Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 355

Too many unknowns: hope isn't an investment thesis

Over the next several weeks, investors will experience horrendous macroeconomic data. For instance, based on initial jobless claims data, more jobs were lost in the US in four weeks recently than were created during the entirety of the now-ended 11-year business cycle. So yes, economic data will get worse, but it may not matter to capital markets because this is a market known.

Markets factor in expectations

Markets are a discounting mechanism of ‘known knowns’ and the weighted probabilities of many ‘known unknowns.’ And an upcoming earnings recession won’t surprise markets any more than terrible labour data will.

Two known unknowns are the pace of the economic recovery and the path of post-recession earnings. Since the March 2020 lows, US equities have retraced over half of their losses. Stated another way, in the face of the worst recession of our lifetimes, equity valuations are down only to June 2019 levels. Over the past few weeks, investors have increasingly assigned a higher probability to a shorter-than-anticipated recession and a stronger acceleration in profits.

We’re not epidemiologists, so we won’t opine on the infection curve or the risks of a second wave, though we certainly hope for the best. But as they say, hope isn’t an investment thesis.

Regardless of when the virus peaks or the economy reopens, life will be different. Politicians, the media and investment strategists and economists (but not us!) have equated the world’s efforts to contain COVID-19 with fighting a war. While it may feel that way with everyone pulling together (thank you to the brave health workers and first responders!), pandemics alter long-term behaviour differently than wars.

The catalysts that generally drive V-shaped postwar recoveries are very different from pandemic-driven ones. In short, precautionary savings by both consumers and businesses create different economic and inflation environments than those previously observed in postwar economies.

The scramble into new capital raisings 

A market known unknown, if you will, that we want to explore further is the likely earnings dilution resulting from future equity capital having to be raised.

During periods of economic strength, many corporations take advantage of all available levers to maximise their appeal to equity investors. Part of the reason for this is that the wrong incentive structure is in place for many corporate leaders. Over the past decade, working capital has been the priority for most CEOs, and lower balance sheet quality has been the lever. That dynamic has been on display more in the recent past than in any other period of recorded history. Exhibit 1 details the steady increase of billions of dollars’ worth of shares repurchased in the S&P 500 Index.

This isn’t new information, so we highlight 2008. As the fat tail risk of the GFC faded, emphasis turned from maintaining liquidity towards recapitalisation. That recapitalisation came via the equity market and at the expense of shareholders who suffered substantial dilution on a per-share basis.

Today, CEOs and CFOs — particularly those of companies that might not be able to carry on — are scrambling to secure liquidity. Profit maximisation is no longer the priority. Survival is the goal, as meeting next month’s debt maturity is all that matters. Balance sheets are now the focus, unlike in the past dozen years.

However, the nature of this recession is different from that of 2008, and not only because the recession is driven by a pandemic. The 2008 meltdown was driven by an overleveraged financial sector. However, this time around, banks and real estate investment trusts (REITs) weren’t the entities that extended balance sheet leverage to unsustainable levels in order to repurchase stock.

Instead it was every corporate sector but financials. And a fresh wave of recapitalisations is likely just getting started. There’s already been equity issuance by leisure and professional services companies in the US and Europe.

Too many unknowns for recovery conviction

None of us can guess what the duration of this recession will be, nor can we tell how strong the recovery will be. Yet many seem to believe they have sufficient visibility into any such recovery’s many known unknowns to make the high-conviction call that the recovery will be strong. We wish we had such conviction, but we don’t, and we don’t think you should either.

Instead of trying to make those calls, we’ve chosen to invest carefully, owning assets of enterprises for which the growth of working capital isn’t dependent on externalities such as financing, recognising that you can’t plan perfectly for black swan events such as the one we’re experiencing.

 

Robert M. Almeida Jr. is a Portfolio Manager and Global Investment Strategist, and Erik Weisman, Ph.D. is a Portfolio Manager and Chief Economist at MFS Investment Management. The comments, opinions and analysis are for general information purposes only and are not investment advice or a complete analysis of every material fact regarding any investment. Comments, opinions and analysis are rendered as of the date given and may change without notice due to market conditions and other factors. This article is issued in Australia by MFS International Australia Pty Ltd (ABN 68 607 579 537, AFSL 485343), a sponsor of Firstlinks.

For more articles and papers from MFS, please click here.

 

  •   29 April 2020
  • 1
  •      
  •   

RELATED ARTICLES

The iron law of building wealth

The bright outlook for Australian fixed income

3 investment themes for 2023

banner

Most viewed in recent weeks

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

Four best-ever charts for every adviser and investor

In any year since 1875, if you'd invested in the ASX, turned away and come back eight years later, your average return would be 120% with no negative periods. It's just one of the must-have stats that all investors should know.

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

Family trusts: Are they still worth it?

Family trusts remain a core structure for wealth management, but rising ATO scrutiny and complex compliance raise questions about their ongoing value. Are the benefits still worth the administrative burden?

13 ways to save money on your tax - legally

Thoughtful tax planning is a cornerstone of successful investing. This highlights 13 legal ways that you can reduce tax, preserve capital, and enhance long-term wealth across super, property, and shares.

Warren Buffett's final lesson

I’ve long seen Buffett as a flawed genius: a great investor though a man with shortcomings. With his final letter to Berkshire shareholders, I reflect on how my views of Buffett have changed and the legacy he leaves.

Latest Updates

Retirement

Why it’s time to ditch the retirement journey

Retirement isn’t a clean financial arc. Income shocks, health costs and family pressures hit at random, exposing the limits of age-based planning and the myth of a predictable “retirement journey".

Financial planning

How much does it really cost to raise a child?

With fertility rates at a record low, many say young people aren’t having kids because they’re too expensive. Turns out, it’s not that simple and there are likely other factors at play.

Exchange traded products

Passive ETF investors may be in for a rude shock

Passive ETFs have become wildly popular just as markets, especially the US, reach extreme valuations. For long-term investors, these ETFs make sense, though if you're investing in them to chase performance, look out below.

Shares

Bank reporting season scorecard November 2025

The Big Four banks shrugged off doomsayers with their recent results, posting low loan losses, solid margins, and rising dividends. It underscores their resilience, but lofty valuations mean it’s time to be selective. 

Investment strategies

The real winners from the AI rush

AI is booming, but like the 19th-century gold rush, the real profits may go to those supplying the tools and energy, not the companies at the centre of the rush.

Economy

Why economic forecasts are rarely right (but we still need them)

Economic experts, including the RBA, get plenty of forecasts wrong, but that doesn't make such forecasts worthless. The key isn't to predict perfectly – it's to understand the range of possibilities and plan accordingly.

Strategy

13 reflections on wealth and philanthropy

Wealth keeps growing, yet few ask “how much is enough?” or what their kids truly need. After 23 years in philanthropy, I’ve seen how unexamined wealth can limit impact, and why Australia needs a stronger giving culture.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.