Investing In These VUCA Times

Time, knowledge, and patience are the biggest virtues of investing.?If we do our due diligence in picking our investments, have the patience to hold on to our quality assets when the market is down, and give ourselves a reasonably long investment time frame, we will likely end up making good returns.?

Calendar year 2022 has been a tough year for the markets; with a decline of 20-30% (S&P 500 down -20%, NASDAQ -30%). The predictors of doom are painting a bleak picture of the future, yet the economies seem resilient so far. Despite the COVID-19 pandemic, the Ukraine war, and the global political crisis, the S&P 500 since January 2020 is up +19% over 2-years. Simply put, 2022 erased the gains of 2021 to keep the returns at zero in the last 12 months. Of course, those who entered the market on January 22 will get the full brunt of a 20-30% unrealized loss (realized if positions are liquidated).?

How the markets will play out in 2023 depends on many factors, including inflation, Fed rate hikes, GDP growth, quarterly earnings results, global events like the Ukraine war, the persisting COVID-19, and international political unrest causing supply issues. For sure, there is uncertainty and volatility in the market. So, in these times, should we remain invested in the market or liquidate our positions and take a loss but preserve our remaining capital??

The opinions are varied, and that is how the market operates. If everyone were thinking alike, then there would be no market. I am sharing my perspective on investments through this article to trigger some thoughts in the minds of my readers. Here are the critical questions to consider as you make your investment decisions:

1.???Do I have the holding power to weather the economic downturn?

It is one of the most important questions as you consider investing or staying in the market. If you are investing by borrowing or using funds, you will need a few months down the road; then, I would not invest in times of uncertainty. Instead, I keep aside at least a couple of years' worth of funds to maintain my family's needs in cash. One year's deposit in USD can fetch you 3.8-4.0+%, which is not bad, but you can argue that it is less than current inflation. Yes, it is, but it also gives me the liquidity to pass through any stock market crisis without the need to liquidate my positions and make the unrealized personal balance sheet loss a realized actual loss.?

If you have the liquidity (cash reserve, sustained salary, or business profits) to fund your needs without liquidating your investments, why liquidate due to some volatility? In the long-term S&P 500, NASDAQ, and other stock exchanges have consistently grown. For example, the S&P 500 has increased by +171% in the last ten years or +35% in the previous five years. Of course, there will always be difficult years, but if we have the power to brave these out, we can make a good profit.

2.???Do I have enough knowledge to pick the right assets/investments??

Financial literacy is essential if you want to be an investor or an entrepreneur. As a principle, never invest in any asset unless you comprehensively analyze and understand the risks and rewards. For example, if you are investing in a company's stock, thoroughly assess it by asking the following questions: 1) Does the company have a strong balance sheet? 2) What has been the CAGR sales and profit growth in the L5Y? Does it have a moat to defend itself from the competition and continue to win? What are the analysts saying about its future? How are its financial ratios' especially liquidity? Is the company's intrinsic value higher/lower than its share price? Do I use the products or services of the company I am looking to invest in, and do I like its products??

Let's take an example of a company I love, Apple. Its products are the most innovative, beautifully designed, and user-friendly. I use I-phone, Mac Pro, I-pad, Apple Watch, and cloud services from Apple. The company has a market cap of $2.1 trillion with revenue growth of 51% from 29/09/19 to 29/09/2022 (source Yahoo finance). It has a strong moat and is in a league of its own. Its current assets stand at $135 billion, with a cash balance of $48 billion. It's an excellent stock with a great team building the brand, so investing and staying with its stock despite the market-related sell-off is fine. Instead, investing more when low prices would be a good idea.?

The problem comes when we invest with limited or no knowledge of the asset. May it be a stock, bond, cryptocurrency, gold, structured product, real estate, or any other investment. My friend once told me that he lost a lot of money when he shorted oil, which went up. Well, it is easy to talk about others; I, too, made many mistakes. For example, I invested (luckily a small amount) in an upstream pharma that had lost 90% of its stock value. I thought, what can go wrong? I will make a killing. The stock since then has continued falling, and its price is in cents. Investing is all about knowledge. The best investors mitigate the risk by understanding the asset and the marketplace. I suggest building knowledge before you enter the market. Refrain from relying only on your relationship manager or friend's advice or tips from unknown people. Remember investing is not gambling, and knowledge is the king and queen of investing.

3.???Do I take debt or keep my investments debt free??

For sure, there are benefits of leverage. However, it is better to be debt-free in the uncertain and volatile market, as leverage can magnify your losses. During the last many years, when the interest rates were negative, and we generally had a bull market, it was good to leverage investments. I remember buying a car on Lombard (loan against personal portfolio) at 0.8% and paying off the entire vehicle through my portfolio appreciation within four months. Now, this could also go south if the market goes down. Therefore, I like to keep my debt as low as possible when the market is volatile and uncertain. Imagine individuals on variable mortgage rates benefit from low-interest rates and would be feeling the pinch with the seven rate hikes. Remember, leverage is a double-edged sword.

