A COACH'S PLAYBOOK

PREPAREDNESS, A SENSE OF CALM, AND SIMPLICITY

Michael Lewis, the author of Moneyball, The Undoing Project, and Liar’s Poker, is out with another season of his podcast “Against the Rules”. The first season covered how referees impact our lives. This one covers coaches. In this season’s second episode, Lewis highlights how his high school baseball coach, Billy Fitzgerald, changed his life and how overbearing parents today are prohibiting coaches like Fitzgerald from doing what they do best - coach. Listening to it, I could not help but reflect on my own experiences.

I had the good fortune to play for a number of good coaches in my life, but only a few were truly great. What made them different? They were incredibly prepared, never got rattled, and when a game was on the line, they could get us to execute without overcomplicating the situation.   

I have no idea where we are in this matchup against the Coronavirus, but I can tell you this. Taking a page out of these coaches books wouldn’t be a bad idea. 

The Backdrop

When a team falls behind early, it is often referred to as “being on the wrong side of a run”. For much of 2020, America has been on the wrong side of a run. We underestimated our opponent and our response was slow. As infections spread, hospitals fell under pressure, and shelter-in-place orders were ordered. Shortly thereafter, businesses shuttered, airline and hotel bookings plummeted, and the economy contracted nationwide. Meanwhile, the S&P 500 sold off faster than at any point in history. Then something interesting happened. Investors diverged. 

After the market fell close to 35% by mid-March, one cadre of investors walked off the field and sold, while another group went to the whiteboard to diagram the most complicated plays imaginable, otherwise known to investors as esoteric alternative investments. Vince Lombardi and his “sweep left, sweep right” mentality would be rolling over in his grave. 

The reason for this divergence is logical. 

For those who walked off the field, fear is more pronounced than ever. Not necessarily because there is more risk today than in prior generations, but rather because the perception of risk is so much higher. How so? Because technology has dramatically increased the speed and ease of information proliferation, which has resulted in much more information than we can handle. Couple this with competing media outlets reporting conflicting data and “experts” making drastically different projections, and no one knows what to believe or who to trust anymore.  

For those who went to the whiteboard, their reaction ties back to what Michael Mauboussin refers to as the “Paradox of Skill”. In short, Mauboussin posits that the more skilled a group becomes (be it baseball hitters, poker players, or investors), the more difficult it is to outperform. Therefore, instead of trying to outperform in an increasingly harder “game”, participants do one of two things -- they either stop playing altogether or they look for new games. This whiteboard group has decided on the latter. 

But, what happens when so many participants exit stage left and right? Could there be an opening, or rather a re-opening, in the middle? Quite possibly 

Making Sense of it All 

Looking back at what has transpired over the past few months, many investors are dumbfounded. How can the market be down less than 10% in spite of everything that has happened? The answer is more obvious than you might expect. 

To date, the market has been telling us that the industries that will be most negatively affected by COVID-19 are those tied to travel, energy, restaurants, and retail, while the sectors that will be positively impacted are technology, communications, and biotechnology. The reason why this matters for the market is that the first group represents a very small percentage of the S&P 500 (less than 15% in aggregate), while the latter represents a very large percentage (over 50% in aggregate). In short, one of the largest segments of the index is expected to be net beneficiaries, while a relatively small percentage is expected to be the hardest hit. That, in part, is how you get your modestly negative returns to date. It is also a reminder of how the markets and the underlying economy are different. 

You didn’t have to get this trend right in order to navigate this period though. Sure you could have bought tech stocks or the S&P 500 and held on, but you also could have added to the most beaten up parts of the market. While the energy (-57%), consumer discretionary (-30%), and materials (-34%) sectors were three of the worst performing sectors through the middle of March, want to guess what the three best performing sectors since the bottom were? You guessed it -- energy (+68%), consumer discretionary (+42%), and materials (+41%). It doesn’t always work this way, but it is safe to assume that when entire sectors fall by 40% or more (and certainly close to 70%), planting some seeds makes a lot of sense. Just as importantly, it doesn’t require a complicated approach. While few expected this sharp of a snapback, the fact is that if you truly have a long-term time horizon, these opportunities are extremely rare. The lesson? Don’t get cute. Don’t let great be the enemy of good. Just be thoughtful and buy. 

Looking Ahead

The first trend in the COVID-era equity market came in the sectors and companies that investors believe will be the long-term winners in the wake of this pandemic. Examples include companies that enable remote work like Zoom, Slack, and Microsoft (Teams) and Google (Hangouts); e-commerce platforms like Amazon, Shopify, and Wix; delivery services like GrubHub and Doordash; home fitness companies like Peloton; and the countless companies geared towards transitioning businesses to the cloud like Datadog, MongoDB, Twilio. Even if this virus dissipates more quickly than the experts expect, these secular trends are likely here to stay because this period has shown companies how valuable it is to have both on-premise and remote capabilities, a dynamic online presence, and systems that enable your company to operate digitally without a hitch. 

The next chapter for this market will likely be largely dependent on the virus’ path from here and our ability to deal with it. If a vaccine is developed more quickly than expected, things will likely go back to “normal” relatively quickly. However, given this is not the base case scenario, it will likely come down to how people learn to live with it. Or, as hotelier Ian Schrager recently said in an interview on Bloomberg radio, “People will determine the path of the pandemic”.

So what does this path look like? If the rally to date has been grounded in the belief that COVID-19 will lead to a future that looks different than the past, keep an eye out for signs that indicate the future might look less different than expected. The reason? While the S&P 500 is down just 7-8% year-to-date, parts of the market tethered to the world as we knew it just a couple months ago are still down anywhere from 20% to 35% (industrials -23%, financials and small cap value -30%, and energy -35%). If we get a pick up in economic activity that buoys these sectors, they could return to their January highs, which would equate to a return of +30% to +50%. It might be too early and this is just one day’s performance, but yesterday (March 26th) the year-to-date laggards dramatically outpaced the year-to-date winners as highlighted by the chart below.

What Lies Ahead

The truth is, I have no idea what lies ahead. No one does, but if I could quote one of my former coaches who falls into the great bucket, 

“I always said, a good idea is a good idea. It doesn’t matter who said it.” 

The fact is that the world around us is evolving, which is why it would be a good idea to remain prepared for whatever comes next. We may see another spike in COVID-19 cases, we may not. We may see another large correction in the equity markets, we may not. We may see a lot of things happen that are unexpected, we may not. The fact is though, all of this is out of our control. So, the only thing we can do is control what we can control. Namely, remain calm no matter what occurs and execute.