WHAT WAS THAT??

WHAT WAS THAT??

Four Things to Consider

In the classic Saturday Night Live skit titled “What the Hell is That??”, Bill Murray and Steve Martin play two tourists who can’t figure out what something is out in the distance. For two minutes, they repeatedly say, “What the hell is that??” Finally, Martin turns to Murray and says, “Oh, I know what that is.” The two then walk off stage, only to walk back on and say again, “What the hell is that?” This is how I feel about 2020. What was that?

I have no idea what just happened. I don’t have a profound takeaway. Yet, a few things stood out and are worth mentioning.

Crisis Investing

Imagine we are back in March of last year. The realization has set in that COVID-19 is pandemic in nature and spreading through the world. Shutdowns are being implemented and economies are beginning to contract. Equity markets have plummeted, with major indices down anywhere from 30-50%. You are approached with the opportunity to invest in one of two strategies: (a) a strategy that invests in companies that stand to benefit from the acceleration in digital technology as a result of COVID-19 (think Peloton, Zoom, Shopify, and Wix) or (b) a strategy that invests in restaurant companies that largely operate in retail strip malls (think Brinker International -- Chilis, Maggiano's, etc., Jack in the Box, Dave & Busters, and Dine Brands Global -- Applebee’s, IHOP). With the benefit of hindsight, which option do you choose? The answer is obvious, right? Why would anyone invest in restaurants on the verge of bankruptcy over the next great tech companies that are transforming the fitness, business communications, and e-commerce worlds? Well, what if I told you that from March's market lows, the high flying tech companies are up 330%, while those distressed restaurants are up an astounding 475%?

The further stocks fall, the more asymmetric a recovery can be. If a $100 investment falls 75% to $25 (as each of these four restaurants did) and rebounds back to $50, an investor with the nerve to invest at the bottom would double their money. If that investment recovers all the way back to $100, an investor would quadruple their money. Given this dynamic, I am forever amazed that more investors don’t take a private equity-like approach to investing in public markets by utilizing capital calls, measuring performance on an IRR and net multiple basis, and investing in "private equity-like" businesses when they are in a fire sale. In the case above, the entire restaurant industry was in turmoil due to shutdowns and restrictions, both in the public and private markets. Yet, there was a key difference. Private businesses weren't for sale because their owners largely refused to dispose of their assets at distressed prices. On the other hand, since public investments are always available, there were endless opportunities to invest in businesses at 75-85% discounts. While there is no way of knowing when selloffs of this magnitude will occur or what sectors they will affect, the fact is it will happen again. When it does, the asymmetry of a potential recovery will be in your favor.

Implications of an Accelerated Future

An endless cadre of people have commented about how COVID-19 accelerated existing trends by 5-10 years, “pulling growth forward” in the process. Modern technology has allowed employees to work from home, Zoom calls to replace business travel, consumers to shop for bigger ticket items online, food delivery to keep restaurants in business, and online education to become a bigger part of higher education. This said, the market quickly sniffed this out and priced the acceleration in. Look no further than Peloton. Pre-COVID, the company had a market cap of $9 billion. Had it compounded at 18% annually for a decade (double the historic average for the S&P 500), the digital fitness company would have been up 400% by 2030. Yet, because of COVID, its stock captured all of that growth in a single year and now sports a market cap of $45 billion. From this point, for it to appreciate another 400%, one of two things would have to happen --- more future business growth would have to get pulled forward and/or investors would have to stretch their time horizons even further into the future (i.e. multiple expansion). The former is unlikely, the latter would be concerning. 

The Ripple Effect

Issac Newton once said, “For every reaction is there is an equal and opposite reaction”. COVID caused countless reactions, none more so than how technology enabled society to operate remotely. On one hand, this made the economy remarkably more resilient. On the other, it made us more isolated, divided, and contentious. Without technology, workers would have likely continued going to work, students to school, and shoppers to stores. Masks may have been more widely accepted, the government may not have needed to pass such a large stimulus, the hardest hit sectors may have been spared (energy, retail, etc.), and Donald Trump may have won re-election. Or maybe things would have gone in an entirely different direction. I honestly have no clue how things would have unfolded. My only point is that when a system is shocked, people react, which creates a subsequent reaction, which creates yet another reaction. These reactions shape the future. Those who can envision the path of these reactions will be a step ahead.

The Office Needs to Come Back

A well known comedian did a stand up bit a few years ago about his behavior inside and outside his car. When he wasn't driving, he was a normal and conscientious member of society. However, when he got behind the wheel, he lost his mind. He would say things to people in other cars that he would never say to someone in person, let alone in an office or an elevator. 

Substitute a computer for a car and a keyboard for a wheel and you have our current situation. In this new work-from-home world, we have collectively become this comedian behind the wheel. People are saying things to each other (largely on Twitter and social media) that they never would have ordinarily.

Why does this matter?

It indicates we need to get back to working with other people in person. The office forces you to interact with people who do not share the same beliefs, while the web forces you to interact with only those you agree with. The office forces you to be more accommodating, while the web forces you to become more polarizing. The office forces you to see the the entire picture, while the web forces you to see just the extremes. While we may never return to the office environment we were accustomed to pre-COVID, my guess is that it would be healthy to get back into the office in some shape or fashion in order to avoid this “behind the wheel” mentality. 

My Takeaway

  1. Counter to what one might think, the most effective way to make outsized returns can come from identifying areas going from bad to less bad; these opportunities are often only available in the public markets.
  2. When the future gets accelerated, the market is almost always one step ahead. Not recognizing is a significant contributor to bubbles forming.
  3. People do not sit by idly when confronted...they react. Spotting these reactions and their direction separates the good from the great.
  4. The office needs to make a comeback. 
Matthew Mulqueen

Chief Revenue Officer @ LILT

3 年

Very good!

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