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Quarterly Letter to Clients 

April, 2020

Indices at quarter-end (March 31, 2020):

    Dow Jones Industrials:             21,917.16       1Q'20            -23.20%          YTD      -23.20%

    Standard & Poor's 500:             2,584.59        1Q'20            -20.00%          YTD      -20.00%

There is a lot of dark humor out there: A cartoon shows a man stumbling over a large coronavirus. As he falls, he drops his nest egg.

A few years ago a friend told me about the “Black Swan,” a book/theory by Nassim Taleb. A Black Swan is something totally unexpected that comes along out of the blue and changes everything. Today’s Black Swan is the COVID-19 virus.

February saw the first declines related to the virus, and in March the decline accelerated. Fears of a global pandemic rattled the markets. Before quarter-end, the gains made since 2016 were wiped out. Just so you have a yardstick (in round numbers):

    Market peak, February 18, 2020:   29,950 (Dow Jones Industrial Average)

    Lowest point during March, 2020:   18,200 reached March 23

    Year End Close 2019:   28,500 passed on February 24

    Year End Close 2018:   23,300 passed on March 12

    Year End Close 2017:   24,700 passed on March 9

    Year End Close 2016:   19,760 passed on March 18 (regained March 24)

    Year End Close 2015:   17,400

    Quarter End Close:       21,917

Measured off the peak, a correction (10%) would have been 26,955, a bear market (20%) 23,960. We crossed the bear market line in the second week of March. Commentators called it “price discovery,” meaning no one knows at what level stocks should sell. Before the end of that second week of March, we were down more than 25% from the peak. A few days later we slipped under the close of 2016, down well over 30% from the highs, and at one point before the quarter-end we had given back over 35%, with the Dow trading as low as 18,200. The speed and depth of the decline was unprecedented.

At this point a recession is a given; it’s length and severity remain unknown. Earnings will tumble; estimates are no longer reliable; dividends are in jeopardy. Without knowing how low earnings will go, we cannot determine a good price at which to buy; it becomes guesswork.

Even if you’re not out of work, the simple fact of the market’s decline psychologically leads people to defer commitments. They will put off buying that new car, or any other major expenditure, simply because they feel that they have less money. And fear of the virus means they won’t go to that tennis tournament in Miami (cancelled), or take their kids to Disney World (closed).  Even after the pandemic passes they’ll likely eat out less often, avoid the movies, travel less in general and certainly avoid going on a cruise.

Earnings growth, which was slowing before the virus, now seems assured, bringing along shrinking multiples and thus lower stock prices. Even if the panic subsides relatively quickly, damage has been done, and it may take quite a while to get back on the economic track.

The Fed, in its wisdom, and undoubtedly under political pressure, cut rates, twice, to zero. The TV pundits immediately chimed in that a rate cut was not a cure for the virus. The Fed is behind the curve; they did not raise rates when business was good, and now find themselves with no ammunition to aid the economy. The 10-year Treasury bond yields around 0.6%, and the 30-year bond, now yielding approximately 1.25%, traded under 1% at one point. At these levels, interest rates have already done what they can to spur the economy.

Employment, which had been full, is suddenly looking woeful. The government is sending checks to every American. They are looking at injecting two trillion dollars into the system--and that's just phase one. Will that bring toilet tissue back into the stores?

Exuberance has been replaced by fear, with multi-thousand point swings becoming a common occurrence. The exchanges have “circuit breakers” which trip after declines of 7%, 13%, and 20%, and halt trading for 15 minutes or more. The 7% breaker was effected several times, and while it did tend to slow the fall, it did not stop stocks from sinking further. (These “safeguards” were not in place in 1987, when we fell 22% in a single day.)

Through this storm, bonds have been the only relative bright spots. Their luster was not unblemished, as prices fell across the board, but still you learned why we balance accounts. The hardest hits in bonds happened in the oil patch, where prices were devastated due to the Saudi-Russian price war. Even so, our balanced accounts (a mix of stocks and bonds) fell significantly less than the market.

We have become conditioned to buy any dips, and that maxim holds true in a bull market. In a bear market the maxim changes to “sell any rallies.” But at what point do we find values so compelling that we feel we must wade in? To my mind, 45% off the high would tempt me to sell bonds to invest in equities. We were close for a moment, but who knows if we ever get that much of a decline? The passage of the two-trillion dollar stimulus package brought a sharp bounce off the lows, and though we like to buy at lower prices, still we hope the bounce holds.

So we are left to watch the stocks on our buy list and try to determine, should we buy them, if we will still be happy if they were to fall further.

There are so many periods when this business is boring, sort of like watching crops grow—pulling the occasional weed, adding a bit of fertilizer. This is not one of those times, this is the Biblical plague of locusts, the hundred-year flood. The harvest will be sparse this year, and perhaps next year. Whole states are closed.

I am used to volatility caused by financial matters, things like recession; companies missing earnings or revenue estimates; balance sheet issues; competition. But my experience does not include the sort of panic that leads people to hoard paper products and cleansers, leaving supermarket shelves bare of necessities. Why are milk, yogurt, eggs in short supply at Publix? You can’t stockpile those items, they are perishable.

My grandparents suffered through World War I, the Spanish Flu in 1918, and then the Great Depression. My parents had World War II. I thought my life might avoid such global disruptions (Viet Nam notwithstanding) and for three-quarters of a century I was right. Our forebears got through much worse times than we might expect today, and we will too.

I have written and re-written this letter several times, trying to be relevant and to respond to the dramatic swings. Warren Buffet advises to be greedy when others are fearful. That is a difficult proposition, but one that we should strive to heed. I can’t say where the bottom is, or even if it is behind us, but I believe that putting available cash to work in stages as the market drops is most probably the correct course of action. We will invest for the longer term, emphasize dividend payers that trade at relatively low multiples, and we will hope and pray for a quick end to the virus and to the economic and human devastation it has caused.

Eventually, this too shall pass. Please stay healthy.

Jim Pappas

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