How We Think Long-Term Growth Investors Should Consider the Coulds

Financial news headlines have run the gamut lately, but we have encountered many that share a commonality: the operative verb is could. Some are good coulds. Some are frightening coulds. We suspect even the most careful critical thinker could have a hard time sifting through the flotsam and jetsam to determine what is most meaningful for equities. An easy place to start, in our view: Our research finds that over the medium to longer term, markets generally move most on probabilities, not possibilities. The word could grammatically puts a theory squarely in possibility-land. Just because something could happen doesn’t mean it is likely to happen.

The array of possibilities we have seen thrown around over the past several days is dizzying. Among the many we have encountered in the financial news sites we review regularly? The IMF and others warned COVID-19 could reduce living standards indefinitely, with social distancing required until there is a vaccine—potentially years away. Some speculate humans could never get lasting immunity from COVID, or the disease could circulate near-permanently, crippling the world economy indefinitely. Others argue fear of infection could keep people in self-induced lockdown even when governments let more businesses reopen. Or reopening could happen too gradually to enable an economic recovery. The ongoing civil unrest throughout America and Europe has prompted many to speculate that these impromptu mass gatherings could be the catalyst for a COVID second wave—and another round of lockdowns globally. Even under a rosier scenario, where businesses reopen quickly, some warn prolonged mass unemployment could permanently alter people’s shopping habits. We have seen many a headline warning a lack of international travel could kill airlines and tourism-reliant economies. Elsewhere in the reopening is no elixir category, we hear millions of small businesses could close permanently, cementing an L-shaped recovery. Or a wave of bankruptcies could slow the recovery and wreck corporate debt markets. Last but not least, we see at least one headline daily warning the economic damage could last for years without additional financial assistance from governments.

To be fair, we have also seen some positive coulds. With pharmaceutical researchers fast at work, some suggest we could have a working vaccine by autumn. Even if that doesn’t happen, some medical researchers think COVID could fade away like SARS (also a coronavirus) did and never return—a prominent British virologist made this very argument in a Telegraph op-ed published at the beginning of June, explaining why models based on the 1918 influenza outbreak’s second wave may not be the most scientifically sound. He isn’t the only one claiming COVID could fail to resurge with a properly executed reopening. In various interviews we have read, multiple researchers claim the fatality rate could wind up being very low.

Many fine minds make these arguments. Many of them show their work in compelling ways, making the task of determining which thesis is valid a daunting one. That is the discouraging news. The encouraging news? You don’t need to pick a side. In the strictest sense, all of these theses are correct—all of these things could happen. So could myriad other outcomes. An economic recovery could be underway. Or recent improvement in retail sales and other metrics could be a false start, with genuine improvement still months away. To put it succinctly, when you are in the could camp, the range of outcomes is literally endless.

This isn’t so different from how things normally are. At any time, the world could go an infinite number of ways, good or bad. In our view, equities sift through all of it by skipping over distant possibilities and focusing on probabilities. Hence, we offer our two-step plan for dealing with this cacophany of coulds. One: Turn off your preconceived notions, opinions and biases, lest you blind yourself unnecessarily. Two: Whenever you see a could, ask yourself, is it possible to assign a probability to this happening?

For all the coulds we rattled off, we think the answer to that second question is no. All of it—the good and the bad—is sheer speculation. Hence, in our view, the dismal possibilities aren’t reason to avoid equities, and the optimistic possibilities aren’t reason to take speculative, concentrated positions.

Yet this doesn’t make the speculation useless for investors. In our experience, all the chatter reflects and influences sentiment. We think being familiar with all these competing theories—and observing how the masses react to them—is a good way to take investors’ temperature, which is crucial as markets generally move on the gap between expectations and reality, in our view. Today, from our vantage point, the dismal possibilities have more traction and acceptance amongst the vast majority of financial commentators we follow than the positive ones. That suggests to us sentiment remains down in the dumps, with some degree of positive surprise more likely than negative surprise. Should the positive scenarios begin gaining more favour, then that could reduce positive surprise power, potentially signalling markets are too optimistic. We don’t think we are there at the moment, but it is worth keeping an eye on.

Absent a new, big, bad development that few identify, we think calling the rally since 23 March genuine is the most rational viewpoint. Something could thump markets anew, whether a worse-than-expected second wave of COVID or another negative scenario people can’t fathom today. But without the ability to assign a probability to this, we don’t think it is wise to position a long-term growth orientated portfolio for it today. The risk of being wrong strikes us as too great. Equities’ long-term returns include all bear markets along the way.^[i] But common sense states achieving those returns requires participating in bull markets. Therefore, for investors seeking long-term growth, we think being out of the market is one of the biggest risks out there. To take it on, we think one need a rock-solid reason with a strong likelihood of coming to fruition. Could happen, in our view, just isn’t good enough support.