The COVID-19 crisis has challenged and changed us all in different ways, including what we think of as essential. The conversation over what qualifies as an “essential” versus “non-essential” business has impacted many companies that produce and sell items and services considered essential for everyday use. What do you think of as essential (?) – we encourage you to reply to this email and let us know.
Traditionally defined, consumer staple stocks are broken down into five main industries: beverages, food, household goods, personal and hygiene products, and tobacco – services and items that individuals are either unwilling or unable to eliminate from their budgets even in times of financial trouble. Recently, a more contemporary definition of a consumer staple has emerged from our pandemic-altered lifestyles, and consequently, the definition of a consumer staple stock has arguably changed. Introducing, the FAANG stocks:
Facebook (social media). Amazon (e-commerce). Apple (smartphones and tech hardware). Netflix (video streaming). Google (online search and services). All five companies are known for their dominance in their respective industries and sizable customer bases. Combined, they have a market capitalization of more than $4 trillion! Additionally, as a group (below, in purple), the stocks have collectively outperformed the overall stock market (as measured by the S&P 500, below, in yellow) by a healthy margin so far in 2020:
Will companies like the FAANG stocks continue to dominate in the hazy and nebulous “new normal” we are all continuing to get used to, or will things revert and this outperformance be temporary? One thing is for certain – we should get used to life, as well as the financial markets, remaining unsettled and uncertain for the foreseeable future.
Good news heading into the weekend: While one additional coronavirus diagnosis is too many, the curve is flattening, as new COVID-19 cases in the United States have been stable for over two weeks now, according to Deutsche Bank, the World Health Organization, the CDC, and Worldometer:
More than 90 Sacramento restaurants are re-opening for dine-in service this weekend. To see the full list within the Sacramento Bee article, create a free account with the SacBee, or click HERE, and then cut and paste the URL into a web browser opened in “incognito mode” (a nifty little trick):
In addition to our dependence on the aforementioned technology behemoths and our desire to dine out again, a number of trending and notable events occurred over the past few weeks:
We are seeing early signs that these times of separation are beginning to pass, and opportunities to be back together in person with those we have been missing, are beginning to grow. And as always, whether in person or via a Zoom teleconference, we sincerely value our relationships and partnerships with each of you, as well as your trust and confidence in us here at Towerpoint Wealth. We encourage you to reach out to us at any time (916-405-9140, firstname.lastname@example.org) with any questions, concerns, or needs you may have – the world continues to be an extremely complicated place, and we are here for you.
As we trend towards gaining back the freedoms we surrendered in the name of saving lives and flattening the curve, the slow unwind of sheltering-in-place is beginning:
We are continuing to witness the COVID-19 pandemic re-order virtually every industry in the world, and concurrently, many aspects of our formerly “normal” lifestyles. And as we have adapted to today’s slower lifestyle and “new normal,” we have been reminded of just how important our homes have become – as a safe haven, a de facto schoolhouse, an impromptu remote office, and a warm family nest. However, as much as we have learned (a bit forcibly) to love being at home, and as integral as home has been in this new normal, most of us would agree that being at home this much has gotten a little long-in-the-tooth.
There are many more chapters yet to be written about the COVID-19 crisis, and as much as we love our “warm family nests,” this next chapter in the story is one that we all have been anxiously awaiting – the safe and sturdy return to shared communal life, outside of our homes.
As the dawn of the decline of the shutdown approaches, we are all eager to regain the ability to step outside our homes and see friends and family again, to shop at our favorite stores, to eat at our favorite restaurants, and yes, to trade in our trusty sweat pants for our favorite work attire as we begin to head back to work. But make no mistake about it, what our lives will look like as summer approaches will be markedly different that the way we lived our life in February. A “new normal” is upon us, and being adaptable, and socially, economically, and physically aware, is paramount.
A summary of our views:
We are all working more hours now than before the COVID-19 outbreak – expect it to continue
Companies will begin bringing employees back to work over the next two to six weeks, with strategies for doing so being differentiated and customized based on geography and industry
On a much lighter note, and for anyone who is a fan of Billy Joel (who isn’t?), click HERE (or below) to spend four minutes listening to/watching a VERY entertaining “social distance-sing project” where the Phoenix Chamber Choir performs The Longest Time – the adapted lyrics and instruments are great!
Tragically, some have lost loved ones during this time, and we acknowledge that will change life for them even on the upside of this pandemic. But for most of us, these times of separation will pass and we will be back together, in person, with those we have been missing. And as always, we sincerely value our relationships and partnerships with each of you, as well as your trust and confidence in us here at Towerpoint Wealth. We encourage you to reach out to us at any time (916-405-9140, email@example.com) with any questions, concerns, or needs you may have – the world continues to be an extremely complicated place, and we are here for you.
