Quarterly Reflections - July 2020

In three words I can sum up everything I’ve learned about life: it goes on. ~ Robert Frost, American poet (1874-1963)

On the economy

Clinically speaking, we are in a recession. Typically recessions are declared after the fact, as in, “oh yes, that slowdown six months ago? That was a recession!” No such nuanced declaration will follow this COVID-19 pandemic era. The National Bureau of Economic Research (NBER) has confirmed how unusual this is, saying the “unprecedented magnitude of the decline in employment and production, and its broad reach across the entire economy, warrants the designation of this episode as a recession”.

The average recession is 11 months. As peak activity occurred in February, that would suggest a recovery around December or January 2021. But there is nothing average about this time, either the reason for the recession (global quarantine caused by extremely contagious virus) or the way out of recession (treatment of tricky virus or vaccine). Economic conditions are already showing signs of bouncing off extreme low spring levels so perhaps this recession will be shorter than normal, as the NBER has suggested.

Consumers’ feelings about the future are slowly improving as millions have gone back to work, mobility trends have moved up from their lows, and spending is beginning to resume. We are moving through a period of pent up demand that is coming through now with more conviction.

This is the high season for residential real estate sales and buyers and sellers are starting to get braver about returning to the market. There is strong competition for container space to ship durable consumer goods (the kinds of goods that last like furniture and cars, as opposed to consumer staples like food, paper towels and medicine.) Manufacturing is far from the basement levels we saw a few quarters ago and is showing proof of life.

The world wants to get back on with it. But will this reemergence stick?

The virus tail is wagging the dogged economy and will continue to do so until either a vaccine, better virus care management, or herd immunity brings about general health. The path to normalcy for the U.S. and global economies will be hesitant and uneven. We may even touch upon the dreaded “double dip” recession if business closures are a repetitive coping strategy.

On the markets

After one of the worst first quarters in history for U.S. stocks, the second quarter turned out to be one of the best in decades. The snap back came on the heels of the government’s four massive stimulus packages. A fifth may be coming later this month.

Even more important for the markets was the Federal Reserve’s commitment to purchase bonds on the open market. The March move of fund rates from 2.5% to 0% was not that interesting to investors; it was more or less expected since zero has been the rate for much of this century. But the talk around the bond buying spending spree was a huge catalyst for firing up the markets again.

Thus far the central bank has purchased the bonds of 794 different companies, including Apple, Verizon, AT&T, and the U.S. divisions of Toyota, Volkswagen, and Daimler. The Fed is in the process of doing this through buying fixed income exchange-traded funds and directly buying individual bonds. This encouraged many corporations to issue new debt. The Fed is also purchasing U.S. Treasury bonds, often from big financial institutions, which are huge owners of treasuries. This has the effect of dumping millions back into their vaults, giving banks the option to increase loans, or not. So far, banks do not seem partial to additional lending.

This interference in the natural cycle of a business and market has frustrated many. Yet the bigger arc of the Fed printing money in the face of an exogenous shock quickly instilled confidence to a truly panicked market this spring. The Fed’s safety blanket gave tenacious investors the coverage they felt necessary to get back to buying stocks.

Investors started buying even though most publicly traded companies did not have nearly enough clarity to give guidance about their future earnings. As of late June, 40% of the companies in the S&P 500 index had walked back or kept silent about expected future revenue and earnings. Another 30% had communicated lower outlooks as a result of the pandemic. On average, shares for the companies that withdrew or withheld guidance recovered somewhat in the quarter but were still down on average of 18.2% annually through June 28th. Compare this to the S&P 500 only down 7% as of the same date.

Companies that could speak to revenues or had a clear advantage in the safer-at-home period were the first to start clawing back losses. Extremely popular were those that could help us clean our homes (Unilever, +9% quarterly return), entertain our families (Netflix, +21%), deliver items A-to-Z to our door (Amazon +41%) and keep us connected to the rest of the world (Apple +43% and Microsoft, +29%). Most of the best quarterly performers were only bounce backs from the ugliness of March’s market bottom. Among the S&P 500 companies, 451 stocks rose during the second quarter, but only 135, or 27%, were positive for the first half of the year.

Trading volume was extremely high during the quarter. Some of the most heavily traded companies still face highly uncertain futures, such as Carnival Corporation (Q2 up 24%, YTD -67%), American Airlines (Q2 +7.2%, YTD -54%) and Ford (Q2 +26%, YTD -33%). Speculation and then excitement about the “next new thing” also defined trading in the second quarter.

