2020 Second Half Considerations
Clients of the Firm,
The rally on July 6, 2020 put the stock market within less than 2% from being flat for the year. This is an almost unbelievable result given the backdrop of challenges faced in 2020 and a significant testament to market confidence in the Fed and Treasury actions along with a litany of other action steps and conditions that have propped up markets, which I will discuss below. As we begin the second half of the year, it is appropriate to take stock (pun intended) of where we have been in order to assess where we might go and the risk attitude we should adopt on our journey.
Initially after the March 23, 2020 low, markets began to recover on the hope that some recovery was possible and that an oversold bounce was likely given the complete carnage that took place in the preceding 30 days. Simultaneously, as that rally started taking shape, case counts in New York, Massachusetts and other places that experienced the worst COVID outcomes began to improve on margin and then accelerated to where we find them today. For example, Massachusetts as of July 5, 2020 had only 636 patients hospitalized with COVID-19 and 46 intubated. You can find a link to the source data here: https://www.mass.gov/doc/covid-19-dashboard-july-5-2020/download
Many of the worst projections of hospital overload did not come to pass and I believe we were able to achieve the virus mitigation results in NY and MA by social distancing, closures and vigorous mask wearing. Once the spread factor is reduced, the mitigation accelerates as there are less infected people to spread the virus. Thus, proper mitigation is also asymptotic as was the uncontrolled spread we saw in early days and are now seeing in states where guidelines were leapfrogged or ignored. Predictions of the future path of the virus surge, peak, flattening and mitigation remain highly unreliable and run the spectrum from apocalyptic to similar to past influenza outbreaks in scope.
Optimism is well placed in vaccine candidates from Moderna and Pfizer that are both messenger RNA based and seem likely to proceed to stage 3 clinical trials. ICUs are getting better at treating acute cases and even as cases spike in the aforementioned states, deaths are not yet spiking at rates previously seen in New York and Italy. Let’s hope this trend continues as we cautiously recall that deaths lag hospitalizations. Large gatherings still need to be contained, managed or cancelled until there is a vaccine that is widely available. Our best guess is that this will be Q1 2021 at the earliest. CDC is now recommending an in-person school experience with masks and social distancing for children under the age of 19. According to Dr. Fauci, studies have now shown in countries where school was not cancelled that the infection rate was low amongst school age kids and, importantly, that the spread rate was actually very low due to the asymptomatic nature of youth infections. In Massachusetts, zero (0) children under the age of 19 have died from COVID -19. Thus, the primary risk of mortality remains with staff, especially those with pre-existing conditions and/or co-morbidities. This risk needs to be balanced against the potentially lifelong mental health issues and developmental disruption that keeping kids out of schools creates.
The reason I bring this up in the context of this note is to underscore the importance of the impact of the state of the virus on the state of the economy and thus the stock market. Market conditions like FOMO (fear of missing out), interest rate suppression, the low risk free rate fueling justification of current valuations and the seeming unlimited ability of the Fed to backstop bonds continue to be tailwinds for market highs. In a recent letter to investors, Howard Marks points out that we have now entered the third stage of a bull market where “everyone concludes everything will get better forever”. This is clearly not the case. Market cap weighted indices continue to drive higher markets despite entire industries like leisure and travel performing at depression levels. Money continues to flow into the most popular cloud, stay-at-home and COVID-19 cure companies. In addition, story stocks like Tesla and Zoom continue to attract enormous amounts of capital at incredibly high prices taking on characteristics of a year 2000-like market peak.
To conclude whether markets are rationally priced or not depends entirely upon knowing the unknowable. What will the virus endgame look like? What other risks will emerge? What will the election outcome be and what will the impact be on policy? From our perspective, it remains important to be appropriately cautious about equity investing at these price levels. Markets appear to be priced in a very optimistic way and that optimism does not appear to be balanced against a page long list of potential headwinds and as of yet, unrealized risks. Money is made from investing in capital assets at prices where one has a reasonable chance of achieving a return on equity consistently above inflation. Those returns are then reinvested in other capital assets at reasonable prices to generate a compounding effect that magnifies wealth over time. As Warren Buffett famously said, “Price is what you pay, value is what you get”.
We shall continue to keep you informed as market conditions unfold. Thank you for your continued confidence in our firm.
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