The ability to freely and creatively communicate with clients has proven to be critical during the COVID-19 crisis. And it is this freedom that served as one of the primary drivers of the decision to establish Towerpoint Wealth as a fully independent wealth management firm back in 2017. Click below to listen to Louis Diamond, of Diamond Consultants, interview our president, Joe Eschleman, as they discuss how leaving Wells Fargo, with the help of Dynasty Financial Partners and Charles Schwab, and establishing Towerpoint Wealth allowed him to freely and creatively engage with clients and prospects, offer a much broader suite of services and products, and act as a true legal fiduciary to each TPW client.
At least 316 million people (or more than 96% of the U.S. population) in 42 states are currently under a stay-at-home or shelter-in-place order as the coronavirus pandemic continues to upend life as we know it. However, as California’s Governor Gavin Newsom stated just last month, “This is not a permanent state, this is a moment of time,” and the good news is that we are seeing hopeful time-frames for reopening:
In the meantime, our economy is in an absolute tailspin due to the national lockdown, and Great Depression-esque numbers are expected for the second quarter:
And while it might sound crazy to say, understanding these are nothing short of horrific numbers, there is a clear light at the end of the tunnel.
Why is the stock market (as measured by the S&P 500) up 29% over the past month? One simple answer: The stock market is not a reflection of the current economy. Investors are forward-looking and future-oriented, and they are buying in advance of, and belief in, better days ahead. It can be confounding to grasp when the current state of affairs seems so grim, but it is an essential point for longer-term investors to note and internalize. Since 1953 (with one exception), the S&P 500 stock index has bottomed anywhere from three to 11 months prior to the official end of a recession. In other words, as Warren Buffett said:
The fact that the upcoming ugly U.S. economic figures and data are EXPECTED is especially important to note. While horrific, these numbers will come as no surprise to savvy investors, who understand that stocks almost always rebound before the economy does, and who understand that the market expects the pain experienced by the U.S. economy to be temporary. Questions remain about the shape of the economic recovery and the shape of our new lifestyles, but fortunately the correlation between the temporary nature of our economic pain and the temporary nature of our current shelter-in-place lifestyles cannot be denied.
In addition to anticipating the end of conscientious sequestering and the slow birth of economic recovery, there have been a number of non-COVID-19 newsworthy events over the past few weeks that you may have missed:
As we have mentioned previously, it is important to take comfort that better days are set to return. We will be with our full families again. We will be with our friends and colleagues again. Together. And as always, we sincerely value our relationships and partnerships with each of you, as well as your trust and confidence in us here at Towerpoint Wealth. We encourage you to reach out to us at any time (916-405-9140, firstname.lastname@example.org) with any questions, concerns, or needs you may have. The world continues to be an extremely complicated place, and we are here for you.
A Talk with Dr. Ben Bernanke, Former Chairman of the Federal Reserve
Our President, Joseph Eschleman, was recently invited to sit on a conference call led by Ben Bernanke, former Chairman of the Federal Reserve and PIMCO senior advisor. Bernanke discussed why recent policy moves made by the Federal Reserve (“the Fed”) and other central banks will be critical to a more stable future for the global economy and financial markets. Bernanke discussed why given today’s unpredictable environment, policy response must first focus on public health to promote recovery, and should be senior to current economic policy. To be clear, the role of monetary and fiscal policy, while hugely important during this pandemic, is primarily meant to keep things alive and to support the economy during this temporary economic downturn. The Fed has acted with alacrity in this current crisis to help support liquidity in the capital markets, help financial institutions have access to cash, and to keep credit flowing to the real economy. Domestically and globally, recovery will depend on 1.) public health, 2.) science and 3.) the public’s confidence in both. It will likely be slow, and with false starts, and it will assuredly be different across regions, industries, and businesses. And while 2020 will assuredly be a year of severe recession, our hope is that the economy will open up by the latter part of the year, especially as the medical situation improves, with growth prospects for 2021 being significantly better
Current Economic Environment
Bernanke did not waste any time pointing out that we are facing a deep global recession. And while there may be an emotional relationship between the COVID-19 crisis and the 2008 global financial crisis (primarily the stress created by uncertainty and similarities surrounding the extreme market volatility), the chain of causality is quite different. The ’08 recession was caused primarily by financial system dysfunction, which led to economic instability and weakness, while today’s COVID-19 recession has been caused not by problems in our financial system, but instead by a natural disaster bringing the global economy to a near standstill.
The good news is our banking system is strong and healthy, unlike in 2008. Debt issued by major banks and financial institutions has been backstopped by the Fed, and banks today are well-capitalized and a source of economic strength, opposite of the environment during the 2008 recession.
Today, the critical element will be public-health policy response to the pandemic, which is even more important than economic policy. Working towards a vaccine is obviously a critical step to recovery, with the purpose of monetary and fiscal stimulus to keep things alive in the shorter-term until a vaccine is ready and we can begin to get back to life as normal.
