Blind Spots

“Bull markets end when the perception of earnings growth disappears […]. Manias, on the other hand, end when the market runs out of buyers.” – Andy Kessler

2020 ended with the world collectively eager to put a challenging year in the rear-view mirror while looking forward to the light at the end of the tunnel. The US election results are now (mostly) behind us, and we have two approved Covid-19 vaccines being distributed in the US with an additional 5 being used in other parts of the world.  What is most surprising to me is, having witnessed a year where we endured the worst global pandemic in a century, the fastest bear market in history, a global recession, and a contentious presidential election; that I would find myself in the same place I was exactly a year ago: contemplating whether the market accurately reflects the reality of our economy.  

Even in the face of violence and domestic terrorism at the nation’s capital, the market still goes up.  Once again, the market is looking past the present to the recovery:

  • The Biden victory has been officially certified. (The market loves clarity.)
  • The recently passed $908B relief bill is likely just a “down payment” on more spending.
  • Senate victories for Democrats Warnock and Ossoff signal more relief funds to Americans.
  • And while Democrats were victorious in the Senate, the split is 50/50 and so the path to future tax increases is not smooth.
  • Investors are certain that vaccine rollouts will lead to a broad reopening of the economy. 

The market is looking forward, but had all of the above outcomes been reversed, the market would still have found a positive narrative.

Over the coming weeks, the clouds from the Presidential election will (hopefully) fade, but Covid-19 will continue to dominate both concern and conversation.  With the distribution of vaccines globally, we are on a path back to “normalcy”, but investors must realize that the vaccine is no panacea. It won’t cause the virus to magically disappear:  

  • Vaccination does not provide instant immunity – People will be even less inclined to wear a mask once vaccinated. It can take 4 to 6 weeks from initial dosing to achieve immunity. 
  • This was the fastest vaccine ever created – We could see efficacy diverge from controlled clinical trials for a multitude of reasons including participant real world behavior, unique medical conditions, and vaccine logistical considerations. (i.e. how the vaccine is stored, transported and administered globally.)
  • Length of vaccine coverage is yet to be determined – What if antibodies fade exactly 13 months after the second dose is administered?
  • It is unclear whether vaccinated persons can still spread Covid 19 – Consider newly vaccinated college students innocently visiting unvaccinated Grandma.

And when we consider “normalcy,” what will be the lingering effects?  

One aspect of the pandemic that has intrigued me is the existence of so called “Long-Covid” patients. Sometimes called “Post-acute Covid”, these patients are typically young and healthy when they contract the virus.  Their symptoms are often mild enough that they do not require hospitalization.  But months after their initial infection, they continue to experience life altering symptoms including severe fatigue, memory lapses, digestive problems, cognitive issues, erratic heart rates, headaches, and hair loss.  For these patients, contracting and recovering from Covid is not the end of the story.  

I see similarities in the broader business economy. As we plunged into the heart of the pandemic last year, businesses ramped up borrowing to bolster their balance sheets for whatever lay ahead.  By September, U.S. Bond sales had surpassed the full year bond sales record ($1.92T) set in 2017. U.S. Debt has now reached its highest level compared to GDP[1] since World War II. Only a few nations have debt loads that exceed their economies and those include: Japan, Italy and Greece. 

(Source: Visual Capitalist)

More concerning than the absolute public debt levels are those who are in debt: financially challenged individuals and companies. Many companies had burdensome debt levels prior to the pandemic.  They have survived through a combination of increased debt and government relief. Post-pandemic, they will have to work much harder to reduce borrowings if earnings do not fully recover as the economy re-opens. 

A quick case study can be found in the airline industry. We analyzed the six largest U.S. airlines[2] to compare industry debt metrics pre- and post-pandemic.

Notes: Median annual interest rate is implied based on additional debt raised during the pandemic.  Coverage ratio assumes recovery revenue will be 65% of pre-pandemic revenue and operating margins remain the same as pre-pandemic. Data sourced from SEC filings and internal calculations.

