Our finest hour
April 13, 2020
Market Summary – 1st Quarter, 2020
“I see great reason for intense vigilance and exertion, but none whatever for panic and despair.”
– British Prime Minister Winston Churchill in his famous “Our Finest Hour” address in 1940.
The first quarter of 2020 will be remembered as among our country’s darkest days. The dire forecasts seem endless. Doctors and epidemiologists project death rates that we can barely fathom. Economists warn that we could be headed for the most dramatic short-term economic slowdown in the history of the country. Politicians find themselves struggling to get their arms around a crisis that is unlike anything they were prepared to handle.
These dark days have created an anxiety-producing investment environment. The recent downturn in the market is not surprising given the forlorn headlines that constantly bombard us. Dramatic daily price swings have become routine.
As investors, we acknowledge the hardship and anxiety brought about by the current state of affairs. We encourage readers to appreciate that long-term optimism and deep appreciation for short-term challenges are not mutually exclusive.
The nation’s most relentless challenges and its gravest threats have ultimately shaped its character. From the civil war to world wars – from the Great Depression to the terrorist attacks of 9-11 and the financial crisis of 2008 – America has always risen to the challenge. The collective prosperity of our country arose not in the absence of adversity, but because of it. While it can be difficult to uncover reasons for a positive outlook in the depths of these dark days, we believe this momentous period in our history will prove again to be, coining a phrase from Sir Winston Churchill, “our finest hour.”
Despite all of the obstacles we’re likely to confront in the coming weeks and months and the ominous predictions, we are convinced of this: powerful forces are converging from many different directions to mitigate the problems caused by COVID-19. There are both economic and scientific developments that will contribute to a change in our fortunes. Investors who fail to recognize how these forces will help turn our markets around risk being left behind.
Force #1 – The “Bank of Uncle Sam” is open
We are seeing a massive and unprecedented combination of fiscal and monetary intervention from the U.S. government and the Federal Reserve. Noted economist and former PIMCO managing director Paul McCulley explains that this is critical to act as “a bridge to the other side of an act of God.” The expanded Fed balance sheet and the dramatic deficit spending in three stimulus packages enacted into law reflect, says McCulley, today’s imperative. “The bank of Uncle Sam needs to be open, period.”1 Today, it is open, with extended hours.
The Federal Reserve has stepped in aggressively, not only dropping interest rates to zero percent, but expanding its balance sheet dramatically in a matter of weeks to maintain liquidity in the markets. The Fed has moved even faster than it did during the financial crisis in 2008-09. At that time, we pointed out that investors should “never argue with a man who buys ink by the barrel,” a reference to the Fed’s power to print money at will. McCulley says of Fed chairman Jerome Powell, “Mr. Powell has a printing press and he gets his ink for free.”2
In the meantime, fiscal policy has been far more aggressive as well. When the financial crisis was at its peak in 2008, it took Congress five months to pass a stimulus package. This time, in about a month, Congress enacted three different stimulus bills, the last for a record $2.2 trillion. It is recognition that for now, the government will have to play a major role as a backstop to an economy that it was forced to close down. There is more legislation on the table, which should mean additional government money pouring into the economy.
©Jon Adams/The New Yorker Collection/The Cartoon Bank
Force #2 – Banks in a strong position
We all remember that the big U.S. banks were part of the problem in 2008. The Fed took steps to prevent that from happening again. It implemented rigorous “stress tests” that required banks to prove they are well capitalized and can withstand a significant economic downturn. As a result, banks today carry only one-third of the leverage they held at the time of the financial crisis. This time around, banks will be part of the solution, providing liquidity to help businesses navigate these rough waters. This is a reminder that beneath the scary headlines about the likely COVID-19-triggered recession, the U.S. economy is prepared to bounce back.
Force #3 – Consumers and businesses will be hungry to spend
Prior to the emergence of the virus, the U.S. economy was thriving. Unemployment was at a 50-year low, corporate earnings and the stock market were at record levels and the economic recovery was into its second decade. Only a self-imposed economic shutdown in response to an act of nature led to our current economic woes. During this time, consumer spending has been mostly limited to necessities (food, shelter, housing). At some point, stores will reopen, employees and business owners will go back to work, and restaurants and bars will again welcome customers. As we return to normal, we should see a notable pick-up in consumer spending, which represents approximately 70 percent of the U.S. economy. In addition, many businesses will be ready to do the same.
Force #4 – Interest rates stand at record lows
At this point in the crisis, we not only have excessive Fed intervention and record government spending, but we also happen to enjoy a low interest rate environment. The benchmark 10-year Treasury note continues to linger under one percent, an historically low level. Low interest rates mean companies can borrow cheaply to invest in growth, individuals can take advantage of low mortgage rates to buy or refinance a home, and government deficit spending becomes less expensive. All of these factors work to support asset prices going forward.