Bernanke said to expect the near-term economic numbers to be brutal, with -30% GDP and a double-digit unemployment rate here in the United States over the next few quarters. However, these unprecedented figures are expected to be temporary, and to some extent should be taken with a grain of salt. The key question: How long will the temporary shutdown last? One quarter? Two quarters? All of 2020? Longer? If it lasts through the summer, we could be looking at severe bankruptcies and permanent job losses and layoffs.
The Fed’s Toolkit
Currently, the Fed is operating at an unprecedented scale, and when compared to 2008, has already done much more, and quicker, to provide support to the economy and to the financial system. Current Fed Chair Jay Powell deserves credit for his swift decision-making, as well as his use of the monetary “playbook” that was established during the 2008 financial crisis. The Fed remains the global lender of last resort, and has already taken action to provide $2.3 trillion of loans to support the United States economy. The size of the Fed’s current balance sheet is $6 trillion (and growing), the biggest it has ever been. And while the sheer size of it concerns some economists, Bernanke was quick to point out that the Fed is acting as a lender, and not a grantor, and is lending on a collateralized basis. These loans are self-liquidating, meaning the money the Fed is loaning is being used to buy assets (bonds), which will in turn be used to then pay back the loan when the bonds mature. Over a period of time this will automatically cause the Fed’s balance sheet to shrink to a more normal level.
Additionally, the Fed recognizes that the U.S. dollar is still king, is still viewed as the world’s currency, and that the availability of dollars is critical to maintain global liquidity and to fuel global credit. Demand for dollars is very strong right now, and to satisfy that demand and to provide dollars to foreign central banks, the Fed has also opened dollar swap lines with 14 different foreign central banks, acting as a repo facility for these banks and collecting interest while doing so.
Bernanke also focused on the emergency credit programs originally introduced to deal with the strained credit conditions of the Great Depression, and utilized more recently during the 2008 financial crisis. Section 13(3) was added to the Federal Reserve Act in 1932 to expand the Fed’s lending authority beyond banks, permitting it to extend credit to individuals, partnerships, municipalities, and corporations – a type of “Main Street” lending facility. Credit markets have recently been extremely dysfunctional, and these 13(3) lending facilities have allowed the Fed to backstop the credit markets in a secure manner and reduce overall volatility. The popular Paycheck Protection Program (PPP) is authorized under section 13(3), and a $500 billion municipal liquidity facility has also been established to offer credit to state and local governments.
In addition to its lending capacity, the Fed also has monetary policy as ammunition to combat the severe economic slowdown. Short-term interest rates have been cut to zero, and the Fed is buying Treasury and mortgage-backed bonds to provide liquidity to the economy. This extremely loose monetary policy is meant to be a temporary placeholder and create an “economic bridge” until we are out of lockdown and the economy begins to pick up speed. Bernanke expressed concerns that people may start saving more and spending less after we see a loosening of the lockdown, and any additional Fed easing will be based on the pace of the economic recovery. It is going to take a while for the economy to get back on track and up and running again, with things not approaching normal in our economy until at least later 2021 and into 2022.
Negative interest rates were discussed as a possible economic policy tool in some circumstances, but the Fed is not inclined to pursue them over the near term. Why?
1. They have a very limited scope.
2. They may disrupt the money market industry.
3. They are most useful to fight deflation (see Japan in 2016), and the COVID-19 crisis is not deflationary.
4. The Fed is on record as saying they are not willing to consider negative rates.
Fiscal Policy and the Political Environment
The 2020 recession is very different when compared to 2008’s recession. It may sound surprising, but Congress is significantly more bi-partisan about today’s economic crisis than they were in ’08. Today, we are fighting a common problem – the virus; in 2008, the problem was the health of our banks, and bailing out the banks was an extremely unpopular issue. The fiscal response to today’s crisis has been very good, and Bernanke believes we will need more from fiscal policy as the economy begins to open back up. Our fiscal response is a de-facto relief package due to a natural disaster, but absolutely necessary to avoid even greater economic pain.
The United States is fortunate in our capacity to borrow, and demand for Treasuries is very high. The big question of how government can afford all of this stimulus and issue and backstop debt like this is a hugely important one, understanding the CARES Act was funded entirely by debt issuance. Bernanke was quick to note that he has no problems with what the U.S. has done to borrow substantially to stave off this crisis, especially understanding the financial burden of doing so is minimal with interest rates close to zero. Emergencies like the coronavirus pandemic are exactly why the United States has a deep debt capacity, although we certainly do need to do better longer-term planning about the structure of the U.S. budget.
