The investing phenomenon of the year has been how much, how quickly and how eagerly investors have bid up almost all asset prices, even as we’ve remained in one of the worst economic and health crises in history. Stocks, junk bonds, gold, houses – there’s been tremendous appetite for all. Competition for the brightest ideas has been fierce. Anticipation of golden opportunity has been high. And yet, it’s precisely because there’s been so much anticipation that the opportunities haven’t been quite so golden.
The best opportunities come when you play a field that is not crowded and you do what no one else is doing. Howard Marks of Oaktree Capital wrote in his most recent memo that the biggest returns come in the darkest hours when you have two things no one else has: cash and guts. You need capital ready to deploy – usually because you were prudent before things turned dark. And you need the nerve to step in and buy when everyone else is running scared. That was the case during the financial crisis of 2008-2009. Financing dried up, there was a credit crunch and then a downward spiral in asset prices and panic selling. It was when things seemed truly hopeless that you could buy “assets at prices from which extremely high returns could be achieved, often with low attendant risk.”
This crisis, however, has been different. There was a brief period of fear, but things turned so quickly that we did not get to see what Marks calls the “spectacular implosions that mark most crises.” Instead, “Pessimism was replaced by willingness to think about better times ahead.” In fairly short order, we saw plenty of capital and plenty of people willing to deploy it.
The big difference this time, as we’ve said before, was the Fed. After cutting rates twice in early March to little effect, the Fed stepped in big on March 23 and said it would buy risky assets in gargantuan quantities if needed. That was unprecedented. It also was the turning point, though we didn’t know it at the time. That became clear only in retrospect.
Take a look at New York University professor Aswath Damodaran’s mapping of the crisis. The “meltdown” starts February 14, the day Italy announced 200 coronavirus cases that weren’t from China or a cruise ship. We knew then we had a serious problem. But it’s not long before we go from “meltdown” to “melt-up” starting with the Fed’s March 23 announcement. Today, we’re in what Damodaran calls “recalibration.” That suggests that COVID has become a “known unknown” and that we’ve had the chance to re-value risk.
Once the Fed succeeded in getting people to see through to “the other side,” more people started looking for “crisis-like” investing opportunities and prices got bid up. As Damodaran writes, risk capital stayed in the game. Stocks went up. Mergers and acquisitions have been easy to finance. IPO activity has been brisk. And high-yield bonds have been in high demand. Otherwise, how can we understand Carnival Corp. — the highly indebted cruise operator and the very symbol of COVID’s crushing effects – issuing a junk-rated bond that gets oversubscribed?
On top of this, we’ve gone through serious psychological turmoil that while challenging, has also set the mind to thinking about how to profit. COVID has been a tragedy, but when we live and breathe massive disruption in everything we do, it’s human nature to start searching for the fantastic opportunities that surely must be out there if only we look hard enough. Investors have stopped worrying about the prices they pay for assets and gotten obsessed with picking winners and losers in the brave new post-COVID world. That’s not so different from the mindset of the internet bubble of the late 1990s when we realized we needed to imagine a vastly different way of living and doing. And there’s nothing wrong with thinking like this. It’s just that everyone else is too. You are not the only one thinking about the digitalization of everything or watching and waiting like a hawk. And that makes for a tough, competitive investing game full of risk.