Investment Insights

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. 🙂