Forward Guidance, Outlook and Recovery
It is clear that the shape, and extent, of the current recession will be directly correlated to the health response to COVID-19. Recovery will be directly correlated to the level of focus, energy, and resources placed on medicine, science, and public health. A vaccine may not be available for 12 to 18 months, and opening up the economy will be a slow and regional process, with false starts a reasonable expectation. How to keep proper distance between workers, and how to regularly test the work force for COVID-19 are key questions that will impact what the recovery will look like, as well as the seasonality of the virus. Hopefully the beginnings of a recovery begin this summer, although it remains to be seen if it will be “V” or “U” shaped, or possibly a more uneven “W” shape. Public confidence is key, as this is obviously a highly uncertain environment that requires caution and care. Bernanke holds hope that 2021 should be significantly better than 2020, as some of this year’s economic figures will be Depression-esque. However, the Great Depression lasted 12 years, and we are hopeful this recession will be measured in months. And understanding the IMF made huge changes to its global growth expectations for 2020 (from +3% to -3%), their 2021 forecast is for growth of +6%.
The United States is institutionally strong (governors, mayors, CEOs, presidents of universities, etc.), having high levels of diversity and innovation. As a country, we have weathered many other crises in our collective past, each of which was unique in its circumstances and impact, and we are confident that this pandemic will prove to be no different.
At Towerpoint Wealth, we are a fiduciary to you, and embrace the legal obligation we have to act in your best interests 100% of the time. We encourage you to call (916-405-9140) or email (email@example.com) to open an objective dialogue.
Towerpoint Wealth, LLC is a Registered Investment Adviser. This material is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Towerpoint Wealth, LLC and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Towerpoint Wealth, LLC unless a client service agreement is in place.
Tony has been asking top advisors from leading wealth management firms their opinions on the dual management of the coronavirus and market meltdown crises, as AdvisorHub has been documenting how leading wealth advisors are managing one of the most unique challenges we have faced as a financial community.
With the spread of coronavirus continuing to keep many Americans away from the office, we spoke to six advisors to find out what they like, and dislike, about working from home.
Likes I don’t miss the decaffeinated coffee our director of operations brews.
Dislikes Being a six-person boutique wealth management firm, we all get along really well together, and I miss the camaraderie that our Towerpoint Wealth family shares on a daily basis, as well as general office tomfoolery! We are serious when we need to be, but just like any family, have built a culture based in part on each of us being very good at giving each other a hard time, and it stinks not having the daily opportunity to rib someone for an honest, funny mistake that they’ve made!
The drumbeat of unnecessary, repetitive, and extraneous information and news (read: noise) will always be a constant part of our lives. The challenge is to define and identify what information is truly meaningful, and what is false or useless, and then how to deposit it into our personal knowledge bank. Finally, and we believe most importantly, is the pursuit and application of wisdom, or the ability to think and act using our knowledge, insight, understanding, and common sense, growing slowly with experience over time.
Instead of being distracted, worried, and reactionary, one of our central goals at Towerpoint Wealth is to help our clients be more confident and purposefulinvestors, which ultimately leads you to gain greater economic peace-of-mind. However, as we are all now acutely aware, the global public health and economic uncertainty surrounding the coronavirus/COVID-19 disease makes the attainment of this economic peace-of-mind a much more difficult endeavor.
Reducing and even flat-out ignoring noise is a difficult thing to do, as it oftentimes is a battle against deeply-entrenched habits. Our smartphones, our friends, and the media are regularly our greatest economic enemies, and at Towerpoint Wealth, we believe that a large part of our legal fiduciary obligation to each of our clients is to help you properly tune out. The discipline needed to filter is one of the primary determinants along the path to successfully building and protecting longer-term wealth. And as we continually nurture our client relationships at TPW, we not only set the expectation that we will be explicitly objective about the importance (or lack thereof) of newsworthy external events and the glut of immediately-available information (even if they may not like what they hear from us), but also act as an “information filter,” taking our knowledge and experience and having it translate into the wisdom our clients desire.
Please do not mistake our commentary about noise as being at all insensitive or tone-deaf to the seriousness of the coronavirus situation. More than 100,000 worldwide infections, and at at least 3,383 confirmed deaths do to COVID-19 are sobering figures, and we recognize there are many unanswered questions about what may lie ahead. Additionally, we certainly do not advocate clients walk around with their head in the sand, as it is important to have an awareness and understanding of what is happening. We simply want to help you avoid and ignore the shorter-term distractions that none of us have any control over. Put differently:
As mentioned in the Special Report we issued on February 26 (Coronavirus and the Stock Market Pullback), we firmly believe the US consumer is on solid footing, and will continue to be one of the key drivers of US economic growth in 2020, and that any drop in corporate earnings and economic activity due to the COVID-19 disease will be more than made up for over the remainder of the year. Additionally, we encourage you to click on our March 2020 Monthly Market Commentary found below for our updated outlook and details.
In summary, we think you will enjoy (and ask you to think about) Barry Ritholz’s tongue-in-cheek list below:
What’s Happening at Towerpoint Wealth?
Our esteemed Client Service Specialist, Raquel Jackson, stopped by the office last weekend to do some over-and-above work, and enlisted the help of her three daughters, Zaida (18), Zenia (14), and Daijah (3), while doing so!
