Stewarding Your Financial Resources, Together!

Tulip and Willow, 1875 By William Morris, from Birmingham Museums Trust

July 31, 2020

Dear Friends,   

With everything that is going on right now we recognize that this may be a good time to begin assessing the next cycle in the markets and together with you, to discuss a strategy. We can’t say with any real confidence that we see the entry point yet for new money. However, we do think that this is the beginning of what it will take to have confidence in an entry point. 

Earlier in March, our sense of what the economy would have to demonstrate is now becoming the dominant view: that the devastation in the economy will be much more significant than it might have appeared at the onset of the whole COVID impact. At that time, we expected 2020 to be a lost year economically. We still do, but now we think there is a strong likelihood that it will now extend further into 2021 and not grow to new heights until perhaps late 2022. That’s the economy. 

The markets are on another path: they have reflexively and prematurely discounted the economic destruction and how much of it will be permanent. After the March ~35% market drop, it simply turned around and “resumed” 2019 assumptions from a significantly lower level. This just demonstrates that with enough institutional money, underpinned by the Fed and Congress, temporary opportunism and speculation can appear to be the same as the normal market “discounting” mechanism. It is not. It takes a much larger gain to overcome a loss. A 50% loss takes a 100% gain to offset the loss and you are only back where you started.

The Fed and congress can dump $6-8T into the economy, with an additional few $T coming soon, but it is the equivalent of vapor wear in tech.  It is economic junk food, a sugar high. The money injected does not represent human productivity and cannot actually add additional value, only survival value. Survival value is very important, but if the mechanism of human economic activity is damaged or broken, it will take much longer to surpass the economic productivity of “the day the earth stood still.”*

The earth is fortunately no longer standing still, but the extent of the damage is not yet even known. The cumulative effect of all the unemployment and bankruptcies is accelerating. Much of the landscape of business and local commerce will disappear and it will take time for the void to be filled. That is the economics. The human experience will be carried for several generations. The scale of real people suffering and dying, the loss to families, cannot be assimilated or replaced.

So, when will the markets recognize and reflect this? So far, the fear-generated self-interest of markets is ignoring the obvious U.S. and global hole that has been created. Somewhere in all this, markets will have to adjust to the loss of the essential valuation tool that generates market prices: earnings and how much one is willing to pay for the future earnings of a company. How can there be a price to earnings ratio when there is little or no way to predict earnings with confidence for the next year or so? This fundamental discounting mechanism of markets cannot really function well at this time. Only a handful of companies, fortuitously positioned to ride the wave of destruction have surfed to earnings nirvana (tech, online merchandising, pharmaceutical and healthcare, communications). The vast majority of companies have suffered greatly. An increasing number have disappeared as we have known them, or disappeared forever.

The markets are beginning to see the real depth of the underlying debris field and, even more importantly for investors, the duration needed to recover. It is a sobering sight. The U.S. will probably not break new GDP territory until very late 2022 or early 2023. However, as equities adjust to this and sort the companies that can both benefit and/or accelerate earnings growth, from those that cannot, the markets will more clearly demonstrate the smoke screen behind which the indexes hide. Only a handful of companies have generated the index “gains” for quite a while. The large majority of companies began decelerating before the COVID issue and shutdown obscured this. In general, the major indexes are dominated by 5-10 of the largest companies. The thousands of other companies, that may be suffering, do not counter-balance Apple, Microsoft, Netflix, Amazon, Alphabet (Google) and a few more.

So, in as much as the markets have jumped a few years ahead in anticipating earnings, while ignoring the present, we expect the markets to encounter a reckoning before they begin to grow again upon solid economic ground. This does not mean we should abandon the markets. Trying to time markets for the vast majority of us is more risky by far than examining our overall allocation of assets and confirming the quality of the companies owned. This stressful condition was not caused by a faltering economy. Quite the opposite. The economy at the end of 2019 was slowing from record growth, but still growing. This was caused by an unforeseen and unforeseeable, powerful, although microscopic, agent. Moreover, it induced a massive disruption of the entire global economy.

As is commonly said on Wall Street, the “bottom line” will not be pretty and it will take a few years for the landscape to rebuild. Moreover, it will. So, as market values have periods of decline over the next year or two, our suggestion is to continue to hold and build a well-diversified global portfolio with appropriate personal risk-adjusted asset allocations and, in addition, to continue to add to your holdings of high quality companies that contribute to human progress. Fortunately, these days this can be accomplished in small increments. One does not have to act impulsively or commit large sums all at once, just consistently add what you can to your ownership of the great companies of America and the world.

We have been processing a voluminous amount of information and analysis of late. From among them, we wish to share three recent pieces that we think will be of both interest and value to you as you also seek a deeper understanding and appreciation for our current situation. Each piece speaks from a different perspective; Liz Ann Sonders is more technical in this piece; David Kelly is bringing a macroeconomic viewpoint and Morgan Housel speaks more to the personal experience.

We wish everyone continued good health in the full knowledge that together we can steward your financial resources through to their ultimate service of supporting you to live the life you wish to live in bringing about the world you wish to live in.

Jerry!
Bernard