Category: Investments

Despite the looming recession and potential U.S. default, investor sentiment continues to be noticeably positive. As of yesterday’s market close, the S&P 500 has bounced back slightly more than 50% from its decline since January 2022. Furthermore, the trading volume for Nasdaq 100 call options saw its highest mark since 2014. Yet, this bullish outlook in growth stocks is seemingly disconnected from the more pessimistic economic data.  This week new data revealed that U.S. consumer confidence in April dipped to a nine-month low due to fears of an impending recession.

The S&P 500’s rebound from a significant downturn suggests that a recession may not be as imminent as feared. This resilience is partially attributed to a corporate earnings season that has, by and large, surpassed expectations. Propelled by robust earnings reports, cost cutting, and enthusiasm for innovative trends in AI, investors have been reallocating towards growth stocks. It’s worth noting that value stocks have underperformed, seeing little to no investor demand. For instance, the Vanguard Value Index has slipped -1.33% this year. Additionally, dividend-paying ETFs like the Schwab US Dividend Equity ETF have performed even worse, falling by -5.75% this year. Consequently, growth stocks have become pricier, while the inexpensive stocks lack buyers. This situation seems eerily similar to 2021, with such a marked disparity between growth and value stocks. I expect these stocks will eventually return to their means, much like they did in 2022. However, I don’t foresee this trend changing in the near future. I also prefer buying and owning growth stocks at a discount, but these stocks are anything but cheap.

The decline in consumer confidence is visibly impacting the retail sector. Walmart CEO, Doug McMillon, stated on Tuesday that inflation is creating strain among American consumers, with effects varying across product categories. He noted that consumers are prioritizing their purchases, sacrificing certain electronics in favor of essentials. For pricier items like TVs, they are holding out for sales, and cutting back on their apparel and home goods shopping. In a similar vein, Target’s recent earnings report echoed these observations. “American consumers grapple with difficult choices, juggling family wants and needs,” shared Chief Growth Officer Christina Hennington during a post-earnings call, “The looming threat of a potential recession is a major concern for many American families.” Despite the note of caution, both Walmart and Target have actually increased their yearly guidance, thanks in large part to successful cost-cutting measures and improved inventory management. This helps to explain the scenario we are seeing played out across the economy which is the economic data isn’t so hot but investors are still upbeat.

In the weeks ahead, we can expect the focus to shift from earnings reports back to politics. Likely, the politicians will need to come together and delay this major debt issue, with both sides proclaiming victory in the final hour. Once this crisis is averted, investors will shift there attention back to problems like slowing economic growth, stubborn inflation, or a potential recession. Inflation continues to be a wildcard, and considering the Fed’s data-driven stance, the market’s reactions to economic updates will be key. Personally, I don’t rely too heavily on frequently revised government economic reports, as they often provide an incomplete picture of the economy’s health. I find it more useful to listen to management discussions and see what is happening at the business level.

We’re seeing a market situation reminiscent of 2021, with an economy that’s underperforming and growth stocks carrying the day. Yet, there’s a compelling case beginning to take shape for those keeping a watchful eye on overlooked value stocks, which may eventually swing back into favor. The timing of this shift is more likely to coincide with the Federal Reserve’s interest rate cuts, given that going against the Fed’s actions has traditionally been an unprofitable strategy for investors.

My favorite political consultant is Greg Valliere. He has over three decades of experience following Washington for investors and analyzes policy and politics and their impact on the markets. Last week, he wrote in regards to public opinion on race relations in America, “that in my 35 years of polling, I’ve never seen opinion shift this fast or deeply. We are a different country today than just 30 days ago.”

It has become such a politically charged environment. After the rallies and riots, I was waiting for the next shoe to drop and it came with a boycott of social media. It started with smaller companies such as Patagonia Inc., VF Corp., North Face, Eddie Bauer and Recreational Equipment Inc. Then larger companies joined, Verizon Communications, Unilever, and Coca-Cola announced spending freezes. On this news, Facebook stock dropped $20 or 8% and the selling spilled over into the entire market.  Unilever went as far as saying it would pull its advertising from the social media companies for the rest of the year. “Given our Responsibility Framework and the polarized atmosphere in the U.S., we have decided that starting now through at least the end of the year, we will not run brand advertising in social media newsfeed platforms Facebook, Instagram and Twitter in the U.S.”

The boycott worked because Zuckerberg announced new civil-rights protections at Facebook. It took a rally, riots, and a boycott to change Facebook’s policy. Change is happening and I’d say boycotts work the best when you hit the billionaires in the wallet. Yesterday many of our technology holdings felt like collateral damage. I know a few of you hate President Trump with such a passion that a 1% loss in your portfolio never gave you such satisfaction. For Trump supporters, it’s been an awful few weeks. The Wall Street Journal got in the action and ripped President Trump in a few opinion commentaries. Peggy Noonan wrote a commentary titled The Week It Went South for Trump.  She was never a big Trump fan and wrote, “He hasn’t been equal to the crises. He never makes anything better. And everyone kind of knows.” In this politically charged environment, I’m sure the WSJ lost a few subscribers because they too will be boycotted, but this time by Trump supporters.