Lastly and as always, we sincerely value our relationships and partnerships with each of you, as well as your trust and confidence in us here at Towerpoint Wealth, and encourage you to reach out to us (firstname.lastname@example.org) with any questions, concerns, or needs you may have. The world continues to be an extremely complicated place. We are here for you, and look forward to connecting with, helping, and being a direct, fully independent, and objective expert financial resource for you.
Some Reflections and Possible Outcomes with the S&P 500 Down Seven Sessions in a Row
As this year‘s second month drew to a close on Friday, February 28, the S&P 500 index finished in correction territory at 2,954.22, down 12.8% over the seven consecutive loss-days from its February 19 record high of 3,386.15. All 11 of the S&P 500 industry sectors were showing year-to-date losses, and fully 95% of the S&P 500 companies were down 10% or more from their highs. Flows of capital were instead allocated into perceived safe–haven assets, driving U.S. Treasury two-year yields to 0.878% and 10-year U.S. Treasury yields to a new record low of 1.127%. Even as Federal Reserve Chair Jerome Powell inspired a Friday intraday rally when he indicated that the Fed is prepared to lower interest rates to protect the economy from the spreading economic slowdown, the Chicago Board Options Exchange VIX volatility index spiked to 40.11, its highest close since August 2015, which witnessed three devaluations of the Chinese yuan and a 43% two-month decline in the Shanghai Stock Exchange index. Gold finished at $1,564.10 per troy ounce (+2.9% year to date) and West Texas Intermediate crude oil closed at $44.76 per barrel (-23.1% year to date).
Although the rate of new COVID-19 infections in China has slowed, it should be apparent that a series of rather draconian restrictions (including quarantines, isolation, travel bans, lockdowns, contact tracings, and other strict measures) has been necessary to attempt this within the world’s second largest economy and most populous nation. Such measures have led to harmful consequences for Chinese — and thereby global, due to a much more intertwined worldwide economy than 10-15 years ago — manufacturing, logistics, and just-in-time inventory management (on the supply side) and travel, leisure, bricks-and-mortar commerce, and other forms of economic activity (on the demand-side).
In our opinion, the continuing flight-to-safety decline in bond and money market yields and the further selloff in equity prices is being driven by increasing concerns over the spread of the coronavirus within and between other countries in Asia, the Middle East, and Europe, coupled with emerging realizations that (i) an effective vaccine will take a longer time than generally anticipated to test, develop, and administer; and (ii) it is only a matter of time until the United States experiences outbreaks followed by deleterious effects on individual, corporate, and governmental behavior — producing hitherto unanticipated downward revisions to GDP growth and profit forecasts. For example, on February 27, Goldman Sachs predicted that earnings for S&P 500 companies would show zero growth this year, after earlier predicting that they would increase 5.5%. As of now, our call is for low to mid single-digit S&P 500 earnings growth in 2020, based upon some likely further policy stimulus and more of a V-shaped economic contraction and recovery.
It is important to keep in mind that our cautious and conservative stance (before this market correction in the S&P 500 and other equity indices commenced) has been based upon four main factors, among others:
lofty price-earnings and price-to-sales valuation levels, many of which were in the 95 to 99th percentile relative to historical experience;
heavy concentration of market leadership in a limited number of companies (with the top five stocks representing a record 19.0% of the S&P 500 aggregate market capitalization, even higher than the 18.5% previous all-time high, reached at the peak of the 1999 dotcom exuberance);
the more than a decade-long age of the equities price advance and U.S. economic expansion; and
a significant degree of complacency and nonchalance as evidenced in persistently bullish investor survey readings and low volatility metrics.
For now, we envision three possible scenarios going forward:
(Base Case, 50-60% probability in our opinion): The following factors: warmer weather; various preventive epidemiological and public health measures; some degree of measured monetary stimulus; and the experienced realization that — even with a possibly high infection rate and quite unpleasant side effects, the coronavirus mortality rate is quite low; leads to a short and meaningful decline in the economy in 2Q20, followed by a similarly rapid recovery, back to or slightly below earlier forecasted levels of economic growth. Cash levels can be slowly and judiciously deployed into diversified portfolios, continuing our emphasis on attractively-valued companies with solid earnings prospects and dividend protection.
(Optimistic Case, 20-25% probability in our opinion): The above scenario occurs but with large scale stimulus measures launched across a broad front to counteract increased worries over the potential negative economic and financial impacts of the spread of the coronavirus globally and in the United States potentially including:
massive monetary, fiscal, and deregulatory stimulus by the Chinese Authorities;
immense monetary stimulus by the Federal Reserve in the form of swift and larger-than-expected reductions in policy interest rates and a potential resumption of large-scale Quantitative Easing; and
extensive fiscal stimulus in the form of across-the-board corporate and individual tax cuts and additional federal government spending
These actions are followed by sudden and sharp equity price recoveries, in which we would emphasize technology, consumer discretionary, industrial, materials, and energy companies.
