“When you put a fire under a pot, you learn what’s in it.” — Malcolm X
If a deadly pandemic overtakes the world, but the market looks past it, did the pandemic really happen?
The equity markets staged a dramatic rebound during the quarter as local economies opened across the country. The question for investors is, how can the market turn so positive when data points to rough months ahead?
The short answer is “because the market is forward looking.” Investors are peering many months into the future to a point when Covid-19 fades away, the population gains herd immunity, or researchers find an appropriate treatment or cure. Investors are looking past current data towards a recovery.
Should the Market be so confident?
While I am always the optimist and have confidence that we will get through this period, I remain highly skeptical that the market’s return to almost where we started the year adequately discounts the risks ahead.
Surge
We are seeing a surge in Covid-19 cases (a continuation of the first wave) as well as mutations of the virus just when we thought new cases were trending in the right direction.
- 7-day global average of new daily cases recently passed 150,000
- US daily case count surpassed 60,000
- Countries with enormous populations such as Brazil and India are only just beginning to see an exponential spread of Covid-19 cases.
Scientists don’t yet have a clear indication of the wave scenarios for Covid-19, but history tells us that almost all flu pandemics, regardless of when they started, become more viral and deadlier during the months of September and October.
Unemployment will continue to be an issue
The depth of our economic troubles has not yet revealed itself. The pandemic had the broadest impact on the small business sector, and these companies aren’t publicly traded. The economy added 4.8M jobs in June which reduced unemployment to 11.1%. However, an additional 1.4M people filed for unemployment insurance for the first time and more than 19M are still receiving unemployment benefits. Employers forced to operate lean and efficiently are realizing how much they can do with limited staff anxious to keep their jobs. And when companies reach the end of their Paycheck Protection Program coverage period (end of September), they will likely eliminate many jobs they were maintaining to stay eligible for PPP. A large number of Americans will find their jobs are no longer available, and those old jobs don’t come back anytime soon.
Happily, Unemployed
The crisis has created a conflict. The latest edition of the Federal Reserve’s Beige Book reports that employers are in some cases having difficulty hiring workers despite unemployment numbers. Employers claim that many unemployed are getting more money from unemployment insurance than paychecks would provide. For these unemployed, staying at home resolves the issue of finding childcare.
Bailout for State and Local Governments
Unemployed workers dampen consumer spending and municipalities see less money flow in from sales taxes when residents shelter-in-place. In some states, tax deadlines were pushed back due to the crisis, and income tax collection is taking a hit as people lose work. With so many unemployed not paying taxes, state and local budgets will begin to strain. These same state and local governments are seeing an increase in costs for providing unemployment benefits while also supporting communities where residents are getting sick. The coronavirus relief bill passed by The House in May sets aside $875B for municipalities. Will it be enough?
Don’t forget about November
And of course, we still have a Presidential election coming in November. Current trends point to a rising Blue Tide which could flip both the White House and the U.S. Senate. With it would come increased personal and corporate taxes along with business regulation. The 2016 tax decreases for corporations stimulated record stock buybacks and high dividend payments. This, combined with the Federal Reserve holding U.S. interest rates close to 0%, boosted stock prices. The Market seems to have accepted a blue wave in the fall, but it still clouds the outlook for stocks. A more favorable outcome would be a Democratic White House and a Republican led Senate. A balance of power means not too much would change too quickly.
Social Justice
As an African American, I can’t neglect the social justice debate which has further divided the nation. Does social justice matter for stocks? It all matters…
The unemployment rate for White Americans continues to be much lower than the unemployment rate for Black, Hispanic or Asian Americans. Some workers are seeing more opportunities in the recovery than others. And while this issue may not affect you or me directly, widening income inequality will fracture the foundation of our economy. Much of our current divided nation discourse traces its roots to income inequality and Americans not feeling they are receiving their share of the American Dream.
Recoveries seldom proceed in a straight line, and it’s too soon to predict the path of this one. Rather than attempt to predict the outcome, we are positioning our portfolios to navigate uncertainty. A few core tenets we have specifically focused on in the current environment:
Focus – At RCG, we focus our investment process on the individual companies. As we pursue ideas, we are looking for companies that can prosper and thrive regardless of the macro economy. These companies have strong moats around their businesses. And just as important, they are led by management teams that we trust to navigate changing environments. That frees us, as investors, to make fewer decisions.
Valuation – As we enter our fifth (or sixth) month in a pandemic, the most surprising development is that I continue to see irrational behavior and irrational valuations (bubbles) in the market. As we pursue investment ideas, we always pay attention to valuation. The starting price you pay can amplify (or inhibit) the returns you receive from the underlying growth the company delivers.
Patience – This, too, shall pass. I no longer believe that our world is changed forever. We’ve had social distancing before[2], and our population eventually returned to our normal day-to-day behaviors. We are social creatures by nature. The more I see individuals who are exhausted from Zoom calls, distraught over not being able to spend time with friends and family, and questioning the value (and costs) of an education where students can’t interact with peers and faculty, the more confident I am that we will eventually return to our old way of life with a few adjustments. As human beings, we need the energy we get from daily social and office interactions. We will eventually return to those patterns. With this understanding, we are willing to withstand a few dips and bumps within our portfolio with the understanding that our holdings will still arrive at our expected destination.
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