Uncertainty, fear, toilet paper and investing.

Uncertainty, fear, toilet paper and investing

An article from Bruce Apted – Head of Portfolio Management – Australia Active Quantitative Equities

• What can panic buying of toilet paper tell us about investing?
• Has the baby been thrown out with the bath water?
• Recent correction largely typical

What panic toilet paper buying can tell us about Investing
Most of us have seen photos of empty toilet paper shelves in the super markets. What was your emotional response? Did you think about buying
toilet paper too? Despite assurances from the government and suppliers that we have no shortages, fear can take hold of our decision making especially
when there is uncertainty. As humans we are deeply influenced by the crowd.
Faced with uncertainty our decisions tend to be more emotional. In this monthly note we take a look at the recent market correction in the context of
human behaviour.

Uncertainty and emotional decisions are part of everyday life in financial markets. Investors can be both overly optimistic as well as overly pessimistic.
In recent monthly notes we have written often about pockets of exuberance – investors overpaying for growth and re-rating some companies higher
despite deteriorating fundamentals. Recently we have seen the opposite. The coronavirus has created significant uncertainty and many investors are
selling first. As prices go down fear is exacerbated (just like the emotional response to seeing empty shelves in the super market).

Has the baby been thrown out with the bath water?
Do we see significant evidence of the “the baby being thrown out with the bath water”? One way to measure how much a single event is driving all
stocks is to look at the cross sectional correlation of stock returns. The higher the correlation the more company returns are moving together. When all
companies are tending to move to the same beat we say they are highly correlated. This often occurs when larger macro-economic factors are driving
company prices rather than company specific news. High levels of correlation can be a sign that investors are not differentiating between good
and bad companies and are indeed throwing the baby out with the bath water. Figure 1 illustrates that current stock correlations are at extremes,
near levels seen in other market shocks.

Recent correction largely typical
Whilst the degree of correlation is high we do still see many companies responding to the information as we would typically expect. Figure 2 below shows the median returns for different sectors within the S&P/ASX 300 index from the market peak on the 19th of February to market close on the 9th of March. Over this period the S&P/ASX 300 index declined -18.7%. Figure 2 illustrates both the median return (in the blue outlined box) and the variability of
returns within each sector. As you would expect the more defensive sectors, Consumer Staples, Gold, Utilities, Communication Services and REITs faired significantly better than the more economically sensitive sectors. While the median return for Consumer Staples stocks was down only -3% some companies actually had positive returns while some were down -16%. The wide range of return outcomes across every sector is supportive of investors differentiating between companies based on fundamentals.

Looking at the types of companies that outperformed in the correction we do not find too many surprises. Figure 3 highlights the types of companies that outperformed in the correction. Companies that have lower volatility outperformed as investors gravitated towards greater certainty. Companies with better financial strength and better operating metrics outperformed as well as did those with higher environmental, social and governance scores. With
earnings season fresh in investors’ minds the companies that produced the largest surprises continued to do better than those that disappointed. Larger companies outperformed smaller, past winners outperformed past losers and higher yield marginally outperformed lower yield.