(Unfavorable Case, 15-20% probability in our opinion): High levels of indebtedness, and lingering economic and psychological aftereffects of the coronavirus crisis, lead to a broad decline in hours worked, employment, wage growth, consumer confidence, and personal consumption, bringing on a recession in the second half of 2020, which is exacerbated by late and/or ineffectual policy responses and fears (unfounded, in our view) that it is a replay of the global financial crisis of 2008-2009. In such a scenario, emphasis should be placed on money market instruments, high-quality fixed income securities, and defensive equity industry sectors such as utilities and high-quality companies paying well-protected dividends.
Overall, we stand by our call over the past several months. We have been counseling and continue to counsel diligence, caution, and conservatism — with shorter duration, higher-grade exposure in the fixed income realm, emphasizing high-quality companies whose business results may have been affected by the coronavirus crisis, but whose intrinsic business models remain fundamentally sound, in defensive sectors with reasonable earnings multiples and well-covered dividend support.
As we did last month, we feature a select group of charts and associated commentary below.
Investment Lessons from a Master
On Saturday, February 22, 2020, Warren Edward Buffett released his annual letter to the shareholders of Berkshire Hathaway, and for the 55 years from 1965 through 2019, the compound annual growth rate in per-share market value of Berkshire was 20.3%, versus 10.0% for the Standard & Poor’s 500 with dividends included and reinvested. This means that an investment of $1,000.00 in the common shares of Berkshire Hathaway on January 1, 1965 was worth $25,978,226.78 on December 31, 2019, compared to $189,059.14 had that same $1,000.00 instead been invested in the S&P 500 with dividends included and reinvested — demonstrating: (i) the immense power of significant differences in compounding rates; and (ii) the massive effects of compounding over long time periods.
Page ten of the 2019 Berkshire Hathaway annual report also lists the 15 common stock investments of Berkshire that at yearend had the largest market value, shown above. It can be seen that over the 55-year lifetime of Berkshire Hathaway under Buffet’s stewardship, the total equity investment portfolio had as of yearend 2019 generated a pretax capital gain of $137.687 billion, of which just five stocks — American Express ($17.6B), Apple ($38.4B), Bank of America ($20.8B), Coca-Cola (also $20.8B), and Wells Fargo ($11.6B) accounted for $109.186 billion. This indicates that 79.3% of the total capital gain in Berkshire Hathaway’s equity investment portfolio over five-and-one-half decades came from five investment ideas, underscoring two of the important precepts espoused in “A Lesson on Elementary Worldly Wisdom,“ Warren Buffett’s partner Charlie Munger’s famous 1994 speech given at the University of Southern California Business School: “Stay within your circle of competence — figure out where you’ve got an edge, some of which you may have been born with, and some of which are slowly developed through disciplined effort.” And “Bet seldom and bet significantly, when markets offer you compelling opportunities.” Recognizing the wisdom of these two principles, for the majority of mainstream investors, we also emphasize investing in high-quality assets for the long-term rather than attempting to trade in-and-out on a short-term basis.
Energy Stocks Near Multi-Decade Lows
U.S. energy stocks have recently plummet to their lowest price relative to the Standard & Poor’s 500 in almost 80 years. This underperformance has taken place against the backdrop of:
elevated coronavirus-related concerns over the 2020 trajectory of global growth (thereby putting downward pressure on demand for energy products);
an oversupplied worldwide energy market, meaningfully augmented by the significant increases over the past 10 years of U.S. oil and gas output driven by hydraulic fracturing (a well stimulation technique, also known as “fracking,” in which oil- and gas-bearing rock is fractured by a pressurized liquid); and
rising antipathy toward hydrocarbon-producing companies and/or divestments of some or all categories of fossil fuel assets by a number of institutional investors, including endowments, foundations, pension funds, and certain large sovereign wealth funds.
Noting the tendency for cyclical rebounds to gradually unfold following such extreme readings in energy stocks’ versus the S&P 500’s relative price performance, we think that value-oriented, somewhat contrarian-minded, mean reversion-aware investors may consider carefully building some exposure to this sector in a disciplined manner, focusing on companies with:
meaningful plans to encompass renewable energy; and
dividend maintenance strength.
The “VIX” represents the ticker symbol and the popular name for the Chicago Board Options Exchange’s CBOE Volatility Index, a popular measure of the stock market’s (and financial markets’ more broadly) expectations of volatility as calculated based on S&P 500 index options. The VIX is computed and disseminated on a real-time basis by the CBOE, and is sometimes referred to as the “fear index” or “fear gauge.” Traders on the floor of various options and futures exchanges have for several years employed a shorthand expression regarding the VIX volatility measure: “When the VIX is low, it’s time to go slow, and when the VIX is high, it’s time to buy.” In other words, a low VIX reading usually indicates a fair degree of investor quiescence, complacency, and nonchalance, and sharply elevated readings generally reflect widespread concern — sometimes, even panicked selling — associated with equity market washouts that may signal a cyclical bottoming in asset prices. Mindful of the continuing degree of uncertainty relating to the impact of the coronavirus on the global economy, our recommendation is that investors should remain aware of the VIX level as a general barometer (rather than a precise thermometer) of financial market sentiment, viewing a series of too-low readings with ongoing skepticism and by contrast, considering significantly high readings as potential signposts for adding funds to the equity markets.
