This article was first published in the National Post on December 19, 2020. It is being republished with permission.
by Tom Bradley
Last week, DoorDash went public and its stock soared. On the first day of trading, it closed at US$190, 86% above issue price. The next day, Airbnb repeated the feat, closing at US$144 (after trading as high as US$165), more than double its issue price.
These moves were remarkable given that they were big offerings and were already priced above their projected ranges. What’s also interesting is that these companies key off of opposing economic themes. DoorDash is a lockdown story — it’s benefited hugely from COVID-19 restrictions — while Airbnb is a post-vaccine, opening-up story. Contrary market themes running hot on back-to-back days.
Generally, investing is all about trade-offs. To get something, you need to give up something else. You can have higher returns or lower volatility, but not both. Higher bond yields come with an increased chance of default. And when an acquisition is announced, one stock goes up and the other down.
But in 2020, there are numerous examples of investors having their cake and eating it too. It developed into an “and” year as opposed to an “or” year. To explain, I’ll start with the two market themes I mentioned.
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As the year comes to an end, the lockdown beneficiaries are expected to continue doing well. Companies like Amazon, Netflix, Zoom and DoorDash have lockdown-like expectations built into their stock prices — i.e. rapid growth well into the future.
Meanwhile, stocks hit hardest by COVID-19 have experienced a nice bounce back. Companies in travel, manufacturing, and commodities aren’t yet hitting new highs, but their stock prices are now assuming that people will be mobile and able to congregate again by the middle of next year. Consumers will be reallocating their budgets towards things they used to spend money on.
The tech stars are expected to benefit from more lockdown and the recovery stocks are assuming a resumption of somewhat normal business activity.
Heads I win, tails you lose
There are more “ands” at the macro level. Investors are expecting interest rates to stay at recessionary levels and the economy to have a robust post-COVID recovery. They’re also assuming that more government subsidies are coming and tax rates will be unchanged.
This favourable combination comes into play when analysts are valuing companies. In general, they’ve reduced their discount rates (required rate of return) in their valuation calculations due to the decline in interest rates. This has boosted values because, in many cases, they haven’t made the commensurate adjustment to slower economic growth and higher taxes. Combining the bond market’s pessimism with the stock market’s optimism is a powerful, if tenuous, combination.
Having it all
As for M&A, there have been deals where the stocks of both the acquiror and the acquiree went up. This week, Aphria announced a deal to buy Tilray and both stocks reacted positively. Last week, it was the same result when Whitecap Resources announced it was buying Torc Oil and Gas.
In the bond market, the yields on high-yield bonds and direct loans have come down nicely (pushing prices up) since the spring, even though default rates have started to increase.
And maybe the best example of investors having it all in 2020 is the disruptor stocks. I’m speaking of companies like Tesla, Uber, Airbnb and Netflix that are growing rapidly while shaking up mature industries. For these stocks, there’s no pressure to make money as long as growth prospects are exciting. They’ve found the sweet spot in investors’ eyes, being rewarded for undercharging customers and going global at breakneck speed. I heard it said that speculators (in these stocks) aren’t being tethered by earnings forecasts and price-to-earnings multiples. It’s a beautiful thing.
If 2020 was the year we had our cake and ate it too, will 2021 be the year of consequences? Will the normal investment trade-offs reassert themselves? Will interest rates rise if the economy roars back? Will the disruptors start to be valued based on profits instead of customer love and shareholder affection? Will the old economy take revenge?
And will 2021 be the year when somebody has to start paying for all of this?
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