The current deep recession coupled with the stock market “crash” has many investors thinking that these events are just a precursor to more trouble ahead for global economies and financial markets – our team shares that concern. However, what if the onset of COVID-19 and its effect on global economies, businesses and financial markets in hindsight results in a silver lining: a new business cycle and a prosperous, albeit differently “shaped,” global economy?
Our team shares the concern of more trouble ahead – hence our adamant use of risk management tools to mitigate potential catastrophic loss. However, much of investor worry is tied to COVID-19 and its effect on economies and underlying companies. Though the 37% crash in stock prices was dramatic, we considered it to have been fair at the time – knowing what we knew then and more importantly what we didn’t know. However, we as a collective group of investors know much more now than we did when stock prices were reflecting an almost worst-case scenario for global economies, stock and bonds. What we know now about COVID-19 and how it has affected overall economies and individual companies is telling in terms of future successful investment themes and the possibility that we have now entered a new and very different business cycle.
As a firm we have experienced many recessions and bear markets – but none quite like this one. However, most of these periods share certain criteria in common, as does this one. Stocks eventually fall further than the intrinsic value of the underlying securities, the Fed comes to “the rescue,” businesses are faced with rising inventories which in-turn causes them to slow production and reduce employees. All of these criteria fit neatly into the last few months, which in a normal recession takes about a year. However, in this case we have two distinct differences that we believe can provide investors the “edge” needed to succeed in this strange world – namely sector management and liquidity.
Sector Management – A Tale of Two Markets
We have mentioned in recent Strategy Updates that unlike most recessions this one has been outright cruel to certain economic sectors and underlying companies and somewhat supportive to an entire group of others. This is a striking difference that all astute investors should recognize. Simply put, there are many high-quality companies whose businesses are less affected by COVID-19, if not benefiting from its existence. Think healthcare, consumer staples, telecommunications and technology companies. The sectors most hurt include the obvious – high-end consumer discretionary, energy and industrial companies – particularly those with high levels of debt. No one knows what the future holds for the existence of COVID-19, but we do know that these vulnerable sectors face significant setbacks and headwinds. We have never experienced a recession that has allowed us to be as significantly invested and in companies that are “bucking” the recession trend as we are today. We feel fortunate to have chosen the path of focusing on individual stocks and bonds. It allows us to clearly avoid troubled companies and emphasize the best companies in healthy businesses – something the index or fund investor simply cannot achieve.
The speed and degree of support that both the Federal Reserve and Treasury have provided during this crisis is simply historic and should not be overlooked. Every recession gets a liquidity “bailout” and this one is a doozy in terms of what has already been done, but also the degree of what is being “telegraphed” by both institutions – basically “there’s much more where that came from.” Though we can all speculate about how on earth this all gets paid back later, there is little doubt that this funding is making a difference for the overall economy and consumer confidence. The recent and surprisingly strong employment and retail sales data are evidence that injecting liquidity into a contracting economy can be the “silver bullet” that reveals the light at the end of the tunnel. This fact, coupled with the strong likelihood of additional fiscal stimulus – potentially focused on infrastructure – could be the “one-two punch” that reignites faster than expected economic and corporate earnings growth.
The Fed and Treasury’s unprecedented liquidity coupled with the slashing of the Fed Funds Rate to zero has caused treasury rates, particularly short-term rates, to plummet to historically low levels – again! This has also pushed down yields on traditional debt securities making it difficult to find attractive yield on high quality corporate or municipal bonds. Given the world of uncertainty we cannot envision higher interest rates until a recovery in the economy is more present. To capture yield, our team has added preferred shares and dividend stocks. Keeping in this theme, in more stable economy, we may consider the better parts of high-yield corporate paper to achieve higher income.
As mentioned previously, we question the future of COVID-19, the ability of the economy to truly recover as well as the current level of stock prices – hence our risk management tools are firmly in place which include your allocation to stocks, your sector exposure and the use of carefully placed stop loss orders.
When we put our short term concerns about COVID-19, economies and stocks aside, we see many of the characteristics in today’s financial world that are often a precursor to a new business cycle. Recessions give birth to new business cycles and these periods last many years and prove to be prosperous eras for investors! This next business cycle will certainly be led by different kinds of companies than the last cycle (this seems to be happening already). Our team is excited to continue to find companies that will be a large part of this new business cycle’s leadership and your portfolio.
All of us on the team would like to thank you for embracing the virtual meeting protocol that COVID-19 has made mandatory. Prior to the pandemic many clients found the video meetings a preferred method for meeting us due its sheer simplicity and convenience of both time and place. To be honest, as a team, we have found these meetings to be very effective and they have allowed us more time to focus on research, managing your portfolio and attending to your other wealth management and planning projects. Though we think nothing replaces a face-to-face meeting, the video meetings or phone calls seem to be very helpful for keeping you up to speed with our work and allowing you to provide us real-time feedback.
All of us on the team thank you for your continued vote of confidence!
Please let us know if you have any questions about your portfolio, wealth planning or have experienced any changes in your financial circumstances.
Your Team at Main Street Research
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