4.???Do I have a good understanding of the market??

Most people listen to the news and follow global and financial developments on digital media. However, the ability to relate the events to investments and discernment to keep the noise away from your independent perspective is a learned art. We have all seen that expert predictions do not always materialize because these are predictions and not facts. We will make a fortune if we can be 50 times right out of 100. As the future is speculation, it is better to go into it with better knowledge and clear bets so you can gauge how things are going versus your bet and make learned corrections.?

Let's look at the current situation.?

·??Inflation is high across the globe. In some countries like Turkey, the inflation was 85.5% in October and 84.4% in November 22. While in the US, it stands at 7.1% for the last 12 months ending November 2022. In the Eurozone, the annual inflation rate was 11.1% (L12M ending November), with the highest in Latvia at +20%.?

·??The rampant inflation had to be bought under control. The Fed working on its dual mandate of 1) stabilizing the prices and 2) maximizing employment, used the tools of monetary policy to arrest the inflation in the coming years and to bring it to the 2% going level. The interest rates were increased in the US from?0-0.25%?to?4.25-4.5%?by taking seven consecutive rate hikes in the year to cool the overheated economy. The expected terminal rate is 5.1% and can be higher if the inflation does not cool. ECB raised the rates by 2.5%. Early reading is a positive trend in the inflation cooling though it is premature to speculate.

·??Global economic activity is experiencing a broad-based and sharper-than-expected slowdown, with inflation higher than in several decades. The cost-of-living crisis, tightening financial conditions in most regions, Russia's invasion of Ukraine, and the lingering COVID-19 pandemic all weigh heavily on the outlook. Global growth is forecasted to slow from 6.0 percent in 2021 to 3.2 percent in 2022 and 2.7 percent in 2023. This is the weakest growth profile since 2001, except for the global financial crisis and the acute phase of the COVID-19 pandemic (IMF World Economic Outlook, October 11)

·??Despite the COVID-19 headwinds, S&P 500 grew by 15% in 2020 and 21.5% in 2021. However, in 2022 it's down by -20% giving away all the wins of 2021. The decline in the NASDAQ composite is even higher. It fell from 14,935 points on January 03, 2022, to 10,547 points on December 20, 2022, a fall of approximately -30% (yahoo finance).?

·??Meanwhile, GDP growth projections were revised higher for this year (0.5% vs. 0.2%) but lowered for 2023 (0.5% vs. 1.2%) and 2024 (1.6% vs. 1.7%). Inflation forecasts were revised higher for 2022 (5.6% vs. 5.4%), 2023 (3.1% vs. 2.8%), and 2024 (2.5% vs. 2.3%)

So, what is the takeaway? Economists and experienced analysts can provide excellent predictions. I am sharing my perspective on what I deduce from the situation for my investments.?

·??Revised intrinsic value of the companies. The valuation of the companies would be lower with the rising interest rates (if all else remains the same) as the cost of capital used for discounting the future cash flow streams has increased. It is because the falling stock prices have a higher cost of capital priced in. We may see more of these revisions if the interest rates continue to rise.?

·??May see earnings growth in 2023 as we pass the high-profit base of 2021. Calendar 2021 was excellent for the companies. For example, Apple's quarter (OND 21) results were fabulous, with $123 billion in revenue and 11% growth. This is after a first-time $100 billion quarter in OND 2020 and a 21% growth. The high base will make it challenging for OND 2022. However, once the base is changed, I expect better indices that will reflect positively on the stock price for companies that struggled in 2022.?

·??The weakening of the dollar will help companies with global businesses through translation gains. The Euro to USD conversion rate at the start of January 2022 was Euro 1= 1.374 USD (source: Exchange rates org.UK). The dollar appreciated throughout the year; by September 2022, it was stronger than Euro 1= 0.973 USD. The stronger dollar hurts the earnings of US multinationals that have a significant global footprint. However, since then, the dollar has been weakened against the Euro, which stands at Euro 1 = 1.06 USD. If the dollar continues to weaken, it will be a windfall translation gain for the US companies with a European footprint and will lead to better results.

5.???Do I adjust my portfolio in the current situation??

Making some adjustments is good depending on your goals and the market conditions. For example, I reduced some of my tech investments (excluding Apple and Microsoft) to go heavy on luxury companies like LVMH, Hermes, etc. Given the higher cost of capital and supply challenges and the high P/E of tech companies, it will take them time to recover from the lower stock prices. The high-end luxury is not susceptible to recession as the people buying it are wealthy and as such, they have pricing power. For example, in 2022, the stock price of LVMH is down by only -2%, whereas NASDAQ, which has a lot of tech stocks, is down -30%.?

Conclusion

Net, I am staying put with my investments in the stock market. It is because I have more trust in hundreds of thousands of highly skilled and talented people working for some of the world's most loved brands than in a commodity like Gold or Silver or in real estate. As I choose my investments, I want to be part of a vision and purpose of a company and its leaders and trust that they will do their best to sustainably grow the business overtime and, thereby, the value of the stocks.

-Waqi Munim