Equity Valuations Still Above Average
The fundamental drivers of all asset prices — including stocks; bonds; real estate; agricultural, industrial, and other commodities; precious metals; and even such asset categories as jewelry, art, and collectibles — are driven by various combinations of:
fundamental forces (such as earnings, economic trends, and dividend, interest, and rental payments);
valuation measures (relating prices to revenues, earnings, book values, and other measures); and
psychological, sentiment, and technical factors (such as surveys of bullish and bearish views, initial public offering and merger and acquisition volume, aggregate trading activity, charts of price trends, new highs compared to new lows in prices, advance-decline lines, and moving-average computations).
While fundamental factors tend to be the preeminent forces on asset prices during extended upward or downward moves, and psychological, sentiment, and technical factors tend to exert a dominant influence at major turning points (with extreme euphoria and optimism characterizing market tops, and extreme despondency and despair characterizing market bottoms), valuation metrics are used as a reality check and to provide useful and much needed historical perspective on asset pricing. Prior to the recent coronavirus-driven changes in equity, fixed income, precious metals, energy, and currency prices, it can be seen from the above table that many valuation measures of the Standard & Poor’s 500 composite index as of yearend 2019 were registering in the 88th to 99th percentile of their historical valuation readings. Such elevated valuation measures — including U.S. Market Cap/GDP; Enterprise Value/Sales; Enterprise Value/EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization); Price/Book Value; Cyclically Adjusted P/E; and Forward P/E — have been an important influence on our multi-month message of caution and conservative portfolio positioning. Even though the S&P Earnings Yield (the inverse of the Price/Earnings ratio) minus the 10 year U.S. Treasury yield was only at the 28th percentile (due to ultra-low interest rates), in our view, the recent pullback in most of these valuations still leaves them at well-above-average historical levels and underscores our continued counsel of vigilant, careful, and cautious investment strategy and asset allocation.
Equity Performance in Presidential Election Years
Widespread wisdom concerning U.S. equity market performance in the four years of a presidential term — promulgated among other market prognosticators, by Yale Hirsch in The Stock Trader’s Almanac, with his “Presidential Election Cycle Theory“ — usually holds that:
the best year is year three; followed by
year four, as various forms of economic stimulus may be applied in advance of the election itself;
year one, characterized by the good feelings after a national election; and lastly,
year two, when the effects are felt of whatever economic and policy “housecleaning” has been effectuated.
For the 23 presidential election cycles since 1928, the upper panel shows the mean (which is the conventional arithmetic average) and the median (defined as the midpoint) of the S&P 500 average returns in each year of a presidential term. We caution that these outcomes reflect average performance, and a given presidential cycle can deviate, sometimes meaningfully, from the results generated over the past 92 years. This can be seen in the lower panel, which shows the Standard & Poor’s 500 performance for the 42nd, 43rd, 44th, and 45th U.S. presidencies. For example, in year four of President Bush’s second term, the S&P 500 substantially lagged the performance of the other three years, and in both of President Obama’s terms, the first two years produced the best performance. As calendar year 2020 progresses toward Election Day on Tuesday, November 3, we advise to be aware of the psychological and sentiment impact that is likely to be felt on quite a number of industry groups during the upcoming presidential campaign. With corporate taxation, industry dominance, and market power likely subjects of discussion and debate, sectors expected to be in the spotlight include, among others oil, gas, coal, and hydraulic fracturing; pharmaceuticals, biotechnology, and medical devices; and social media and other technology-enabled companies. Investors would be wise to give careful consideration to the intermediate- and longer-term implications of this year’s elections for specific holdings in these and other industries.
Tax Proposals of Presidential Candidates
Regardless of one’s political persuasion and tax bracket, we think it is quite important from an investment standpoint to pay close attention to the likely post-election contours of the top marginal tax rates on labor and investment income. Investor psychology, consumer behavior, and corporate profitability are influenced to a significant degree by the trend and level in federal (as well as state and local) taxes on labor income. In addition, taxes on capital (investment income) affect investment, a major determinative factor influencing productivity growth, and thus, wage growth.
