The Parallels Between Sports and Investing
Market commentators often like to make analogies between professional sports and the world of investing. Although sports and investing can be very similar in certain regards, they’re also very different. Almost every sport is referred to as a game, but investing is not a game, unless you are day trading meme stocks.
In baseball, the length of a game is determined by innings. But in the world of investing, stock market cycles are measured in years. However, market commentators sometimes like to borrow from baseball lingo when they talk about where we are in the stock market cycle. Given the robust market gains of the last 18 months, investors are probably wondering if we are in the middle innings or the late innings of the current bull market. The thing is, you never really know. It’s only with the benefit of hindsight and the onset of a recession that we know with certainty that a bull market is over.
In football they say defence wins championships. But in the world of investing, determining the winners really depends on where we are in the cycle. If it’s early cycle, then offensively positioned (i.e. cyclicals) portfolios typically generate the best returns. But if it’s late cycle and we’re about to enter a recession, then defensive positioning in one’s portfolio will likely generate better returns than an offensively tilted portfolio.
So why are we using sports analogies in a forum that is supposed to be focused on investing? The reason is that it offers some perspective and it allows us to think a little bit outside of the box given the unusual circumstances of the current environment. In my 20 plus years of investing, I have never seen a global macroeconomic setup like the current one.
On a positive note, we are seeing huge pent-up demand related to the reopening of the economy as vaccines are rolled out around the world. Corporate earnings have been extremely strong and have been surprising on the upside. Furthermore, GDP growth in the United States could hit 7%1 during 2021. I don’t recall a single year during my investing career when the U.S. economy grew by 7%.
On a more cautionary note, this market is running incredibly hot. It is very stimulus driven and it is also deficit driven. For example, the federal deficit in the United States will hit $3 trillion2 in 2021. This represents a slight decrease from last year, but it is triple the level of 2019. This amounts to one of the largest imbalances between federal spending and revenue in American history. Given above average valuations, the stock market is vulnerable to any number of shocks whether it be a new COVID variant or surging inflation that causes Treasury bond yields to rise too rapidly.
The conflicting signals that exist today reinforce our belief in taking a barbell approach when it comes to constructing our portfolios. Looking ahead we believe there is a wide range of outcomes for the global economy. Given the current backdrop, we want to own companies that have both offensive and defensive attributes.
And that brings me to soccer and yet another analogy. A midfielder in soccer is a player positioned in the centre of the field in between the defenders and the forwards. The role of a midfielder is to provide a link between the offensive attack and the defense. The role of a midfielder is not limited to just one job, there are many different dimensions as these players are expected to defend as well as attack. In the world of investing, we can make an analogy between the midfielder and an all-weather stock. An all-weather stock is basically a business that can play offense and defense in the portfolio. Midfielders are high quality companies that have business characteristics that allow them to prosper during economic expansions but also demonstrate resilience during an economic downturn. Many of our Technology and Healthcare holdings play the role that a midfielder plays on a soccer team. For example, the majority of our Technology and Healthcare stocks outperformed the market during the COVID downturn and yet they continued to generate attractive returns during the ensuing economic recovery.
Given the various uncertainties of the current economic landscape, we believe it is prudent as ever to maintain the barbell approach that we use in constructing our portfolios. We own a large number of all-weather businesses and we believe these ‘midfielders’ will protect our portfolios should we enter a more challenging stock market environment. On the other hand, if global equity markets continue to grind higher, we believe that our portfolios are well positioned to participate in the gains that lie ahead.
Have a good weekend,
*Cumberland and Cumberland Private Wealth refer to Cumberland Private Wealth Management Inc. (CPWM) and Cumberland Investment Counsel Inc. (CIC). NCM Asset Management Ltd. (NCM) is the Investment Fund Manager and CIC is the sub-advisor to the Kipling and NCM Funds. CIC is also the sub-advisor to certain CPWM investment mandates. This communication is for informational purposes only and is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. Reasonable efforts have been made to ensure that the information contained herein is accurate, complete and up to date, however, the information is subject to change without notice. The communication may contain forward-looking statements which are not guarantees of future performance. Forward-looking statements involved inherent risk and uncertainties, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. All opinions in forward-looking statements are subject to change without notice and are provided in good faith but without legal responsibility. Past performance does not guarantee future results. CPWM and CIC may engage in trading strategies or hold long or short positions in any of the securities discussed in this communication and may alter such trading strategies or unwind such positions at any time without notice or liability. CPWM, CIC and NCM are under the common ownership of Cumberland Partners Ltd. Please contact your Portfolio Manager and refer to the offering documents for additional information.