If we thought it couldn’t get any worse with this virus spiking in the south, now we are dealing with revenue being lost because of boycotts. The markets really had no chance of going up this week.  I never thought I’d miss the days when Trump would send a tweet about trade talks and the market would immediately go up or down 1%. I much preferred trade talks going well or a trade war was going to happen over this harsh reality.

The best advice I’ve read in a long time was from Nanette Jacobson, the Multi-Asset Strategist at Wellington. She wrote, understandably, many investors are gun shy about jumping into value when its performance has been so disappointing for so long. Ironically, this may be precisely why now is a good time to give value stocks a look. I would add that the only reason for most of the market to be down so much is that something has to be broken. The investor optimism poll by Wells Fargo/Gallup had the largest short-term drop since its inception!  Ric Edeman, the founder of the nation’s largest independent financial planning warned advisors in a new report that “until a vaccine is widely distributed, the economy is not likely to fully recover.” He gave great advice and went on to say, “Advisors should be talking to clients about whether they have the financial wherewithal, as well as the emotional wherewithal, to maintain their portfolios for as long as this might last,” he said. Some of his clients are opting to put more funds in cash reserves and lessen their holdings in equities so that they are not forced to sell stocks when prices are down. “It is better to make that determination now than after the market falls again. Taking a cavalier attitude toward the pandemic is not advisable.”

I’d like to finish with a quick story about one my of my best calls I’ve had in a long time with a client that is retired 30 minutes before the market closed on Friday. The Dow was down 750 points for the second time in a few days and he said I’m having trouble sleeping at night. But it wasn’t for the reason you would think. He wanted to buy way more of a stock he held and had been following for years. The dividend on the stock was now at 7.17%. I’d recently listened to a call with the CEO and the dividend was safe and could be as high as 10%, if the company wanted to pay out all of their free cash flow. The stock is not without its risks with its high debt level, but the client said I want to buy and hold and don’t care if it falls more, I know it will eventually come back. He couldn’t be any more right. It took a global pandemic, riots, rallies, boycotts, President Trump to tank in the polls, investor optimism dropping to its lowest levels, warnings from the largest investment advisor, to create the value in this company to now yield 7.17%. This opportunity doesn’t come along when the sun is shining and investors are feeling happy. We ended the call both fully understanding that this is unlikely to be the bottom for the stock because nobody really knows how the rest of this pandemic will play out. But he has the financial wherewithal and emotional wherewithal to suffer some inevitable short-term losses to reap longer term gains. This is how money is made in markets. You have to have more longer-term holding power, understand what you own and the risks, and buy when everyone else is selling because they no longer have the emotional wherewithal. If there is ever going to be a time to buy it’s when everything begins to look bleak. In the first sell-off, we really didn’t know what we were up against and it was stressful, but in this second wave of selling, we are all much more aware of the risks that we face and how our own personal circumstances have changed because of this pandemic. There are some people that are no position to take more risk and might have to follow Ric’s advice because their lives or businesses have been upended. But for others who are in a better position and have a longer time horizon, this could become the opportunity you have been waiting for. I know it was for the client that I spoke with that seized on his opportunity. Hopefully, he now has a better time sleeping at night. 🙂

I wrote last week that my hope was that markets would become more stable and recent gains were consolidated, but something told me that the year 2020 still had a few more surprises for us. It wasn’t a surprise that it only took a week to be surprised. All of the large gains from the prior week were lost this week.

There is a powerful feedback loop in markets that can become “self-reinforced” even if it does not reflect economic reality. This theory was introduced to the market by George Soros in an investment book titled, The Alchemy of Finance. According to Soros’ concept of reflexivity, “financial markets can create inaccurate expectations and then change reality to accord with them. This theory of reflexivity could help explain the underlying force that took the NASDAQ to an all-time high before the correction this week.

The theory of reflectivity was put on display this week when the new hot investing trend became speculating in bankrupt companies. Hertz, Whiting Petroleum, Pier 1 and J.C. Penney, which all declared bankruptcy amid the pandemic, saw their shares surging at least 70% on Monday’s trading alone, some of which more than doubled. Chesapeake Energy went up over 400%! Hertz ended up going up an insane 800%. The low for the week was .40 cents and high was $5.50 and it ended at $2.59. In bankruptcy, Hertz has a $19 billion mountain of debt that will need to be paid before there is any money left for common shareholders. It even received a delisting notice from the New York Exchange. This didn’t stop investors from speculating. This move ranks up there when oil prices went negative $20 a barrel. Hertz is now trying to issue $1 billion in new shares at a $3 stock price. This money could help save the company from bankruptcy! In the end, the bankruptcy filing could ultimately save the company from bankruptcy. There is an army of small retail investors trying to get rich off penny stocks and they are actually able to change reality even though their expectations make no sense. I’ve written a few times since this economic crisis began, the textbooks are not getting this one right. Many investors are not focused on financial statements and are speculating on investments where they can make or lose 100% in a day. For example, the daily return volatility of cruise lines and airlines stocks is now over +/-10%.

