“The Year That Shattered America”
July 17, 2020
Market Summary – 2nd Quarter, 2020
“All of us might wish at times that we lived in a more tranquil world, but we don’t. And if our times are difficult and perplexing, so are they challenging and filled with opportunity.”
– Robert F. Kennedy, 1961
Though we’re only halfway through, it seems fair to say that 2020 will be remembered by current and future generations as one of those monumentally significant years. In January alone, we had a Presidential impeachment trial and the potential of a looming war with Iran following the targeted drone strike of Iranian General Qasem Soleimani. Those events were dramatically overshadowed by late February, as the focus turned to the COVID-19 pandemic. Through June, the number of deaths attributed to the virus exceeded 125,000 in America and 500,000 worldwide. By March, the dramatic economic fallout from the pandemic was already being felt, with millions of Americans laid off and thousands of businesses shuttered. The pandemic has decimated the travel industry. In addition, it has strained our food supply, closed schools, and left many in a frazzled and frustrated state as a return to normalcy is further delayed by the persistency of the pandemic. Then came the devastating events on the streets of our hometown, Minneapolis. The tragic death of George Floyd sparked a worldwide movement focused on the issues of race and police conduct. Still to come is what promises to be a tumultuous election season.
There are a wide range of concerns raised by these headline events, most notably the ongoing struggles the U.S. has with managing the pandemic and the elevated discussions around race. Much could be said on these and most of the other issues that have surfaced this year. But we know that you are reading this newsletter for our evaluation on what these eventful times mean for your portfolio. Some perspective can be gained by taking a look backwards.
1968 proved to be a year of such turmoil and volatility that Smithsonian Magazine dubbed it “The Year That Shattered America.” It went down as a year of many landmark events. You may not remember that among other headline items, there was a pandemic in 1968 – the Hong Kong flu – which killed nearly 100,000 Americans and millions worldwide. Among other big stories during the year, the Vietnam War raged on, complicated by the Tet Offensive, a key tipping point in how Americans viewed the conflict. The assassination of Dr. Martin Luther King, Jr. set off protests in 110 U.S. cities, including both peaceful demonstrations, as well as rioting, looting, and the burning of buildings. Then, Senator Robert Kennedy was assassinated, as he appeared to be gaining momentum for the Presidential nomination. The clash between protestors and police outside the Democratic convention in Chicago was a landmark event that fueled a very heated election season. In summary, there are remarkable parallels between 1968 and what we are experiencing this year.
It’s also worth noting that despite the strife of that troubled year, the stock market ended 1968 with a return of nearly 11 percent.1 The bigger story, for investors, is what happened in the years that followed. For example, in the 51 years since 1968, the U.S. economy as measured by Gross Domestic Product (GDP), has grown more than 20 times, from less than $1 trillion in 1968 to more than $21 trillion today.
Source: U.S. Bureau of Economic Analysis.
The stock market, as measured by the Dow Jones Industrial Average, has exploded by about 30 times its value at the end of 1968.
While there were calls for “revolution in the streets” back in those tumultuous times, other revolutions occurred in technology, global trade, and the expansion of capitalism as the Iron Curtain was lifted. Within about two decades of the “Year that Shattered America,” the U.S. would emerge as the world’s only true superpower. The period since 1968 has ultimately become one of unprecedented prosperity. The lesson is that investors who are able to see beyond the turmoil of the times are more likely to be positioned to benefit from future economic opportunity and technological innovation.
The market’s strong second quarter seems detached from the tumultuous, day-to-day news. Economic releases that make the headlines today tell us where we’ve been. By contrast, the market is a discounting mechanism that focuses on where we’re going. While a degree of uncertainty about the immediate future exists, particularly in terms of the scope of the pandemic and any further economic fallout, we believe that the future remains bright and promising. For example, Wall Street analysts project that earnings on the Standard & Poor’s 500 Index will drop about 30 percent this year from 2019 levels. But this is likely a short-term decline. Analyst expectations, based on the best information available today, are that S&P 500 earnings in 2021 will exceed 2019 levels.
You aren’t investing in headlines
Stocks still represent the greatest wealth creation vehicle for investors. This is often overshadowed by news that tends to focus on the negative. We’ve seen it all before. For example, in 2011 we were warned that the European Union was on the verge of collapse due to Greece’s debt crisis. That same year, the bond markets were considered at risk as the U.S. lost its AAA credit rating. These were among the macro issues that took up a lot of the market’s oxygen, but in the end, these headlines proved to be interestingly unimportant. For the five-year period from 2011 to 2015, stocks generated an “above-the-trendline” average annual return of 12.6%.2
In that time, a number of businesses enjoyed great success, and rewarded investors accordingly. The world is constantly confronted with problems that require solutions, the kinds that often dominate the day’s headlines. Savvy investors choose to own businesses that adapt to the circumstances and that are positioned to solve problems and generate profits as a result. By focusing on businesses like these, investors can be rewarded even amidst the noise of the markets.
The willingness to overlook that noise was on display in the second quarter. After major indices lost 34 percent over a five-week period in February and March, we experienced the greatest 50-day rally in history. This unprecedented market rally occurred amidst the harsh reality of a reeling economy that some associated with the days of the Great Depression. In what may have been the worst quarter economically in decades, stocks generated their best quarter of performance since 1998.3
In short order those who refrained from owning stocks due to concerns about an uncertain environment were reminded of how quickly they can miss out on a dramatic opportunity. This is a time to heed the lessons of history and remain faithful in the power of equities.
Trillions and Trillions
Investors were perhaps justifiably caught off guard by the severe disconnect between the markets and the current headlines. Negative news dominates the airspace, contributing to a sense of uncertainty and perhaps even doom in the general population. The significant news that is mostly overlooked, yet perhaps has the greatest impact on investors, is the Federal Reserve’s dramatic intervention to help “save” the economy.