Force #5 – Persistently low oil prices
At the same time the worst of the crisis was beginning to hit, the bottom fell out of the oil market. World demand is projected to drop 20 percent.3 Add in the dispute about oil production between Russia and Saudi Arabia and we have a glut of oil supply. Prices have plummeted to the $20 – 30/barrel range for an extended period of time. At most, we would expect it to move only modestly higher. Compare that to a year ago, when oil was priced at more than $60/barrel. Lower gasoline prices at the pump act like a tax cut for consumers, and some estimate that this factor alone could add as much as one half of one percent of annual growth to the economy.4
Force #6 – Science steps up
In addition to all of the fiscal, monetary and economic developments that should temper a near-term downturn in the market, we can’t overlook the contributions of science. Over the past two years, we’ve frequently touted the amazing advances that are taking place in science and technology that will improve our lives and societies. Now, many of the same great minds already working on those developments have set aside that work to focus on COVID-19. We will benefit from this new golden age of science. Our society has never been so well equipped to deal with a viral threat.
The ultimate solution to get our economy back on track is for practical treatments to be developed; and then, an effective vaccine to become widely available. Dozens of companies as well as government entities worldwide are working together to solve this problem quickly. Treatments are more likely to emerge first, perhaps later this year. A vaccine is probably at least a year away, but even that is a dramatically stepped-up pace from the usual development process for vaccines. This is a Manhattan Project for our times, and there is every reason to have confidence that our greatest scientific talent will come to the rescue in a reasonable timeframe.
We don’t know time, but we know price
Many are asking whether we’ve hit bottom in the current bear market or if there is more room on the downside. The truth is that it is impossible to say. But this much is clear – stocks are dramatically more attractive from a valuation perspective than was the case just two months ago. Value is recognizable even if timing is hard to pinpoint.
We’ve experienced a broad and indiscriminate market selloff. Stocks of “best-in-class” businesses have been punished in a similar fashion to those of weaker companies. This has created a tremendous opportunity for investors to own quality businesses at rarely seen valuations.
It is widely understood that corporate earnings in 2020 will be negligible or non-existent. Savvy investors have the opportunity to look beyond the here-and-now and focus instead on potential earnings growth in future years. There is significant value to be found in companies that are changing the world. Although this market brought plenty of pain in the short run, it represents the birthplace of great wealth-building potential.
Look for a shakeout to occur. The best run companies will have a chance to hit the ground running while others, with weak balance sheets or substandard management, may struggle to return to normal. We believe selectivity in choosing stocks will make a difference.
We’ve seen repeatedly over the past 90 years that stocks tend to enjoy a long recovery after escaping the shadow of a bear market. While nobody is predicting when the bottom of the current bear market will occur (or if it already has), there is every reason to expect an impressive recovery. History shows that stock prices tend to recover before the economic data indicates that the worst is over.
Why this will be our finest hour
The darkness that hangs over our lives and our economy today will ultimately lift. The crisis is real, but it will end. We are confident that this will be more than a return to normal. When you consider the economic, fiscal, monetary, political, scientific, and capitalistic forces that are converging to deal with the current crisis, we could be well on our way to a much stronger economy on the other side of the pandemic.
While the COVID-19 threat is unlike anything we’ve seen in our lifetimes, the market impact is very similar to what we’ve seen in previous crises. As a panic-driven market selloff compounds itself, the disconnect between stock prices and the true value of underlying companies becomes more pronounced, as we’ve seen today.
One important trend we’ve noticed among stocks in our portfolio is that executives of a number of these companies are putting their money where their mouths are. They are taking advantage of the market downturn to add to their own positions in the stock of their respective companies. We see that as an indication of the confidence these insiders have in the future of their own firms.
This is a period in our lives where patience is required. We have to tolerantly put our normal lives on the sidelines while we wait for the pandemic to pass. Investors need to take a similar approach as the markets may continue to go through their gyrations based more on fear and uncertainty than on underlying, long-term fundamentals. The future will be brighter, and with it will come an opportunity to profit from the resurgence of our economy. Stay healthy, remain diligent and maintain patience. In the end, we’re confident that we will all look back and consider this our finest hour.
1 Cox, Jeff, “The government budget deficit is about to explode to fight the coronavirus,” CNBC.com, March 22, 2020.
2 Paul McCulley appearance on CNBC, March 26, 2020.
3 Nasralla, Shadia, “IEA says global oil demand could drop 20% as 3 billion people in lockdown,” Reuters. March 26, 2020.
4 Newburger, Emma, “Plummeting oil prices and mortgage rates could boost consumers rattled by coronavirus fears,” CNBC.com, March 8, 2020.