There are two prevalent views on Wall Street and Main Street: Bulls, who view the huge amount of liquidity from government stimulus checks, loans and spending, coupled with the dramatic increase in the Federal Reserve Bank’s balance sheet, as sufficient to buffer against any storm and eventually reignite economic growth; and Bears, who see the still-increasing numbers of infections and deaths, along with the spikes in unemployment, business closures, and loan defaults, as dire headwinds that will significantly impede any sort of near-term economic renaissance. Essentially, the Bears believe that the economic damage has been so severe that, despite a seemingly overwhelming government response, the recovery will be a slow grind over a number of years. The Bulls still believe in that increasingly mythical “V-shaped” recovery.
Before determining which camp to be in, it’s imperative that we are all working with the same reliable data. In this hyper-divisive political climate, we’ve witnessed a surge in unreliable reporting on both sides of the political spectrum. We shouldn’t have to evaluate the veracity of reporting based on which outlet is doing that reporting. But that’s the way it is, and now I’ll get off my soapbox.
There is good news, and there is not-so-good news. Yesterday we learned that despite a dramatic decrease in new COVID-19 cases in the New York metro area, new cases outside of New York appear to be still trending upward. Even so, many state governments have become emboldened by the national data, which was heavily influenced by the NYC data, to begin reopening their economies. It’s not my place to opine on the wisdom of opening up individual state economies. I’ll let the experts make those calls. But I did think it was important to point out that the incredible success in battling this disease in NYC has not yet materialized throughout the rest of the country. We should all be able to agree on that basic premise.
As state responses to the crisis ensue in highly uncoordinated fashion, Congress is debating a new stimulus bill. There is little support for the President’s demand of payroll tax cuts, but it seems highly likely that additional action will be needed. The debate is just starting to heat up, which means no announcement is imminent. A month ago, there were encouraging signs of bipartisan collaboration in Washington, but that was a month ago. Wouldn’t it be nice if the US economy had the resilient strength of current nasty partisan politics? However additional aid gets worked out, there seems to be considerable agreement that more aid is necessary.
Investors are split too. One undeniable effect of all the government’s intervention is that the capital markets have been heavily supported. After falling more than 35% from all-time highs, the S&P 500 is now down less than half of that amount (-16%). The debt markets have also rebounded mightily, including riskier high-yield, or “junk” bonds, that the Fed has pledged to support through the purchase of exchange-traded funds (ETF’s) that hold such bonds. It seems the powers that be have left nothing to chance as volatility has been all but stamped out – for the time being anyway.
The Bulls believe there is room for continued upside for stocks. Some say that the worst is past and that the market-leading FAANG stocks, which have provided stalwart defense throughout the crisis to date, should now be shunned in favor of economically sensitive companies that have dramatically underperformed. Many of these stocks are still down 30-40% from their highs early in the year, they say. Therein lies a rare opportunity to increase one’s exposure to the growth of Corporate America.
Bears, for their part, think that the economic shock caused by COVID-19 will take time, perhaps years, to overcome. They feel that there are still many companies at risk of not surviving this recession as a result of poor revenue visibility and onerous debt burdens. An economy driven by consumer spending, they say, will not quickly rebound with an unemployment rate north of 20%, falling incomes and a new-found sense of frugality.
Are you a Bull or a Bear? Should you be investing aggressively or defensively or at all? Navigating recessions and Bull and Bear markets is something I’ve done for decades. I’ve gotten through all the ups and downs to date, but I’ve never seen anything like this before. As the US marches through this period, experience tells me to rely on data and not desire. What I want to see happen can have no influence on my capital commitments. The dispassionate, disciplined and dogged analysis of data is my most reliable guide. Though it causes me great discomfort, many of my questions don’t have answers yet. A lot of what I’d like to know in order to make informed decisions isn’t knowable and will only be revealed in the fullness of time. So what does one do with investments?
Our answer is that quality reigns supreme for the foreseeable future. Rock-solid balance sheets (low debt, ample liquidity) and little dependence on the capital markets (no urgent need to raise capital) are our first screens in looking for new investments these days. We are also looking for companies with competitive advantages that act as an economic moat. We want management teams who have experience at the helm during previous crises. Also, our portfolios typically have a tilt towards companies that are less dependent upon the recovery in the economy. Finally, valuations must be reasonable and offer a compelling risk/reward trade-off. A margin for error is a very nice investment attribute in this type of environment. (I’m not comfortable naming names because we are still adding to the positions opportunistically. I’m happy to share our market approach, but specific decisions that we see as opportunistic are reserved for our clients.)
A reliance on data is at the foundation of what we do at Farr, Miller & Washington. Though we would all like this health and economic crisis to be a thing of the past, it is not. It isn’t likely even half over (the numbers are still increasing). Navigating this period will be studied and written about in history books. A deliberate, cautiously optimistic, determined approach is our best course to pursue, protect and defend our clients’ interests and well-being. We will get through this. Please call if we can help you in any way.