The first shock of bankrupt companies doubling took markets to all-time highs and the second surprise caused the largest market drop since March. Chairman Powell of the Fed said that, “It’s a long road. It is going to take some time…..Twenty-two, 24 million people – somehow as a country we have to get them back to work, they did not do anything wrong. This was a natural disaster.” We all agree with this statement, but the surprise was keeping rates at 0% through 2022. At the time of this statement, the NASDAQ was at an all-time high and investors were thinking the recovery would be early next year. I was also in this camp. President Trump blasted the Federal Reserve on Twitter Thursday after this grim outlook on U.S. recovery that took down the Dow by more than 7%. “The Federal Reserve is wrong so often,” Trump tweeted, “We can use our tools to support the labor market and the economy and we can use them until we fully recover.” This might be the one instance in 4 years that Democrats and Republicans can all agree with a Trump tweet. It’s much better to give investors some return on their money. The Fed is always quick to bail out lenders, but maybe this time they should be paying more for borrowing money given the higher risk to invest money.

You need this “animal spirits” alive to get this recovery rolling. Animal spirits was a term coined by the famous British economist, John Maynard Keynes, to describe how people arrive at financial decisions, including buying and selling securities, in times of economic stress or uncertainty. I believe it’s great that some investors are willing to buy bankrupt companies in the hope of getting rich. They might end up saving a few jobs at Hertz and buy the company some time to get through this pandemic without declaring bankruptcy. However, Hertz and all the other companies financial statements in bankruptcy do not support their valuation, but there is something to this theory of reflectivity. On Friday, American Airlines reported a 90% slump in revenue. Their expect daily cash burn rate to slow to about $40 million in June, and said it plans to fly 55% of its domestic schedule and nearly 20% of its international schedule in July. This “good” news was the reason why the stock went up 15%! Imagine if they reported a 100% drop in revenue. The stock might have went up 20%. 🙂

I immediately texted a friend when the Fed made their interest rate decision. I knew markets were in trouble when they dampened animal spirits with this negative economic outlook. I didn’t know that it would cause an almost 20% correction in banks and 10-15% drop in most other blue chip companies. By now we all know how bad the economy is and that this virus is not going to disappear anytime soon. In fact, the curves are still rising in some states in the south and west. In the months ahead, investors will continue to need more positive reinforcement and the power of reflectivity working its magic in financial markets even if some of the short-term predictions seem wildly inaccurate.

Yesterday I had a client sum it up well when she said that as a financial advisor I have both everything and nothing to do with politics. This was one of those weeks where everything seemed to do with politics. It’s always difficult to write about politics because of how polarizing it is, but it is undeniably having an influence on markets. The market sentiment has gotten much worse this week after George Floyd was murdered in broad daylight by a police officer and Minneapolis was engulfed in fire from rioting. Twitter also made an executive decision to suddenly fact check President Trump’s tweets, and Trump, in turn, signed an executive order targeting social media companies. The US and China relations have deteriorated to the point that free trade with China could be coming to end. On Friday, President Trump held a news conference on China, but he stopped short of terminating trade with China as many people had expected. The pandemic now has led to more than 100,000 deaths in the U.S. and 40 million claims have been filed for unemployment. The Chief Market Strategist at Baystate Wealth Management wrote, does the stock market reflect economic reality?

I prefer to focus much more on the part that has nothing to do with politics, which is following corporate earnings and business trends. If you focus on the current events and politics, you might put all of your money under the mattress. If you follow the pulse of the market, good news is good news, and even bad news is good news. With the hope of a vaccine by the end of the year and trillions in stimulus money floating around the system, and $3 trillion more on the way, there might be some extraordinary opportunities. Value stocks have continued their long period of underperformance against growth peers amid the Covid-19 market uncertainty. The Russell 1000 Growth Index is up 2.5% year-to-date, while its value counterpart is off 20%. I believe this is a trend worth following and I’m already seeing signs that a rotation is taking place into these dividend paying, value stocks which are beginning to outperform large cap growth.

John Rogers, co-CEO and chief investment officer of Ariel Investments, said on a recent call that value is extraordinarily cheap. “There are just extraordinary bargains there. I think it’s going to be a violent turn that will give value investors a great opportunity over the next decade.”  David Herro, Harris Associates’ CIO, argued that the underperformance of value has scared away investors. “There’s so much underexposure to these businesses. I don’t know exactly what the catalyst will be – probably some view of the light at the end of the tunnel in terms of economic recovery. But when it does happen, I think it will be to value.”

The long-awaited rotation to value stocks may finally be coming, according to Evercore ISI. A combination of smooth re-openings, improving infection rates, high retail-investor cash levels and the historically extreme relationship between growth and value stocks all support conditions for a risk-on rotation in the next couple of months, strategist Dennis DeBusschere wrote in a note on Monday. The P/E spread between the top quintile of historical growth and traditional value stocks is extreme and investors need to be prepared for a violent move toward value if there is better-than-expected economic news or development of a vaccine.

The positive news this week for markets came from JP Morgan CEO Jamie Dimon speaking at the Deutsche Bank Global Financial Service conference. He surprised people when he said there is pretty good odds for a fast economic rebound. Banks may not need to build more loan loss reserves in the second half of 2020. He went on to say about a third of consumers requesting forbearance haven’t used it and he expects high repayment rates for those exiting forbearance. This economic crisis is much different than 2008. “It’s a healthier consumer,” he said. “You see that in underlying delinquencies. It’s completely different from a consumer standpoint” than during the financial crisis in 2008. However, Dimon did warn that a prolonged downturn is still possible, “If it does go on for a year, it won’t be very good,” he said. “You can’t prop up the stock market forever.”

