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Home As Featured on BT The Key Investing Lessons From COVID-19

The Key Investing Lessons From COVID-19

It may feel like a lifetime has passed, but it’s only been around seven months since COVID-19 emerged and upended the lives of people all over the world.

Given the short span of time, I don’t think there can be many definitive investing lessons that we can currently draw from the crisis.

But I do think there are already key lessons we can learn from. At the same time, we should be wary of learning the wrong lessons.

A mistaken notion

As of 21 July 2020, the S&P 500 index – a broad representation for US stocks – is flat year-to-date. Meanwhile, the Nasdaq – a tech-heavy index of US-listed companies – is up by more than 17% in the same period.

Even more impressive is the BVP Nasdaq Emerging Cloud Index’s 55.5% year-to-date gain. The BVP Nasdaq Emerging Cloud Index is created by venture capital firm Bessemer Venture Partners and it is designed to track US-listed SaaS (software-as-a-service) companies.

The huge gap between the performances of the S&P 500 and the Nasdaq and Bessemer’s cloud index is not surprising.

Large swathes of the physical economy have been shut or slowed down because of measures that governments have put in place to stamp out COVID-19.

Meanwhile, companies operating in the digital economy are mostly still able to carry on business as usual despite lockdowns happening across the world. In fact, COVID-19 has accelerated adoption of digital technologies.

Given this, it’s easy to jump to the following conclusion: A key investing lesson from COVID-19 is that we should invest a large portion of our portfolios into technology stocks.

But I think that would be the wrong lesson.

We have to remember that crises come in all kinds of flavours, and they are seldom predictable in advance. It just so happened that COVID-19 affected the physical world.

There could be crises in the future that harm the digital realm. For instance, a powerful solar flare – an intense burst of radiation from the sun – could severely cripple our globe’s digital infrastructure.

I think there are two key investing lessons from COVID-19.

In the face of adversity

First, we should invest in companies that are resilient – or better yet, are antifragile – toward shocks.

Antifragility is a term introduced by Nassim Taleb, a former options trader and the author of numerous books including Black Swan and Antifragile. Taleb classifies things into three groups:

● The fragile, which breaks when exposed to stress (like a piece of glass, which shatters when dropped)
● The robust, which remain unchanged when stressed (like a football, which does not get affected much when kicked or dropped)
● The antifragile, which strengthens when exposed to stress (like our human body, which becomes stronger when we exercise)

Companies too, can be fragile, robust, or even antifragile.

The easiest way for a company to be fragile is to load up on debt. If a company has a high level of debt, it can crumble when facing even a small level of economic stress.

On the other hand, a company can be robust or even antifragile if it has a strong balance sheet that has minimal or reasonable levels of debt.

During tough times (for whatever reason), having a strong balance sheet gives a company a high chance of surviving. It can even allow the company to go on the offensive, such as by hiring talent and winning customers away from weaker competitors, or having a headstart in developing new products and services.

In such a scenario, companies with strong balance sheets have a higher chance of emerging from a crisis – a period of stress – stronger than before.

Expect – don’t predict

Second, when investing, we should have expectations but not predictions. The two concepts seem similar, but they are different.

An expectation is developed by applying past events when thinking about the future. For example, the US economy has been in recession multiple times throughout modern history. So, it would be reasonable to expect another downturn to occur over the next, say, 10 years – I just don’t know when it will happen. A prediction, on the other hand, is saying that a recession will happen in, say, the third quarter of 2025.

This difference between expectations and predictions results in different investing behaviour.

If we merely expect bad things to happen from time to time while knowing we have no predictive power, we would build our investment portfolios to be able to handle a wide range of outcomes. In this way, our investment portfolios become robust or even antifragile.

Meanwhile, if we’re making predictions, then we think we know when something will happen and we try to act on it. Our investment portfolios will thus be suited to thrive in only a narrow range of situations. If things take a different turn, our portfolios will be hurt badly – in other words, our portfolios become fragile.

It should be noted too that humanity’s collective track record at predictions are horrible. And if you need proof, think about how many people saw the widespread impact of COVID-19 ahead of time.

Conclusion

There will be so much more to come in the future about lessons from COVID-19.

We’re not there yet, but I think there are already important and lasting ones to note.

My lessons rely on understanding the fundamental nature of the stock market (a place to buy and sell pieces of actual businesses) and the fundamental driver of stock prices (the long run performance of the underlying business).

COVID-19 does not change the stock market’s identity as a place to trade pieces of businesses, so this is why I think my lessons will stick.

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Note: An earlier version of this article was published at The Good Investorsa personal blog run by our friends.

Disclosure: Ser Jing does not own shares in any of the companies mentioned.

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