- What’s changed and what hasn’t
- A tale of two halves
- Investment implications
In a recent ad campaign from the travel company Expedia, actor Ewan McGregor asks the question, “Do you think any of us will look back on our lives and regret the things we didn’t buy or the places we didn’t go?” It’s a clever ad that plays on the burning desire of many to get back out there now that most of the pandemic restrictions have been relaxed.
What’s changed and what hasn’t
Just as we’ve all had a lot of personal change in the past three years, so have the economy and the market. Trends are changing at a much faster clip than we’re used to. For instance, 2020 was a year of adjustment to the live/work-from-home shift. Year two of the pandemic, 2021, was all about buying goods as we had little else to do. As Mr. MacGregor suggested, this year is shaping up to be one that’s all about experiences – like travel.
Despite the rapidly changing landscape, one thing that’s remained unchanged is human behaviour in the markets. Many market participants continue to show classic signs of greed, by extrapolating near-term trends with little respect for the underlying durability of business trends and long-term investing. What else can explain the meteoric rise and subsequent fall of some of the live/work-from-home pandemic favorites, such as Zoom and Peloton? (See figure 1)
Figure 1: Total Returns (Indexed) in USD
A tale of two halves
Recently, we’ve seen a number of established retailers suffer as inflation, supply chain, and inventory (mis)management have become problematic for earnings. The impact of these issues has been so great that even the mighty Amazon couldn’t escape them. While many consider these to be the underlying causes affecting earnings, we view it as normalization from the demand pull forward in the stimulus-rich year 2021 (the buying goods phase of the pandemic).
Figure 2 shows sales growth for several large U.S.-based retailers. The first five are “essential” businesses, while the last one is primarily a clothing retailer (TJX owns Winners and Marshalls, among other banners). The essential retailers, such as Walmart, had impressive sales growth in 2021 while TJX saw sales decline by over 20% sales in 2021 due to lockdowns. In 2022, the script has flipped as TJX is now thriving while the other retailers have seen slowdowns and earnings pressure.
Figure 2: Sales Growth - demand pull forward in 2021
What’s selling within these retailers is also flipping in 2022. For instance, fitness and beauty product spends are improving (got to look good to see people in person again), while early pandemic winners, such as home improvement and athletic wear, are showing a deteriorating trend. Such variability and volatility in demand of goods and services over a short period of time tests even the best of management and retailers. After all, they’re as human as all of us and navigating such an environment is challenging.
Some things never go out of fashion, like investing in a diversified portfolio of companies with sound business models and superior management, at lucrative valuations for the long term. While we don’t claim to predict any of the macro variables that impact businesses with any certainty, we’ve seen that investing in such a manner has yielded superior returns over a period of time.
This is simply because good businesses, with the right management teams, adapt and evolve to perform better than the rest irrespective of the environment. Investing with a long time horizon allows these businesses to just do that and avoid short term noise. To emphasize the importance of having a diversified portfolio, imagine having both Dollar General and TJX in your asset mix during 2021 and 2022. Both mellowed the declines in sales for each other during these years.
With these principles in mind, we see that volatility is a friend of long-term fundamental investors, such as ourselves, as it gives us the opportunity to buy good businesses at lucrative prices when many market participants worry about short-term noise.
In our U.S. portfolios, we hold a number of diversified retailers that showed their resilience during this earnings season, owing to their superior business models and management. We also benefited from our diversified exposure wherein we focus on end drivers of the business irrespective of their sector classification. Off-price retailers, like TJX, and dollar stores, such as Dollar General and Dollar Tree, benefitted us greatly. At the same time, we diligently keep an eye on investment opportunities that come our way due to this increased volatility.
Recessions, inflation, interest rates, supply chain, wars, lockdowns etc. are all part and parcel of the current market dynamic. In the past, while we may not have had COVID-19 or related phenomenon, there was always something that made the markets worry over the long run.
Whatever the worry, we remain invested in a diversified portfolio of companies with durable business models and the right management teams, at lucrative valuations for the long run. In our view, it’s the best course of action to compound our clients’ capital with the least amount of risk. Wars and pandemics come and go, and inflation may wreak havoc, but solid-performing companies outlast them all.
Sources: FactSet, Bloomberg
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