I continue to expect volatility to remain high because of the fear around a second wave of the virus. The personal savings rate hit a historic 33% in April, the U.S. Bureau of Economic Analysis said Friday. As I wrote last week, time will tell if this pent up demand in savings will translate into Americans going out on a future shopping spree. There wasn’t much opportunity for many to go out out and spend money and now with the economy reopening, the hope is that the negative feedback loop will be broken and the stock market will begin to reflect economic reality.

The last time Warren Buffett got this much negative press was back in 1999 during the tech bubble. At that time, value investing was also labeled dead and markets had become disconnected from reality. The Fed was pumping in trillions of dollars into the economy in fear that Y2K would cause an economic disruption. This week what caught my eye was the front page of MarketWatch.com. It is now the most popular story titled, Dud stock picks, bad industry bets, vast underperformance — it’s the end of the Warren Buffett era.

These stories always start out very complimentary about how Warren used to be great. Then they compare the performance of Berkshire to the S&P 500 and show the underperformance. There are 10 investment lessons and stories that I’d like to share in regards to this story.

Lesson #1 – Negative headlines actually create the best investment opportunities. Stocks don’t fall when everything is going well and XYZ stock has to fall for one reason or another which is what creates the value. Rosy headlines do not create opportunities.

Lesson #2 – To the columnist who wrote this story, I’d counter that Warren Buffett doesn’t need a bailout from the Fed. He didn’t take any of the free PPP money either. The S&P 500 desperately needed a bailout about 2 months ago. In fact, it needed $2 trillion in stimulus and it’s going to need another $3 trillion more to get to other side of this pandemic. Warren has $130b in cash on a $430b market cap. Without this much needed stimulus Berkshire would be crushing the S&P 500. I’d estimate the S&P 500 would be down around 50% or more without this stimulus. Berkshire would be using this cash to scoop up all the bargains. This crisis has been different and is unlike anything we have ever seen. Don’t invest expecting a bailout.

Lesson #3 – When the stock market was at it’s lowest, I’d estimate 80% of my clients were beating the S&P 500 return by well over 10%. None of you needed a bailout either for your portfolios. Now if I was managing against the S&P 500, I could have jumped back in and locked in my outperformance vs. the S&P 500. But none of you would have been very happy if the bailout didn’t come and markets fell 20% more and you lost 30% because I was managing vs. the S&P 500. As Buffett said, you don’t want to rely on the kindness of strangers.

Lesson #4 – Warren Buffett’s companies don’t need this $3 trillion or PPP because he planned properly. Your portfolios are all well diversified and I have mitigated risk in this uncertain environment by owning investments that will perform different in various economic outcomes. I expect that some investments will work well and others will underperform. Even your fixed income allocation is well diversified in long term and short term corporates, mortgages, and treasuries. I’m comfortable with the current risk level of your investments because diversification has never been more important.

Lesson #5 – The risk of the S&P 500 is much higher than people assume. It can fall over 50% in a very short time. Without this bailout, it would have taken a month. We have all come to realize the system is rigged to help the rich. The only way to keep the system going is by helping people keep their jobs and putting money in their pockets. The cover of the Economist was Main Street vs. Wall Street. This columnist also had it wrong and you can’t help one without helping the other. The stimulus money is needed, but a strong case can be made that it could have gotten into the hands of the people and companies that needed it the most.

Lesson #6 – Investing is very humbling. You look brilliant one minute and a fool the next. Warren sold all his airline stocks and took significant losses. This was the second time he bought airlines and lost money. The greatest investor of all time got fooled twice. He also lost a boatload of money on an airline preferred decades ago. This time he owned 10% of almost every major airline company. Nobody understands airlines more than Warren. Berkshire owns NetJets which owns the largest flight of aircraft. Another company that Berkshire owns is FlightSafety International which offers training in full flight simulators. You can know something really well and still get it wrong.

Lesson #7 – Keep your losses small and don’t make any one mistake fatal. If you are investing solely in the S&P 500, you can make a one time fatal error. Warren’s loss in airlines hurt, but he is very much still in the game. It took investors who owned the S&P 500 in 2001 and 2008 about 5 years to get back to even. The S&P 500 is a great investment, but it shouldn’t be your only investment. The S&P 500 beats almost everything over time until it doesn’t. This time around investors got a much needed bailout and investors got a second chance. After you make a fatal investment error, there is no recovery. You only get one shot at it and once your capital is gone, it’s gone. If you lose 50%, it takes a 100% gain to get back to even. Without the Fed and all of our favorite politicians, many investors would need a 100% gain to get back to even.

Lesson #8 – The S&P 500 always finds a way to recover. Don’t bet against America because even at nearly 25% unemployment, people want to own a piece of America. We all know that the economy will eventually rebound once we beat this virus. This time around people have placed their bets in advance expecting a fast recovery. Even if the first round of investors are wrong with their timing, there are millions of other investors ready to buy at a lower price. If markets don’t rebound in the next few months, they will eventually recover. Investors will keep buying the dip until someone is right. In volatile markets, dollar cost averaging is the best investment strategy for long-term investors.

