Update

Recovery Surge: Which Assets Will Bounce Back from COVID-19?

There was once a savvy Irishman who went into his bank.

‘If you have my money sitting here, I don’t want it,’ he said. ‘If you don’t have my money here, I want it right now!’

This simple story sums up the most vital component in economics and markets. Confidence. And every market instrument is subject to a ‘confidence narrative’.

In fact, when we look at the price of a financial instrument — be it a share, currency or precious metal — a significant part of its price comes down to this confidence.

Often, that confidence is tied into belief in a country or system. When Iceland’s three largest banks defaulted on foreign-debt payments during the GFC, they collapsed and were nationalised.

Inside a week, the krona dropped 50%, the stock market 95%, and over the ensuing two years, house prices fell 32.5%.

Iceland suffered a deep failure of investor confidence in 2008. Though it has since bounced back. Source: KPMG

I visited the Isle of Man shortly after. A similarly frozen place, even in March. There, depositors with the offshore branch of Iceland’s Kaupthing Bank looked set to lose life savings. Since Kaupthing took over offshore accounts from the Derbyshire Building Society at its Isle of Man offshore branch, this affected many non-resident Brits. Some had life savings, house deposits, pension money, and even business capital from mortgaging a house sitting with Kaupthing.

A limited government depositor protection scheme did step in to assist. But it appears the debacle of trying to recover monies is still ongoing.

The pain, loss, and delay take a toll beyond the financial.

That savvy Irishman was right. About how to approach banks.

A depression is like a run on the bank

They’ve been numerous studies on what affects markets.

An earthquake — even though it may be unrelated to specific companies — has been shown to have a negative impact on the stock market due to the confidence narrative.

The prospect of a depression has even greater impact.

That is what we saw in mid-March, when indexes fell to their lowest point in many years. This was the time to buy, since the pandemic presents recessionary challenge but probably not a depression lasting many years.

Because natural disasters — especially a depression — shake the confidence narrative, they hit the markets like a run on the bank. People want to sell and get out of risk instruments, particularly stocks.

Our job as investors is to assess whether this risk run is overdone. And this presents to us stable bargains to buy.

What we’re seeing in our portfolio right now is a big hit on our REITs (Real Estate Investment Trusts). These normally defensive investments hold commercial and retail property. This area has been shaken by the pandemic. And investors are making a run because they’re concerned tenants will not pay their rent.

While there certainly is risk, it’s useful to remember that these are not technology companies whose software faces competition or declining use. They own buildings which still have value and utility. And provided debt-to-equity is manageable, they should be able to recover on the other side. Two already are now in profit.

On Bitcoin, stocks, and growth

Bitcoin is the ultimate example of the confidence narrative in action.

As a currency, it has never really caught on as a medium of exchange. You can’t buy all the things you’d want with Bitcoin. And as a store of value, it has been so volatile that this faith seems very wavering.

Volatility allows traders to capture gains. But it also makes such activity more speculation than investment. This research here is focused on investment. But also some calculated speculative investment.

For those subscribers who bought Greatland Gold [LSE:GGP] when we saw potential and commenced monitoring last year, you would have enjoyed the sort of spectacular gains that can come from taking more risk.

We closed Greatland before the pandemic at just under 6p, delivering a 260% return in 7 months.

The pandemic then came out of the blue. And sent interest in gold into a frenzy. Obviously not expecting this, we had closed the position near the then all-time high.

If you’d waited through the pandemic, you would now have enjoyed seeing the price climb toward 9p, delivering a return of over 450%.

While many of our picks focus on income and protecting capital, we are now looking for some more growth picks.

The strategy is this: once pandemic fears fade, our REIT and financial stocks could get going again. So we’ll be considering some more risk in exchange for growth drivers.

The new economic paradigm

Greatland Gold had a second wind because of the pandemic. But, in mid-2019, there were also other warning signs that the world was becoming a riskier bet. Those revolved around the ongoing trade dispute between China and the USA. This relationship has since broken down further.

In mid-2019, the gold price started rising again. That continued until mid-March 2020, when the depth of pandemic fear even hit gold.

Source: Goldprice.org

But then, as lockdowns clamped economies and quantitative-easing programmes flooded currencies, gold began to rise on one of its steepest inclines in recent times.

History tends to repeat itself. Following the Second World War, until the dissolution of the Soviet Union in 1991, there existed the Cold War between the world’s two primary nuclear powers.