Median debt levels tripled from December 2019 to September 2020 and the implied annual interest rate more than doubled. Our assumption is that “normalcy” post-pandemic will only bring revenue to 50-70% of pre-pandemic levels as business travel will be curtailed indefinitely.  Business travelers have historically been airlines’ most profitable customers. Post-pandemic, businesses will prefer video conference options over last minute $2,000 plane tickets. This will impact profits and margins for airlines. The median coverage ratio (a measure of a company’s ability to pay interest and principal on its debt) was reduced from 13x to 1x. A minimum acceptable coverage ratio is 2x, and a coverage ratio below 1x indicates that a company cannot meet their debt service obligations.  We have engaged in a bit of statistical manipulation here for effect as these numbers do not fully reflect unspent balance sheet cash. The airline industry is not in nearly as bad a shape as these charts would indicate. But these debt levels are clearly unsustainable and the industry is on a short leash. American Airlines recently reported that their average expected daily cash burn rate would be close to $30M per day ($900M per month) given end of year 2020 flight travel patterns.  Distribution of a vaccine for Covid is not the end of the story.  There will be a hangover for airlines.  

Continued government relief is required to keep the economy running and prevent a longer recession. However, government intervention also kicks the can down the road and postpones the natural sorting mechanism which allows weaker companies to atrophy or fail while stronger businesses invest for the future. Governments can’t provide stimulus forever without residual negative effects.  Eventually, aid will be reduced and new relief funds will go directly to workers who lose their jobs, leaving companies to fend for themselves.  

The airline industry is not the only sector where I have concerns.  There are other heavily indebted industries which will experience lingering effects.  But on the other side of the equation, I continue to see over-enthusiasm for companies that have done well through the pandemic. Future prospects are not nearly as sterling as their parabolic stock prices.  The market is getting ahead of itself. We have long lines at food banks. We have creeping consumer debt. And, due to components of the original CARES Act, credit card issuers are not yet reporting troubled loans. We have rent moratoriums which are scheduled to end at the end of January.  Between 2.4 million and 5 million American households are currently at risk of eviction and millions more will be vulnerable afterward. A Moody’s report noted that tenants could owe as much as $70B in back rent.  

The repeated rounds of liquidity and Federal relief aid have trained investors to take on more risk.  Many believe that markets can no longer have a correction because the Federal Reserve will always step in. This has led to a momentum chase in stocks with inferior underlying fundamentals. Optimistic investors are looking forward to the light at the end of the tunnel, but they are also looking past the realities of business debt burdens and the underlying economy.

This past week specifically was a rough one for our country.  Considering the shock of the actual event and, more importantly its recency, I wonder if we simply perceive it as more shocking than some of the extremes of our past? As I re-watched the footage of the assault on our capital and considered the multi-dimensional depth of what was happening, I was reminded of a quote from comedian and civil rights activist Dick Gregory:

“In America, with all of its evils and faults, you can still reach through the forest and see the sun. But we don’t know yet whether that sun is rising or setting for our country.” – Dick Gregory

I am an eternal optimist and so I prefer to believe the sun is always rising. We can always get better. We are a diverse nation and that is what makes us special. We have different values, religions, belief systems, and motivations. If we embrace those differences as what makes this country unique, we can grow stronger as a nation and move forward.  

2020 was a challenging year in many ways.  The fear of an unknown virus and how it would affect friends and family.  Concerns for jobs and well-being. The mental stress created by the realities of racial divisions within the US. But all of these unforeseen events create opportunities, and that is exciting to me. One of the things I love about the business of investing is that every day is different, and I am in a continuous state of learning.  I have the opportunity to take advantage of dislocations in the market for the benefit of clients. I am rewarded by the prospect of helping clients achieve their personal dreams sooner than expected, or providing them with a better quality of life in their retirement.  That is rewarding, and that is why I put in the long hours. 

If you are interested in joining us on our investment journey, please contact us at  Thank you again for trusting us with your valuable assets.

[1] Gross Domestic Product (GDP) is the broadest measure of U.S. economic output.

[2] Airlines include American, United, Delta, Southwest, Alaska and Jet Blue

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