Lesson #9 – These bailouts have created a misallocation of capital. The true prices are not being realized and money is flowing into assets that will be supported. Warren didn’t buy any new investments recently because his portfolio is already heavy into stocks. He owns 5% of Apple and 10% of almost every large bank, but all the negative stories say that he is fearful. Berkshire is also made up of 80 other companies. There is no other company more leveraged to the U.S. economy. Berkshire Hathaway is America. If it’s an end of an era for Berkshire, it’s the end of America. Warren doesn’t need a bailout in the worst economic crisis the modern world has ever faced. It’s also not the end of an era for America, and while times couldn’t be tougher, the U.S. will prevail in the end.

Lesson #10 – Investing is in the eye of the beholder. The columnist that wrote the most popular story on Marketwatch has a much different perspective of investing than me. This is what creates markets. I believe as stocks fall they become less risky, and as they rise they become more risky. Berkshire trading at $167 seems like a better deal than Berkshire trading at $230. $150 would be an even better deal. If the journalist wanted to make money and not make headlines, maybe he should be writing about what is working rather than what isn’t. Maybe he is right and the Buffett era is over, but I’ll gladly take the other side of his bet. 🙂

Many people are trying to rationalize the disconnect between the stock market and the economy. Why is the unemployment rate at 14.7% and last week the futures market was up over 1% every morning? The trading sentiment indicators are reaching a euphoric level and the economic data is flashing recession. The short answer to this question is there has never been so much stimulus money being pumped into the economy. There is even more talk about another $2 trillion in stimulus money coming.

I’d like to share another observation that hasn’t gained as much press. I’ve realized that many large investors have become very bearish while younger investors have never been so bullish. Younger investors have opened a record number of brokerage accounts in the last three months.

The more experienced investors that I follow have all turned negative in one way or another. Jamie Dimon, Mohamed El-Erian, Carl Icahn, and Larry Fink are all warning about lasting economic damage. All of them were incredibly bullish for the last few decades. They have a front row seat to the real-time economic data and understand the longer term implications of how the business landscaped has permanently changed.

The younger and more bullish investors care less about fundamentals and short-term valuations. They much prefer price momentum and high volatility. I wrote last week that Elon Musk warned his stock price was too high and now Tesla stock is 4% higher than when he gave the warning. Younger investors shrugged off the warning because they are attracted to the daily volatility and positive price momentum and the high level of short interest in Tesla’s stock. There is a strong correlation that the more negative headlines about Tesla, the higher the price goes. The same could be said about the stock market. The more negative the headlines for the economy, the higher the wall of worry that stocks climb.

Maybe the younger and more aggressive investors have it right and the short-term fundamentals don’t matter as long as the long-term fundamentals improve when the pandemic ends?

This week I was on a conference call with Mohamed El-Erian. He is the chief economic adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-chief investment officer (2007–2014). He is a columnist for Bloomberg and a contributing editor to the Financial Times. His opinion is similar to the other views of the business leaders that have become more negative on the economy. Here is what he had to say.

He said we are all out of our comfort zones. Actually way out of it. Things are not going to go back to the way things were before. We are all worried about health risks and have experienced some mental anguish. There are many difficult decisions ahead. We have to reopen the economy, but are likely to see a second wave of the virus. Companies are going to become risk-adverse and they will change their supply chains. He expects companies will become less productive and there will be more of a domestic bias. The demand side of the equation is the major question market. I would add that this is where the more aggressive investors might have it wrong. Will people emerge from quarantine more frugal or ready to spend?

Mohamed believes that the more aggressive investors are also not taking into account that when the pandemic ends we will be left with more debt in the system. Governments, households, and companies will adapt to the changing landscape with higher debt levels. The more aggressive investors believe that they are in a win-win situation. They are betting that the Fed will bail them out or the politicians will mail out more checks. The Fed is your best friend and will even buy stocks if markets go down. Mohamed went on to say that if the Fed is willing to buy a high yield junk bond ETF then they would buy stocks as well. He was shocked by this decision because they are picking winners and losers and taking on default risk. This will lead to a misallocation of resources because people will only buy what the Fed is supporting, which is exactly what is happening. The flows into the High Yield ETF (HYG) have never been higher. This would not have happened if the Fed didn’t release a statement that they could buy High Yield. The Fed hasn’t bought yet, but the ETF symbol HYG is now in record monthly inflows. I have to hand it to the Fed that this bluff helped to stabilize the corporate bond market.

Mohamed finished the call saying that the long-term outlook for employment will depend on the path of the coronavirus and how fast consumers open their wallets when the economy reopens. Your goal should be to survive with your health and mental well-being and stay in the game financially.

It will be interesting to see how this all plays out over the next few years. Will the bulls be right in their early call for a sharp economic recovery or will the business leaders be right with their call for many stops and starts in the months and years ahead. I’d guess that if you are older and closer to or in retirement you will agree with Mohamed and if you are younger you will agree more with the bulls. 🙂

As bad as the economic data has been, the news was even worse for Tesla shareholders. Elon Musk tweeted on Friday, “Tesla stock price is too high imo”. Tesla’s stock immediately fell -10% on this tweet. IMO it should have fallen 30% or more. For those that don’t write in internet slang, IMO means “in my opinion”.

