We hope this letter finds you and your family safe and healthy. It has been a challenging time as the pandemic has impacted all of us and unfortunately, the resurgence of COVID-19 in America is showing that the road to recovery may not be a smooth one. We, like most around the world, are growing impatient to return to our previous routines but acknowledge that the best chance of beating this virus is to do our part by social distancing and avoiding activities that put us and others at risk. Markets appear to be pricing in a return to normalcy soon; we hope they are right.
The volatility over the past four months confirms our belief in an important investing lesson; one should be careful when relying on forecasts. Most, including us, did not foresee the depth of the market dip in March let alone the speed of the rebound that followed. The challenge of picking the right time to sell and then rebuy kept us from trying to time the market. Instead, we continued to incorporate the most relevant and current data into our long-term strategy. During February and March, we identified increasing risk in the market as the Pandemic grew, economies shut down, and growth slowed around the world. This led us to sell ‘at risk’ cyclical holdings and to protect portfolios with options. As markets started to stabilize and economic data troughed, we removed some hedges and increased exposure to the equity markets. This disciplined approach of analyzing the data and investing in quality growth securities continues to drive strong investment results for client portfolios.
“The volatility over the past four months confirms our belief in an important investing lesson; one should be careful when relying on forecasts.”
In our last letter, we reviewed the key items we were watching on the path to economic recovery. Progress towards flattening the curve, understanding the COVID-19 virus, and developing treatments and vaccines continue to be of critical importance to investor psychology. Government lending programs and the Federal Reserve’s actions to bolster market liquidity remain essential for businesses to access the capital needed to staying operational. Lastly, the length and magnitude of economic disruption will impact the health of company balance sheets, unemployment, future consumption, and GDP growth. The guideposts remain relevant and as such, we will review each in this letter. In addition, we are adding the November election to the key market drivers list. The coming election will be sure to influence the path to recovery and will in part determine the future market winners and losers.
The COVID-19 Battle Continues and Markets React
COVID-19. After much of the United States and Europe shut down, the curve was successfully “flattened” in most of the worst hit areas. New York state hit a peak of 11,500 cases per day and is now down to approximately 500 cases per day. Temporary ICU units have been closed and the economy is starting to reopen. Unfortunately, we have seen trends reverse in several states. This has driven the daily national US case count to a new high of 62,000 on July 8th, easily exceeding the 36,000 cases we saw in the April peak. We continue to focus on the level of hospital capacity as the key determinant factor in keeping the economy open. Governments continue to be driven by this statistic as evidenced by the roll back of certain eased restrictions in Florida, Texas and California as hospital ICUs started to reach capacity.
The case counts in Asia and Europe have stabilized at low levels, but unfortunately the number of new infections has continued to rise in many emerging markets including India, Russia, and most aggressively, Brazil. The difficult decision to shut down or deal with the fallout is more contentious than ever as people grow restless and businesses try to survive. Unfortunately, there still is much to be learned about the virus and development of a vaccine is still in the early stages.
“The difficult decision to shut down or deal with the fallout is more contentious than ever as people grow restless and businesses try to survive.”
The work of doctors and scientists has begun to yield some positive data. Both Gilead’s HIV drug Remdesivir and a commonly used steroid, Dexamethasone, in recent studies have reduced mortality rates for severe cases. The standard course of treatment is improving and appears to be lowering the death rate associated with the virus, but the data is complicated. Pfizer and Moderna have released positive Phase 1 data on their vaccine candidates giving hope that a vaccine will be developed in near record time. The next critical step will be the more onerous Phase 3 trials; Moderna will follow Sinovac (a Chinese Biotech) and AstraZeneca this month including 30,000 participants with results expected this fall. Pfizer, Johnson & Johnson, Sanofi, and others are also in the race all with the goal of producing significant quantities of a vaccine in 2021.
After months of broad market volatility, markets are starting to stabilize and differentiate between near- and long-term winners and losers. Virtual meetings, telemedicine, cloud computing, and streaming content are all surging in relevance and related stocks are performing very well. In contrast, many cyclically linked stocks have started to stall as it is becoming clear that certain parts of the economy are going to continue to be weak. Our portfolios are tilted towards the accelerating secular growth trends which have delivered strong performance. For several years we have been investing in companies focused on business efficiency and digitization. As global GDP growth looked weak, we viewed these secular growth trends as the most reliable drivers of revenue and earnings growth. The leaders in many of the highest growth areas are US companies, as a result, we continue to favor the US over most global markets. We believe that these are long-term structural changes that were in motion before the epidemic started and will continue long after it is behind us.
Exceeding Low Expectations – Signs of an Economic Recovery
For markets to continue to rally, investors are looking for confirmation of economic improvement, or at a minimum for data to exceed lowered expectations. The jobs report and retail sales data in May and June although historically weak, came in above consensus estimates and provided fuel to the market. We are also seeing various measures of industrial production and manufacturing data starting to trough and exceed reduced expectations. The improvements are positive, but most levels are still well below 2019. Continued improvement will be needed to drive markets higher.
