ‘multi-year investment theses’ disappeared in favour of the more currently profitable companies.  

There are stocks and sectors that do well in different stages of a market cycle. When interest rates are rising, value, commodity, and bank stocks tend to do well. When rates are low or falling, consumer discretionary, utility, growth, and technology companies outperform. It’s always been this way, in every cycle. 2022 will go down as a transition style year, where interest rates finally normalised, and people were reminded that inflation does in fact still exist, despite all the advances technology has made in the past 30 years (how much did you pay for that ‘massive’ 18-inch television box in 1990, compared to a 55-inch flat screen now?).

Whether 2023 and beyond sees investors willing to be ‘patient’ again remains to be seen.

Separately, a couple of weeks ago, one of our Directors and I had the privilege of seeing what a difference HM1’s donations have made to Kids Critical Care Research (within the Paediatric Intensive Care Unit) and the Cerebral Palsy Alliance Foundation’s research out at Westmead Children’s Hospital. Whenever I have the privilege of being shown around there, I am truly humbled by the work the Professors, researchers, doctors, and nurses all do. The work being done at both organisations is making an incredible impact on so many people’s lives. It brought a tear to my eye, and reminded me of the fragility of life, and also why I work at Hearts and Minds Investments.

Regular readers of this missive know how much of a golf fanatic I am, so it would be remiss of me not to congratulate Cameron Smith on his incredible victory at the Home of Golf (St Andrews, Scotland) in the 150th Open Championship. A record equalling 20 under par, 30 on the back nine with five straight birdies, and Rory hot on his heels in top form trying to capture his fifth Major. As Jack Gibson once said, “done good, played strong son!”

 

Stay safe

Rory Lucas
Chief Investment Officer
Hearts and Minds Investments Limited

Reminder: these are simply my general views and should not be taken as investment advice

 

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