As mentioned in our newsletter three months ago (“Our Finest Hour”), the “bank of Uncle Sam” is open. Congress turned on the spigot in an unprecedented way, led by the CARES Act that injected more than $3 trillion into the economy. The Federal Reserve has committed to adding trillions of dollars in additional liquidity, buying bonds and offering low-cost loans to mid-sized businesses. A recent analysis shows that only about $143 billion of the Fed’s current $2.3 trillion commitment has actually been deployed.4 That means there’s a fair amount of liquidity waiting to be put to work in the financial system.
Perhaps part of the difficulty in understanding all of this talk of “trillions” of dollars of government and central bank intervention is that such a number is difficult to fathom. To help clarify just how massive this fiscal and monetary intervention by the government and the Fed is, let’s consider the term “trillions” in the context of time. For example, 1,000 seconds is the equivalent of nearly 17 minutes. Let’s carry that number out exponentially:
1 million seconds = 11.5 days
1 billion seconds = nearly 32 years
1 trillion seconds = 31,710 years
Looked at in this way, we can see that one trillion of anything goes a long way. When we think that the government and the Fed have added many trillions of dollars to the economy in a matter of months, it is a level of liquidity that can clearly have a major impact on the markets. Most notable is the stated commitment by the Fed (voiced by Chairman Jerome Powell and others, including Neel Kashkari, President of the Minneapolis Fed), that they will do whatever is necessary to keep the economy afloat. As we have pointed out during previous crises as the Fed stepped up to the plate, “never argue with the man who buys ink by the barrel.” The printing press is turned on. The economy will not suffer from a lack of liquidity. The Fed has the ability to commit more of it to the market. Already, the Fed’s pledge amounts to the equivalent of about 12% of the S&P 500’s total market capitalization of approximately $25 trillion. That number could easily rise to 15-20 percent yet this year. The Fed has also indicated it won’t be raising interest rates through 2021 and possibly longer. As we also stated in our previous newsletter, “Investors who fail to recognize how these forces will help turn our markets around risk being left behind.”
Perhaps most notable is that this influx of money is shoring up individuals. In 2008, as the Federal Reserve injected liquidity into the financial system, most of that money went directly toward beefing up flagging bank reserves. Today’s influx has a far broader impact. According to Professor Jeremy Siegel of the Wharton School of Business and a two-time headliner at the MPMG Speaker Series event, one of the most striking statistics relates to the M1 Money Stock. This is a measure of all transaction accounts held by individuals.
The M1 rose almost 25 percent in an eight-week period from the middle of March. Note the large spike on the right side of the chart. “I’d never seen that before,” says Professor Siegel.5
Source: Federal Reserve Bank of St. Louis
Scary, but not dangerous
We are living through a period of scary headlines. But while they may be frightening, from an investment standpoint, they aren’t necessarily dangerous. It is reasonable to expect that we’ll continue to see short-term volatility in the markets, much of it in reaction to ongoing headlines. As we reach the peak of summer and attempts are made to further reopen the economy, the COVID-19 pandemic remains a major concern. A surging infection rate in recent weeks indicates that we’re nowhere near being out of the woods on the health crisis. While that challenge persists, we also face a political atmosphere that will become increasingly intense as the November election nears. These and other issues are contributing to an environment of uncertainty that will likely be reflected in market fluctuations.
As momentous as this year may be in the annals of history, the events we’re living through today will have little impact on your ability to build wealth. What will matter most is how effectively you take advantage of the opportunities that develop through the expected periods of volatility. Investor sentiment is likely to shift frequently. Circumstances in the real world around us are rarely black-and-white, but filled with hues of gray. Yet investor sentiment can sometimes shift dramatically, from despondency to exuberance (i.e., performance of the stock market in the first quarter of 2020 compared to the second quarter).
Over the long-term, a happy medium is found. Through that lens, we can envision many businesses that are in a position to prosper as the economy evolves from current crises. Stocks of these businesses that offer real value represent a true opportunity to build wealth for decades to come.
As we learned from 1968, things may seem dire, but our circumstances are not hopeless. Throughout history, lessons have been learned from difficult times and improvements made. All of this will ultimately be reflected in the performance of the equity markets. Remain faithful in the power of our country, our economy and stocks of strong, well-positioned businesses, particularly those that offer attractive value.
1 Total return of the Standard & Poor’s 500 index.
2 Average annual total return of the S&P 500.
3 DeCambre, Mark, “U.S. stock indexes rally toward best quarter in about 20 years despite warnings from Powell and Mnuchin on economy,” Marketwatch.com, June 30, 2020.
4 Cox, Jeff, “The Fed said it could supply the economy with $2.3 trillion. It hasn’t come lose so far,” CNBC.com, June 24, 2020.
5 From interview on podcast “Masters in Business,” June 19, 2020.
Established in 1995, Minneapolis Portfolio Management Group, LLC actively manages separate accounts for individuals, families, trusts, retirement funds, and institutions. Our proven value-oriented investment philosophy has created long-term wealth for our clients.
Visit our website at: www.MPMGLLC.com
Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted. Market returns discussed in this letter are total returns (including reinvestment of dividends) unless otherwise noted.
The information in this document should not be considered a recommendation to purchase any particular security. There is no assurance that any of the securities noted will be in, or remain in, an account portfolio at the time you receive this document. It should not be assumed that any of the holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable. The past performance of investments made by MPMG does not guarantee the success of MPMG’s future investments. As with any investment, there can be no assurance that MPMG’s investment objective will be achieved or that an investor will not lose a portion or all of its investment.