RANDS AND SENSE
By Jeremy Lang
While many analysts and investors see reason to be cautious at the moment, we see things differently. We believe the current environment is conducive to good investment opportunities and that the recovery we are seeing is not a normal recovery. We are particularly excited about the opportunities in the areas of growth stocks and recovery stocks and the availability of free cash flow – all of which make for an extremely unusual environment for recovery.
There were a lot of interesting growth themes simmering below the surface pre-Covid, which have been massively accelerated as a result of the pandemic – many of them unexpectedly so. This is one of the reasons the world is never going to return to “normal”. Normally in a recession environment, small businesses fail and consequently not a lot of small businesses are created, but in this period the opposite has happened. Where people were expecting demand to disappear completely in some industries, it has essentially exploded.
It’s the same for recovery businesses. This has been a totally different kind of shock which has forced many businesses to really think about what they are doing and essentially start again. Companies that are demonstrating the ability to re-imagine themselves are creating huge investment opportunities.
Take, for example, Capri, the distributor of brands such as Michael Kors, Jimmy Choo and Versace. Their distribution channels, which were already struggling before Covid, completely shut down when the pandemic hit and they have had to tear up the playbook and start again. They have embraced e-commerce, had a complete rethink about their supply chain and revolutionised how they conduct their operations. The breadth of what they have been prepared to do with the business has been exceptional. We are seeing great opportunities in businesses like this.
Finally a lot of this acceleration has made businesses a lot leaner. Businesses have been able to take advantage of huge amounts of free cash flow. Returns are exploding and there is liquidity everywhere.
Not a standard recovery
The recovery we are seeing now is not a standard recovery. Usually in a recovery we would expect to see a cycle in which a massive shock knocks the global economy sideways, there’s concern about the future of capitalism, leading to government intervention in the form of monetary stimulus to kick-start a recovery – at which point investors start to worry about what will happen when the government takes the support away. However, this recovery is different because of what caused this shock: Covid. This shock has forced everyone to rethink what they do – focusing on efficiency and doing things differently. This is the kind of shock that really energises economies.
The whole economic structure has been rethought and a tremendous amount of potential has been unleashed, which we think is tremendously exciting. This has been going on underneath all of the focus on government stimulus and global economic recovery.
We generally view CEOs of companies as dangerous; however, there are times when the experience of a severe shock such as Covid tempers the behaviour of CEOs and makes them temporarily more responsible in their decision-making.
We anticipate that this behaviour will revert back to normal once CEOs forget the feeling and the trauma of this shock, but for now it is possible to trust what many CEOs are saying about their businesses, if only temporarily.
The overwhelming narrative from CEOs is that this is a normal recovery.
Forecasters ‘too sceptical’
Analysts and investors are too focussed on valuation levels and are overlooking the widespread structural changes occurring beneath the surface. We have had a record number of surprises through this recovery – which tells us that the forecasters are wrong. They are too sceptical.
Investors are also sceptical. Stock prices are proving to be resistant to the very powerful recovery numbers coming through and, as a result, valuations have compressed a lot.
People are very worried about valuation levels, but I am more concerned about the path through time that tells me about scepticism – and I see a lot of scepticism. I see a pattern which suggests a narrative that this is as good as it gets and won’t continue once governments stop propping up the economy. But if you look down below, there are a lot of structural changes happening which are extremely exciting.
Jeremy Lang is fund manager of the Nedgroup Investments Global Behaviour
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