INVESTMENT PHILOSOPHY

The market pendulum, opportunity or risk?

Closing positions at times of utmost negativity in the market means consolidating losses at the worst time.

07 . 04 . 2020
VICENTE Martín Brogeras

Investment analyst at Cobas Asset Management


2 minuts

The market is like a pendulum, swinging from one end to the other. When events are positive, everything is usually interpreted in that way and negative events are often ignored. This usually causes asset prices to rise, and risk tolerance is not usually limited at the height of the market. When the situation changes, events are negative and the opposite happens, risk tolerance disappears and therefore asset prices fall.

In times of extreme negativity, asset prices drop so much that the risk of permanent loss is highly unlikely, which offers us very good investment opportunities with low risk and high profitability in the medium term. Closing positions at times of utmost negativity in the market means consolidating losses at the worst time. It’s probably the biggest mistake we can make on an investment. However, investing at those moments in the market, with a medium-term vision, is putting the odds clearly in your favour. 

In a scenario like the current one, where everything you read and hear is negative, things are often fuelled by the prediction of disaster scenarios. Everything is taken to extremes; nobody is positive. The most difficult thing at that moment is to be contrarian. That is to say, to do the opposite of what others are doing, to go against the tide. Today, knowing how to be alone is very complicated.  

In the end, we should think that we are buying small pieces of good businesses and always link the price (what you pay) in relation to its value (what you receive), which is based on their ability to generate profits in a sustainable way.

When we enter a scenario like the current one, it is possible to find companies with more net cash than what they are worth in the market. Simplifying it a little, it’s like buying a house, and when the new owner enters the house for the first time, there’s a cheque in the entrance hall for them worth more than they paid for the house. Isn’t it true that opportunities like this don’t come along every day?

In a similar situation, you might wonder: but can the price of this company fall any further? As hard as it may seem, yes. We are currently witnessing some examples of companies we have in our portfolio at Cobas. This can happen out of panic, necessity, ignorance (passive management), something that seems difficult to understand for a rational investor.

Maximum uncertainty levels

We also find good companies, with a good balance sheet trading at 2/3X normalised earnings. That is to say, we buy the house, we rent it, and in a couple of years, with the rent that we have received, we pay for the house. These are some of the opportunities that the market is currently offering, and that is why the market pendulum is opening up a great opportunity for us.

It is likely that during these days we will be close to maximum uncertainty levels (the indices are close to the average fall in a bear market, around 40% from their peak). While you must recognise and quantify the negative impacts that some businesses will have, you must also weigh them up, given the prices they are listed at, against the opportunities that are opening up for the medium term. 

The experience accumulated from other cycles shows us that the best investment opportunities arise at the worst times, when the feeling is very negative.

As the master Warren Buffett once said: “Be fearful when others are greedy. Be greedy when others are fearful”.