We are now facing the threat of a new Cold War between the US and China.

Physicist Michael Sekora is an intelligence official who served under Reagan. He is calling for a Cold War-era programme, ‘Project Socrates’, to be restarted to keep China in check. He believes China is using the virus to gain competitive advantage. And a programme like Socrates, where the American government backs long-run technology-based planning, is needed again.

Sekora says the US has been at a disadvantage due to finance-based planning. Where the focus is on maximising profits in the short-term rather than producing the best products to establish long-term market dominance.

Over the next few years, we may see incentives and legislation from the US and other Western governments to cut Chinese products out of critical supply chains. There will be a focus on protecting intellectual property and innovation.

A new Cold War could see a refocus on technology and manufacturing within America and its allies. It is competition that builds strong, innovative businesses. And for the past few decades, there has not been much high-stakes competition. Until China reached its zenith.

Although China has developed manufacturing advantage in many areas, its top-down model has struggled to increase innovation or productivity. Returns on capital investment, which mainly go into infrastructure, are showing signs of diminishing returns. In this area, the US has an advantage, whereby a free economy should produce more innovation.

But that innovation now needs to be channelled by government and not left to short-run financial planning.

As investors, we are looking for the businesses that will benefit and grow in this new world.

More research is to follow on this. For now, there is a field of opportunity within our existing portfolio for those willing to embrace the risk-return equation.

Portfolio update

NewRiver REIT [LSE:NRR] is one of our previous high-performing REITs that got smashed by COVID-19. Yet, BoJo (Boris Johnson) has announced that non-essential retail premises can open in three weeks’ time. Pubs are to follow in July. This should see the rest of the tenancy portfolio back in business and provide welcome relief for investors. Possibly a boost for those who got in at the lows.

General Motors [NYSE:GM] largely has its factories open again with social distancing measures. It has also reopened its Mexico factory, where it assembles fast-selling Chevrolet Silverado and GMC Sierra pickups.

The stock price is getting a boost but still presents value in our view.

It is, of course, a contrarian pick. Many analysts see GM having lost its way. And the smart money is on Tesla [NASDAQ:TSLA].

Tesla certainly had its jump in 2019, but since then, it has been rather volatile. For longer-run income investors, we see GM has having more breadth of range.

But, again, the confidence narrative is at play. And there’s much confidence around the future of electric vehicles, of which GM plays a lighter hand. This dynamic could change.

AVJennings [ASX:AVJ] provided an update to the market on the impacts of COVID-19:

• ‘AVJ entered the COVID-19 crisis well placed, with a strong balance sheet, good liquidity and sufficient funding capacity for the medium term.’
• The company has maintained a ‘long-term prudent approach towards acquisitions’, reducing exposure to short-term fluctuations in asset values.
• Example was given of the large land parcels at Caboolture, Queensland. Secured last year on capital-efficient terms that share risks and rewards between the parties, helping to protect the balance sheet.
• Settlements of pre-sales continue to occur largely in line with expectations, with a slight uptick in the number of deferrals.
• There have been a small number of rescissions, which had previously been rare.
• Sales and enquiry levels are below the levels anticipated had the COVID-19 crisis not occurred, but above short-term expectations.
• The company believes that steady sales to builders and other corporate customers rather than retail buyers ‘indicates an underlying level of confidence in the medium and longer term outlook as they are acquiring land for their future operations.’

You can read the full announcement here.

Here’s our updated market guidance:

 Current as of 26 May 2020 at 10pm GMT.

A friend of mine was recently wanting to get into Bitcoin. My colleague Alistair follows crypto. And I spent some time in Europe working for the world’s first regulated Bitcoin hedge fund.

People have been asking why we don’t recommend some crypto investing here?

It comes down to the confidence narrative.

The Bitcoin price depends on confidence in the ongoing value of those coins. By conventional analysis, there is little intrinsic value. No doubt, there is money to be made in the trading volatility.

But this is not this product. We’re seeking to protect capital along the way. And build Lifetime Wealth through both high growth and income picks.

Our confidence narrative involves spotting valuable assets that the market may not have priced correctly. At some point, as the world continues to wobble, this reality will become important.

PS: On the 5^th of June, we’ll be chatting to former BNZ Chief Economist Tony Alexander. And we’re taking questions for him now! Simply visit the latest Wealth Talk podcast and leave your questions for him.