Stock prices may be disconnected from media negativity and risks related to a still-untamed coronavirus pandemic, but this can be understood and is normal, in our opinion. In this newsletter we argue that uncertainty and possibly scary valuations do not mean you should run away from equities. Our view is unchanged. We remain bullish regarding the long-term outlook and prospects for exceptional companies to create value.
Dire forecasts for the end of the world have not come to pass. The resurgence reflects 1) investor anticipation of things getting better at some distant point in the future, 2) the fact that some companies have actually seen business improve during the Crisis, and 3) a broad-based shift in sentiment to optimism from fear. We remain bullish on the long-term potential for the U.S. economy and for exceptional companies to do well.
Despite the biggest disruption to life in a generation, it makes sense that stocks have barely declined. First, as we discussed last month, the market looks forward, and economies are already in the process of reopening. Second, the Federal Reserve is again backstopping the economy and flooding the market with liquidity. Similar efforts successfully saved the U.S. and global economy during the 2008-2009 housing and financial crisis. Most investors remember this. Third, investors are anticipating accelerated secular change, and bidding up the shares of large technology and other companies, which are perceived to benefit.
Was last week’s mid-week 20% rebound real? Unemployment is exploding. 100 Million Americans are entombed in their homes. Businesses are shuttered. A pandemic threatens widespread death and suffering if some forecasts are to be believed. The stock market staged a dramatic three-day jump. We are saddened by the job losses, business foreclosures, stress, and tragedy but remain optimistic from a clinical investment standpoint.
Summary: Stocks needed an excuse to pull-back. The media storm and negative feedback loop around coronavirus have proven to be just the trick. Our view: Don’t change your investment strategy. The DJIA dropped 12% last week. The severity of the sell-off is due to three factors. First, stocks were extended following the recent resolution of uncertainty on trade disputes with China. Second, financial and other media have stoked fear by massively amplifying reporting and risk around the threat of coronavirus. Lastly, companies and industries are experiencing a real negative impact from reduced consumer spending, travel, and disrupted supply chains. Earnings will be lower than previous estimates.
Summary: The debate over the past year has considered on one hand consistently strong employment growth and consumer spending (2/3 of U.S. economic activity), and on the other slowing corporate earnings growth and risks including the impact of trade disputes, potential increased regulation for big tech (Facebook, Google, etc.), and actions of the Federal Reserve. The threat from the Fed was reversed early in 2019 when it pivoted to cutting rates (and thus providing stimulus) from raising rates. However, it wasn’t until last week with the signing of both the USMCA (United States Mexico Canada Agreement) and Phase 1 of a deal with China that 2019’s most powerful fear-based narrative on trade disputes lost its force.
Summary: The strongest consumer environment in our lifetimes, low interest rates, and ample access to capital underly the market’s favorable momentum heading into 2020, in our view. 2020 is an election year, which is typically disruptive to the consumer. Certain left-leaning policies would be very negative for economic growth, if they were to be enacted. Our advice is focus on 1) the strength of the consumer (whose spending represents 2/3 of U.S. economic activity), 2) the stability of the financial system, and 3) the innovative nature of U.S. companies and industries.
Summary: Markets pushed to new highs on the combination of better-than-expected earnings and stimulus from rate cuts, offsetting and providing a counterpoint to the slowing global growth narrative. The debate in the market over the last 12-months has revolved around the length of the current expansion, valuations, and the likelihood of a downturn in the economic cycle. While there are certainly reasons to be concerned, we continue to focus on the strength of the U.S. consumer. (Consumer spending is more than 2/3 of economic activity in the largest economy in the world, after all.) The consumer remains in a very good state due to the best job market in decades and modest-to-non-existent inflation. We also remain bullish on the innovative qualities of U.S. companies and we believe that access to capital (both for companies and individuals) remains good.
The financial media remains focused on fear-related themes and potential for a recession, but we believe economic weakness can actually be good, if you’re invested in the right companies. On the other hand, the U.S. consumer remains very strong, and consumer spending is more than two-thirds of the U.S. economy. U.S. companies also remain very innovative and ability to raise capital is good. The main risk to global growth seems to be trade disputes between the world’s two largest economies, but, in our opinion, this is a war in name only. We continue to think it makes more sense to position for a positive resolution.
Summary: Threats to economic growth remain minor relative to underlying positives, in our opinion. Last week, markets fell as the Federal Reserve lowered interest rates, but signaled no future cuts. This was followed by Thursday’s announcement that the U.S. would impose a 10% tariff on $300B of Chinese imports. Both events served to stoke fears of slowing global growth. Our view remains more constructive due to our focus on the strong consumer (unemployment is at 50-year low), the innovative nature of U.S. companies and industries, and favorable conditions for access for capital, among both private and public companies. We continue to see the tariff and trade “war” talk as mostly noise relative to economic momentum.