PepsiCo CEO Ramon Laguarta summed it best on a call with investors when he said expect “ups and downs.” He went on to say we don’t think it’s going to be a straight line once people go back to moving around…with potential second waves in some particular markets.

IMO no matter when governments stay-at-home orders are relaxed business will not get back to normal. The source of the economic shock is not 100% the governments fault, it’s the pandemic. Over the last six weeks, 30 million Americans have filed for unemployment benefits. GDP growth showed the economy contracted 4.8% quarter over quarter. Companies and consumers are all preparing for a recession. U.S. banks have seen a sharp increase in both loans and deposits as people are taking out debt while they still can still show income. JPM and Wells Fargo put a stop to this practice as they are no longer offering home equity lines in fear that job losses will lead to in increase in defaults. The economic news couldn’t get much worse with almost 25% of the population now out of work. The conundrum we find ourselves in is the massive discrepancy between the horrible economic data and the rebound in the stock market. This begs the question, why would anyone want to own stocks in the worst economy since the Great Depression?

IMO the reason that you can still own stocks is that the Federal Reserve and Treasury are printing money at a level never seen in U.S. history. Below is a chart of the speed at which the Fed has printing money compared to the last 3 quantitative easing. The recent stock market recovery mirrors the rapid response of the Fed printing money. The Fed balance sheet ballooned by 50% to more than $6 trillion and economists believe that it will increased to over $10 trillion.

The unemployment benefits were most beneficial. For anyone who showed income in 2019 and lost their job or had their income substantially impacted by the coronavirus, they can collect unemployment plus an extra $600 a week for 13 weeks. If you own a business, the government will help pay your payroll for 60 days with no questions asked. There are moral arguments against accepting this money if you don’t need it. I believe that if the government is offering you free money then you should take it. Without people receiving extra money, the economy would never recover. Many people are actually making more money on unemployment as this chart below shows.

Moreover, the government dropped an extra $1,200 checks in the bank accounts of most Americans. With the increase of the supply of money, will this cause inflation?

IMO there is no inflation. The problem the economy is facing is deflation. Between the collapse in incomes, 20% drop in GDP, and 50% drop in energy, the biggest threat is deflation. I do expect inflation for food. There has been a shortage of meat due to the disruption in the food supply chain. With 30 million people out of work and companies slashing paychecks, deflation is starting to take hold. Companies are now in survive mode and they are going to continue to cut overhead and salaries. The only way out of this mess is for consumers to spend at the level of Christmas this summer. Hopefully, there is pent up demand and people are feeling flush as they have built up their savings over the last few months. Unfortunately, the consumer is likely to tighten their belts and hold off on going on a spending spree until there is a vaccine.

I’m not at all worried about inflation, but it could become a problem if the economy begins to overheat in a stronger economic recovery in 2021. I would welcome this problem and any inflationary pressure attached to it. I don’t believe that it will be this easy, but I’m hopeful that the economy will stage a rebound once we beat this virus. We all want life to get back to normal as quickly as possible and there has been positive developments in speeding up the manufacturing of the vaccine. Pharmaceutical companies are ambitiously targeting 100 million vaccines by the end of the year. In the meantime, expect “ups and downs” until there is a vaccine.

On Tuesday, the price of a barrel of oil fell to -$37! If you did a double take, yes there is a negative sign in front of the $37. You would actually be paid $37 to take delivery of the May contract for oil! Imagine if the gas station would pay you to fill your tank. At first glance this looks like the investment opportunity of a lifetime. If you could buy oil and store it for a month or two, then sell it when things normalize, you could maybe double or triple your money.

I did look closely into how I could profit from the opportunity. The difficulty is that there was nothing that I could buy that didn’t come without a great deal of risk. The oil ETF (USO) which is the largest and most liquid oil ETF was trading at a 35% premium! This premium signifies that the investments held inside of the ETF were valued at 35% higher than what they were worth. I would lose -35% if the NAV of the ETF went back to what the contracts were actually worth. This is exactly what happened over the next few trading days. The only way to profit is if I could buy oil and take delivery of it. Unfortunately, buying an oil tanker was never in my business plans, but it would have been the easiest money that you could ever make. Even if you owned an oil tanker it was already full of oil because the world is flooding in it.

This didn’t stop other people from trying to buy this oil ETF. Another advisor shared a story with me about one of their clients that called them and demanded to buy the oil ETF. The advisor told the client not to buy, but the client persisted because all his friends were buying. This client had the advisor allocate 25% of his account into it. The advisor followed the clients wishes and that oil ETF immediately went down around -40% from the time they bought. The good news for the client was the ETF was down as much as -65%. The advisor joked with me that his clients wife will probably not be at the next annual investment meeting.

The inexperienced investors who rushed in first probably lost more this week than they ever did trading pot stocks and crypto currencies. I’m sure there is someone out there that hit the trifecta of losing -65% in oil, pot, and crypto.