Take vehicle newcomer Nikola Motors, which started publicly trading in early June. Within days Nikola (ticker NKLA) went from a $1 billion market capitalization business nearly $25 billion at June’s end, surpassing giants Ford and Fiat Chrysler. Nikola has no revenue to-date but says the company will turn revenue positive in 2021.6 There are no Nikola products on the road either. (For the super fan, Nikola will now take $5,000 as a down payment for the cyber-truck named “Badger”. It will be publicly revealed in December; until then you can look at the renderings online.)

Earnings for the vast majority of publicly traded companies are in the tank for the rest of 2020. Many will get back to profitability in 2021 and look like their former selves by mid-to late 2022. In that sense, it will feel like a long road back. Still, stocks remain attractive compared to other traditional asset classes. Cash and bonds offer protection, maybe a little interest income, but not much in the way of growth. Many investors feel the TINA effect, despite the risks. There. Is. No. Alternative.

The market is not a slamdunk from here on out. But one who methodically invests in companies with strong balance sheets and profit and loss statements, uses measured allocations and proceeds with discipline and patience, may find a rewarding path.

On personal finance

The emotional impact of the COVID-19 will last long beyond 2020, even beyond any vaccine that could bring back a sense of safety and normalcy. This pandemic will be an event that resets an entire world economy and reshapes futures for every person of every generation.

As with all extremely difficult times, the pandemic has provoked a variety of emotions like fear, anger, anxiety and disbelief. In addition to how you may have felt about your own personal or professional life during this time, you may have felt another way about your investments.

Behavioral finance and the emotions around money have been a popular area of research for years. You may have even heard of a “money coach”, a relatively new profession and therapy style. While society used to finger wag that “polite people do not discuss money”, it is now healthy and purposeful to explore the feelings and actions that money emotions inspire.

Academic researchers have identified several different biases as they relate to money. None are inherently bad, and all define natural human behavior. Here are a few useful ones to know about and perhaps research or ask us about if you would like to discuss further.

Herd mentality. This has been most definitely in play in markets recently, like the phenomena of Nikola Motors. This is also called the “crowded trade”. Our species is a social one and we feel comfort in being a part of the herd. Even if we do not know what is happening is good, we do not want to be left out. This is also known as “FOMO”, the fear of missing out.

Loss aversion. For years studies have shown that some people feel the pain of loss more than the pleasure of gains. People recall investment portfolio declines more vividly than gains, even when the gains are greater.

Anchoring. Anchoring refers to the tendency we have to attach or anchor our decisions to a reference point, even when it has lost relevance in the current situation. Consider an investor who pays $40 for a stock in a company that eventually falls on hard times. If the stock now trades at $20, the investor decides to wait to sell the investment until it reaches $40 again, anchoring the investment to a now unjustifiable price.

Mental accounting. This refers to the protective emotion that one feels towards certain sources of money but not others. Parents say that money their children earn gets carefully saved while money that is gifted is spent. Alternatively, some investors are attached to stocks that grandma gifts to them, regardless of the stock’s future prospects. Employees may to be emotionally attached to their company stock holdings. Confirmation bias. It is extremely common for humans to be drawn to information or ideas that validate their existing beliefs and opinions. For example, many prefer to read or watch news that represents their own political views, avoiding those featuring different opinions. The best way to overcome this bias is to seek out information from multiple sources and listen to differing opinions and views.

Recency bias. This is the tendency to believe that what recently happened will continue to happen. Recent performance can be a strong driver of current investment decisions. It is no secret that investors tend to chase investment returns, often piling into an asset class or investment just because it has done well in the past with the belief that it will continue performing.

Here are a few more. Cognitive depletion and decision fatigue means we make poor decisions when we are tired. Primacy bias is when we focus on what we hear first. Status quo bias means we prefer the familiar to the unfamiliar. The hindsight or planning fallacy says humans are generally bad about planning for the unexpected or worst case scenario. (This is a common behavior that financial planners have to delicately help clients with on a regular basis!)

Disclosure

Statements on financial markets and economics are based on current market conditions and subject to change without notice. Due to the rapidly changing nature of financial markets, all information, views, opinions and estimates may quickly become outdated and are subject to change or correction. We provide information from reliable sources but should not be assumed accurate or complete.

Investment Advisory Services offered through Integrated Advisors Network LLC (IAN), a Registered Investment Advisor. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.

This information is designed to provide general information on the subjects covered. It is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Serene Point Advisors and its affiliates do not give legal or tax advice. You are encouraged to consult your tax advisor or attorney.