Returning to normalcy is very important to the economy and while e-commerce and cloud computing trends can help the equity market in the short term, if large scale unemployment persists, it will have an impact on all industries. According to the Bureau of Labor Statistics, in 2018, roughly 20% of employed Americans worked in either a retail job or in hospitality and leisure. As the reopening of the economy is delayed, we have seen several large retailers file for bankruptcy including J. Crew, J.C. Penny, Sur La Table, and most recently Brooks Brothers. Coresight Research predicts that U.S. retailers will close between 20,000 and 25,000 stores this year, up from a record 9,000 last year. As unemployment benefits start to fade, new jobs will be needed to help maintain consumer spending.
We are, nevertheless, encouraged by the resilience of the consumer. Savings rates have been very strong due to the combination of stimulus checks, increased unemployment benefits, and a month or more at home. Low interest rates and stable home prices are allowing homeowners to refinance at near record low rates and positions them to be more resilient than those in most recessions. We have seen consumer spending rebound as a result, indicated by significantly improved data from credit card spending and same store sales in May and June. Time at home has driven spending on home improvement and home furnishings as well as streaming television services. Even the auto industry has seen a strong rebound as many are realizing that a personal car may be the preferred method of transportation for some time to come.
The Government Response
The market has rallied after efforts by both the Federal Reserve and the Federal Government. The lending and bond buying programs have succeeded in injecting cash into the system and along with the stimulus programs, many corporations and consumers have been able to make ends meet. The capital markets have reopened resulting in a large increase in new issuance of debt and equity as companies bolster their cash balances.
As in past events, in the depths of crisis, both sides of the aisle have been able to agree on efforts to support the economy, but we can feel the sense of urgency starting to fade and partisan divides resurfacing. Disagreement is causing a delay in the next phase of stimulus. The additional $600/week of unemployment benefits are due to expire on July 31st and an extension remains contentious. Similarly, the House recently passed a $1.5B infrastructure bill which is tilted towards energy efficiency and climate change goals that is unlikely to pass in the Senate. Despite clear agreement that an infrastructure bill is needed, the two sides seem far apart at this time. Some agreement will need to be reached to help further the economic recovery.
All Eyes on the Election
Much of the current debate in Congress is tied to political positioning in anticipation of the November elections. The debate will focus not only on the strength of the economy and jobs market, but the inequality between those who have benefited from the changes in the economy over the past 30 years and those who have been left behind. The widening wealth gap in America is leading to a polarization of candidates and the electorate and all sides have become emboldened since the election of President Trump. The pandemic has widened the gap further, as some of the most significant beneficiaries from the pandemic have been the largest companies and their executives. This has made the companies political targets, a key risk we are monitoring.
“The capital markets have reopened resulting in a large increase in new issuance of debt and equity as companies bolster their cash balances.”
No matter what happens, the next administration and Congress will face many challenges. COVID-19 may be present for a significant time-period despite progress towards a vaccine and treatments. With a fast-rising national debt, it will be difficult to maintain large amounts of stimulus and low tax rates. States are likely to be in a difficult position as well coming out of the recession and so the Federal Government will need to make the difficult decision whether to help them out. The results of the election and the promises made during the campaign are likely to shape the future of both the country and the economy.
Staying Disciplined and Invested
When we last wrote in April, we were hopeful that we had seen the worst of the market downdraft. We were reluctant to call a bottom, but we analyzed the data and believed that the risk reward profile was attractive enough to justify adding back some exposure to the stock market. We have been rewarded with some excellent returns including Nvidia which we bought on April 13th and had appreciated by 56% through July 10th. Although valuations are not nearly as attractive as they were in March and April, we continue to see equities as attractive relative to most other asset classes. Quality growth stocks when bought at decent prices, should continue to generate successful investment performance for the long term. We will continue to let data be our guide.
At Bainco we continue to do our best to take advantage of each situation while protecting our clients’ best interests and hard-earned wealth. Our wealth strategies team has been diligently looking at opportunities throughout this market dip, such as converting traditional IRAs to Roth IRAs and utilizing low interest rates for new inter-family loans and to refinance loans and mortgages. Our Portfolio Strategy team is staying connected with clients to ensure that we exceed expectations for communication, service, and performance. In order to accomplish all of this, we want to thank our operations team – Mark, Whitney, and Joyani – who have helped us explore and implement new technology which allowed us to continue to execute at the high level you have come to expect from Bainco. Although we have not been able to meet in person, we look forward to our next conversation and helping you reach
your financial goals. Stay well and enjoy these beautiful summer months. We look forward to our next conversation.
MARKET COMMENTARY DISCLAIMERS
This commentary contains the current opinions of the authors as of the date of publication. All opinions are subject to change at any time. This commentary has been distributed for informational purposes only and is not meant to convey a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell securities or investment services. The opinions and statements set forth do not consider the investment objectives or financial situation of any particular individual or group of individuals. Individuals will need to consider their own circumstances before making an investment decision.
Information contained herein, including market forecasts and forward-looking statements, are derived from proprietary and nonproprietary sources Bainco deems to be reliable; Bainco does not, however, warrant the completeness or accuracy of the information obtained from these sources.
Past performance is not a guarantee of future results.