Many of the new online trading companies monitor what other investors are buying on the platform. On the Robinhood app, 100,000 investor accounts opened positions in the oil ETF and it moved into the top 30 before the -65% crash. Now 196,034 accounts own this position. The lower the price goes, the more Robinhood accounts will open a position. To put this into perspective, Apple is held in 348,820 accounts. Another firm Interactive Brokers had to write down -$88 million in losses because they couldn’t collect the margin calls from their clients accounts fast enough. Not only did inexperienced investors buy this ETF, they did it with borrowed money. This was one of the reasons why the price of oil fell as fast as it did. It was due to all the margin calls. I’m sure there were some tough dinner conversations this week about brokerage accounts blowing up.

The actual price of oil is really closer to $26 a barrel and not the $17 that you see quoted in the news. The contract price for oil delivered for September 2020 is at $26. If you believe oil is going to be higher than $26 in September, then you can buy all the contracts you want. It seems like a good bet, but so did oil for delivery back back in January 2020 for the May 2020 contract and that fell from $40 to -$37.  With this trade, you will either be spectacularly right or spectacularly wrong. This is the perfect investment for someone who wants to gamble.

The most careless retail investors are back in this market. They don’t care about fundamentals or economics. Many also don’t even research the symbol before they buy.  More than a few retail investors bought Zoom Technologies (Zoom), instead of the correct company Zoom Video Communications (ticker symbol: ZM). ZM is the video conferencing company that has benefited the most from the new abnormal stay at home economy. But it was ZOOM stock that increased 700% in a month before the SEC stopped trading in it. These investors were buying the wrong stock and the dumbest ones who made the mistake first profited 700%!

You have to  wonder where they get all of their money to continue to speculate. I’m sure many stimulus checks got lost in the oil ETF. The good news is that over the last few weeks markets have stabilized and trading volume is dropping. This means that most of the short-term selling pressure is over for now. It also could mean many larger institutions don’t want to buy at these high prices. But markets tend to rise on low volume and fall on heavy volume. I’ll continue to monitor this trend. I’ll also look into buying an oil tanker. 🙂

I wanted to share an article from the Wall Street Journal yesterday that I thought was very interesting. Jason Zweig interviewed Charlie Munger of Berkshire Hathaway. Charlie is Warren Buffett’s right hand man and in my opinion is one the greatest investors who has every lived. Charlie Munger’s hero is Benjamin Franklin and many people joke that Charlie is a reincarnation of Benjamin Franklin. Charlie even wrote a classic investment book titled Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger.

There is so much noise right now on what’s happening or what’s going to happen next. At 96 years old, Charlie’s wisdom is a blessing and he cuts through the headlines and gives us insight into what they are thinking inside of Berkshire Hathaway. Charlies investment advice is to play the long game and not be aggressive. The goal is to ride out the storm and come out on the other side stronger financially.  Charlies says that everyone is frozen now.  Even though there might be buying opportunities, Charlie doesn’t have the faintest idea whether the stock market is going to go lower than the old lows or whether it’s not. The coronavirus shutdown is “something we have to live through,” letting the chips fall where they may, he said. “What else can you do?”

Below is the very timely interview in full.

Charlie Munger: ‘The Phone Is Not Ringing Off the Hook’

By  Jason Zweig
April 17, 2020 10:00 am ET

If the coronavirus lockdown has frozen your investing plans, you’re in good company. Charlie Munger is watching and waiting, too.

Mr. Munger, vice chairman of Berkshire Hathaway Inc. and Warren Buffett’s longtime business partner, likes to say that one of the keys to great investing results is “sitting on your ass.” That means doing nothing the vast majority of the time, but buying with “aggression” when bargains abound.

I spoke this week by phone with Mr. Munger, who turned 96 years old on Jan. 1. He sounded as sharp and vigorous as ever, and as usual he drew bright lines between what he’s fairly certain of and what he thinks belongs in the “too-hard pile”—where he and Mr. Buffett consign questions they don’t know how to answer. Overall, Mr. Munger made it clear that he regards this as a time for caution rather than action.

In 2008-09, the years of the last financial crisis, Berkshire spent tens of billions of dollars investing in (among others) General Electric Co. and Goldman Sachs Group Inc. and buying Burlington Northern Santa Fe Corp. outright.

‘Everybody’s just frozen.’

— Berkshire Hathaway Vice Chairman Charlie Munger

Will Berkshire step up now to buy businesses on the same scale?

“Well, I would say basically we’re like the captain of a ship when the worst typhoon that’s ever happened comes,” Mr. Munger told me. “We just want to get through the typhoon, and we’d rather come out of it with a whole lot of liquidity. We’re not playing, ‘Oh goody, goody, everything’s going to hell, let’s plunge 100% of the reserves [into buying businesses].’”

He added, “Warren wants to keep Berkshire safe for people who have 90% of their net worth invested in it. We’re always going to be on the safe side. That doesn’t mean we couldn’t do something pretty aggressive or seize some opportunity. But basically we will be fairly conservative. And we’ll emerge on the other side very strong.”

Surely hordes of corporate executives must be calling Berkshire begging for capital?

