It has been said, “There are decades where nothing happens and then there are weeks when decades happen.” This quote certainly seems relevant to the last several weeks, and while it could describe events across the spectrum of human affairs, we will limit our commentary to our area of expertise, the financial markets.
Recent moves in financial markets have been astounding for their velocity. The S&P500 was down about 35% high to low between mid-February and the end of March. Since that low the S&P500 has moved up 46% in less the 10 weeks. (For our long time clients you will note that a 46% up move after a 35% down move still leaves you 6% below highs, illustrating the importance of limiting downside since it takes a much greater up move then the down move to get back to even.)
We often speak of “fear” and “greed” being short term drivers of the movements in financial markets. The most recent market events have cycled through that range of emotions in record time. As recently as early April many large and significant companies were trading as if they were on the precipice of going out of business. Companies like Viacom, the owner of CBS, MTV and Paramount Studios or Disney, the owner of the famed theme parks and ESPN saw large and rapid declines in the value of their business’. The cruise operators like Carnival and Royal Caribbean traded at a discount to the scrap metal value of their ships. Diversified portfolios of investment grade bonds traded like penny stocks.
Now, just a short time later, we have seen that fear completely dissipate and be replaced by a “greed” that looks a lot like the infamous .COM boom back in 1999. Where do we see that greed in the market? Several companies that have declared bankruptcy, including JC Penny and Hertz, saw their equity rise 300, 400, even 500% over several days despite the fact that they have no value once their debt is restructured in the bankruptcy process. Nikola (NKLA), a competitor to Tesla (TSLA), which has never even sold a car, was trading with a valuation higher than Ford and General Motors combined.
Financial news is filled with stories of investors, and we use that term loosely, rolling their stimulus checks into the stock market and doubling and tripling their money in a matter of weeks. These stories indicate these investors have little experience in markets and are using options and leverage to magnify their returns. Forget Jim Cramer, these investor’s piped piper is Dave Portnoy, of Barstool Sports fame. Portnoy declared, recently in the Wall St Journal, “It took me a while to figure out that the stock market is disconnected from the economy. For trading I have two rules, first stocks always go up, second, see rule number one!” This is the sort if uninformed euphoria that gives us pause on our equity positions at current levels.
The truth about the current economic situation is likely somewhere between the hopelessness of late March and the current euphoria. For the time being, the worst-case scenarios, regarding Covid-19, seem to have been averted. Though it is unclear if we have won the war of just several battles. Nevertheless, much of the negative sentiment in Q1 was predicated on scenarios based on the world’s economy being shut down for 6 or 12 or even 18 months. Even the most pessimistic business executive never did a scenario analysis in which revenue went to zero for an extended period!
With national infection rates stable, or falling, and states in the process of reopening, the most adverse scenarios seem unlikely. However, there are a lot of falling dominos that the outbreak put into motion and it is unclear where they will stop and what path they may take. The government has limited the discovery of the long-term effects with massive stimulus. We do not criticize the government and the Fed for this, but we do think it has made price discovery more difficult. Consumers, with stimulus checks in hand, and abatements on rent and mortgages do not represent their true economic position. Companies with payroll protection loans on the books, incentivizing them to maintain payrolls through a certain period, are not accurately representing their current employment needs. Growth numbers reported as a percent of an artificially low base do not represent true growth. For example, total air travelers from one airport may have been 10mm p/day. That number decreased to 1mm and now is 3mm. Reporting this as 200% growth is misleading since it is still 70% lower than 3 or 4 months ago.
A great deal of the press surrounding Covid has been quite alarmist. That alarmism will not be mitigated quickly. Many in the population continue to be concerned about excessive exposure to potential illness and will limit travel, retail purchases, cruises, casinos, etc.
The government cannot fill the economic gap in perpetuity. Once mortgage mitigation and unemployment payments end it is unclear what employment demand will be and what the real pace of economic growth will be.
There are also macro risks which have been exacerbated by Covid-19. For most of 2019 the markets were concerned about the potential trade war with China. That issue, which appeared settled, is, likely, now not settled. The US and Chinese governments have been engaged in war of words and the Chinese have already failed to live up to their recent commitments on US agriculture purchases not to mention their much more aggressive stance on Hong Kong.
None of this is meant to imply that we see some sort of Armageddon scenario. It is just meant to imply that we encourage patience and a measured approach. We were able to buy equites at prices lower then where they are currently trading and think those prices were great long-term entries. We also have sourced new alternatives which will serve clients well as diversified sources of return and as substitutes for bonds, which we continue to think offer poor risk/reward (we will be issuing a longer piece on this topic soon) As financial advisors we feel it is our obligation to help clients maintain equilibrium and avoid falling prey to the twin killers of financial success “fear” and “greed”. For the most part we helped clients navigate their fear in March and April. Now, we encourage you to avoid the “greed.”
As always, we appreciate your business and encourage questions and comments.