Quite apart from the media and debate attention given to several Democratic presidential candidates’ proposed single-payer health care and wealth taxes, the table to the left sets forth the current federal top marginal tax rates on labor and investment income under current law and also shows the size of the much-less-publicized tax increases on labor and investment income proposed by three of the Democratic presidential candidates. The top marginal federal tax rate on labor is currently 40.2%, (including the 2.9% Medicare tax) with the proposed top marginal tax rate proposed by the three (Buttigieg suspended campaign 3/1/20) cited presidential candidates ranging from 51.8% to 69.2%. The table also shows that the top marginal tax rate on investment income is 23.8%, with the proposed top marginal tax rate proposed by the three cited presidential candidates ranging from 43.4% to 58.2%. Our counsel is to pay particular attention to these and other candidates’ tax proposals, focusing on their impact on corporate, consumer, and investor behavior.
For additional perspective on the evolution and complexity of the U.S. federal tax code, we share the following thoughts:
Approaching the annual April 15 due date for tax filing, we also offer the following reflections relating to the history of federal income taxation and the size of the federal tax code. The United States tax system has evolved through the nation’s history, from an initial revenue-generation reliance on tariffs, with new income taxes and other levies generally introduced during times of war to raise additional revenue, then being allowed to expire once the war was over. In the years after 1900, popular and legislative support began to build for a continual income tax, and in February 1913 the Sixteenth Amendment was ratified to the Constitution, granting Congress the power to collect taxes on personal income.
According to Thomson Reuters-Refinitiv and Wolters Kluwer CCH (the latter of which has analyzed the federal tax code since 1913), in the first 26 years of the federal income tax, the code only grew from 400 to 504 pages, and even during President Franklin Delano Roosevelt’s New Deal, the tax code came in comfortably under 1,000 pages. Changes implemented during World War II increased the total code (including appendices) to 8,200 pages; by 1984, it had swollen to 26,300 pages, and as of early 2018, several Congressional and media commentators have pointed out that the federal tax code exceeds 80,000 pages. The length of the actual current actual tax code itself runs in the neighborhood of 3,000 pages, with over 75,000 additional pages devoted to the inclusion of: all past tax statutes; Internal Revenue Service regulations and revenue rulings; and annotated case law covering court proceedings surrounding the tax code.
Disclosures: Towerpoint Wealth is a Registered Investment Advisor. This platform is solely for informational purposes. Advisory services are only offered to clients or prospective clients where Towerpoint Wealth and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Towerpoint Wealth unless a client service agreement is in place. No portion of any content within this commentary is to be interpreted as a testimonial or endorsement of Towerpoint Wealth investment advisory services and it is not known whether any clients referenced herein approve of Towerpoint Wealth or its services; nor should it be assumed that any references to our clients are representative of all our clients’ experiences.
Clearly the spreading virus has sent shockwaves through the global financial markets, as declines of this magnitude are by no means ordinary, especially after the stock market just hit an all-time high. Understandably, all anyone can seem to think about right now are the potential negatives of the coronavirus emerging in the U.S. and in other major economies; however, we are confident that eventually the bad news will give way, positives will emerge, and today’s worst placed fears will not come to fruition. Considerations:
According to Worldometer, there have been 30,597 coronavirus cases with an outcome (2,699 deaths and 27,898 recoveries). The total active cases now stand at 49,923, a drop of 15% from the peak on February 17.
While one death is too many, let’s put these numbers into perspective: According to the World Health Organization, just in the US alone for the ’19-’20 Flu season, there have been 15,000,000 flu illnesses, 140,000 hospitalizations, and 8,200 deaths. Imagine if everyone with an internet connection followed the spread of the annual flu, case-by-case, hour-by-hour…
We are by no means cockeyed optimists here at Towerpoint Wealth, and we fully understand that equity markets react unpredictably to the unknown. However, we also recognize that historically, Wall Street’s reaction to epidemics and fast-moving diseases is often short-lived, and we feel that today’s current coronavirus fears will be no different. At Towerpoint Wealth, we believe it is not “if” but “when” the markets recover; and that is likely to be when investors believe the impulse of new coronavirus cases has peaked.
Additionally, we firmly believe the US consumer is on solid footing and will continue to be one of the key drivers of US economic growth in 2020. Some have suggested that the 1918 Spanish Flu, which killed hundreds of thousands in the US, could happen again. And despite the severity of the 1918 event, the relatively small amount of research done on the economic effects of that pandemic indicate that they were short term. We all recognize that the US rebounded from the Spanish Flu when all was said and done, and 2020 is certainly not 1918. Technology and medicine are light years ahead of where they were a century ago, and news today is now instantaneous. We suspect that any drop in corporate earnings and economic activity will be short-lived, and more than made up for over the remainder of the year to come.
Put differently, it is not time to hit the panic button. Stay invested, systematically rebalance your portfolio, remain disciplined and faithful to your plan and investment philosophy.
If after reading this you continue to have concerns, and/or do not currently have a thoughtful financial and investment plan or strategy in place, please message us (email@example.com) to talk further. The world continues to be an extremely complicated place. We are here for you, and look forward to connecting with, helping, and being a direct, fully independent, and objective expert financial resource for you.