“No, they aren’t,” said Mr. Munger. “The typical reaction is that people are frozen. Take the airlines. They don’t know what the hell’s doing. They’re all negotiating with the government, but they’re not calling Warren. They’re frozen. They’ve never seen anything like it. Their playbook does not have this as a possibility.”

He repeated for emphasis, “Everybody’s just frozen. And the phone is not ringing off the hook. Everybody’s just frozen in the position they’re in.”

With Berkshire’s vast holdings in railroads, real estate, utilities, insurance and other industries, Mr. Buffett and Mr. Munger may have more and better data on U.S. economic activity than anyone else, with the possible exception of the Federal Reserve. But Mr. Munger wouldn’t even hazard a guess as to how long the downturn might last or how bad it could get.

“Nobody in America’s ever seen anything else like this,” said Mr. Munger. “This thing is different. Everybody talks as if they know what’s going to happen, and nobody knows what’s going to happen.”

Is another Great Depression possible?

“Of course we’re having a recession,” said Mr. Munger. “The only question is how big it’s going to be and how long it’s going to last. I think we do know that this will pass. But how much damage, and how much recession, and how long it will last, nobody knows.”

He added, “I don’t think we’ll have a long-lasting Great Depression. I think government will be so active that we won’t have one like that. But we may have a different kind of a mess. All this money-printing may start bothering us.”

Can the government reduce its role in the economy once the virus is under control?

“I don’t think we know exactly what the macroeconomic consequences are going to be,” said Mr. Munger. “I do think, sooner or later, we’ll have an economy back, which will be a moderate economy. It’s quite possible that never again—not again in a long time—will we have a level of employment again like we just lost. We may never get that back for all practical purposes. I don’t know.”

Berkshire won’t escape unscathed. “This will cause us to shutter some businesses,” Mr. Munger said. “We have a few bad businesses that…we could be tolerant of as members of the family. Somebody else would have already shut them down. We’ve got a few businesses, small ones, we won’t reopen when this is over.”

Mr. Munger told me: “I don’t have the faintest idea whether the stock market is going to go lower than the old lows or whether it’s not.” The coronavirus shutdown is “something we have to live through,” letting the chips fall where they may, he said. “What else can you do?”

Investors can take a few small steps to restore a sense of control—by harvesting tax losses, for instance—but, for now, sitting still alongside Mr. Munger seems the wisest course.

Last Saturday, I wrote that the investment returns for small cap American businesses would eventually register off the charts, but I didn’t expect it to happen in the next 4 days! For my more aggressive-moderate risk taking clients, I did buy small caps, but not enough given the size of the move. If I had known the Federal Reserve was going to bail out all unsecured debt and junk bond investors, I would have moved 100% of all client assets into small caps. The Federal Reserve is now backstopping most fixed income investments and even buying stocks is on their radar.

This recent move by the Fed got an adverse reaction from Wall Street, except of course for those investors that just got bailed out. Today, the Wall Street Journal editorial board wrote an opinion piece titled, The Fed’s Main Street Mistake, that challenged this recent move by the Fed. (For those interested in reading this opinion, I added it to the bottom of this email.) The editorial board believes that the central bank is favoring Wall Street over small business owners.

Tim Seymour, who in my opinion is one of the best financial journalists, said that the Fed is going off the rails on a crazy train. While they pick winners and losers, people have to wonder, “Where’s my bailout?” He was even wearing a t-shirt, “Where’s my bailout” on CNBC when he gave these comments. Tim has been the biggest advocate for capitalism and one of the loudest cheerleaders for the bull market over the last 5 years.

The investment community consensus is that this was a tragic move for our economy and markets. This move created a moral hazard for investors to take more risk because they know the system is rigged and they will get bailed out if there is any trouble. The Fed did not reward prudent and responsible investing and instead favored investors who were reaching for higher returns. The counterargument is that those risky investors who got bailed out didn’t deserve recent losses because a pandemic was out of their control.

My impression from the recent Fed move is that things are much worse in the economy than anyone is expecting. If the Fed is willing to stick its neck out this far then their internal economic models must be showing a severe economic contraction. The debate on this recent program will be felt for years to come. A more effective program would be to help those small businesses that need aid immediately. The Paycheck Protection Program (PPP), which offers companies forgivable loans didn’t go nearly far enough. It’s a flawed program and needs to help small business owners with expenses other than payroll and rent.  The grant money given to these companies needs to be much higher, but so does the verification required that substantial income was lost. The government needs to keep these small business out of debt. I believe that the failure to help these local businesses will stall any economic recovery.

I’m not going to fight the Fed and I’ll make investments alongside the change of rules. It’s a very interesting debate to follow and I have my opinion, but I only care about how this change by the Fed is going to impact your investments going forward. I now feel much more comfortable owning fixed income since the Fed is backstopping everything.  The biggest questions going forward for financial markets will be if the Fed is bailing out even the highest risk investors and printing another $6-$8 trillion, what will happen to the value of the dollar, is the government moving us towards socialism, and will this ultimately create inflation? It is clear that the Fed will do anything in its power to keep interest rates low and they want investors to own riskier assets This move is really not much different than what the Fed was doing before the pandemic. The Fed’s was cutting interest rates into a booming economy. I’ll continue to invest alongside the Fed, but I look forward to the time when small businesses get the help that they so desperately need now.