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Quarterly Letter to Clients
Indices at quarter-end (December 31, 2020):
Dow Jones Industrials: 30,606.48 4Q'20 +10.17% YTD +7.25%
Standard & Poor's 500: 3,756.07 4Q'20 +11.69% YTD +16.26%
The covid pandemic has taught us many things. For example, we now know that a roll of toilet tissue lasts four days. More importantly, if we have forgotten, we have learned how we feel and react when our stock holdings take a tumble. And we learned that sometimes the stock market can be better than the economy.
While the infection counts keep rising, and the death toll has run to over 320,000, there is light at the end of the tunnel. The promise of widespread vaccinations may mean an end to the restrictions of the pandemic. Perhaps by the middle of this new year we will feel safe once again, maybe even safe enough to venture beyond our four walls, to dine, shop, even travel. I would hope that, a year from that point, by mid 2022, the virus will be just a memory—if losing that many people in the space of ten months can be relegated to “just” a memory.
Like a scar that remains long after the pain of the wound has been forgotten, we will carry reminders that significant damage has been done to the economy, especially to small businesses. Many things will not soon—and perhaps may never—return to the “normal” that we once knew.
As we accept and move toward embracing a “new normal,” we know that many businesses have been affected in lasting ways. Those that have survived will have adapted and evolved. Business has always been about change; the pandemic has simply sped up the pace of change.
It’s been a hundred years since the last global pandemic, and the stock market reacted, as it does so often, in the way we least expected. After the collapse in the first quarter, stocks ignored the economic clouds, and focused on the possibility of a vaccine. On that basis, and fueled by money flowing from the government, the market strung together three positive quarters to end the year in the plus column.
We have seen similar drops and recoveries in the past. Notably, in 2002 and 2008 we experienced similar sell offs; the subsequent rebounds weren’t nearly as rapid as in 2020.
To recover as quickly as we did this year, while the pandemic continued to rage and corporate earnings were tumbling, is stunning, and was certainly not foreseen by this observer. I recognize that it has become “market wisdom” to buy on large declines. But in no small part, the reason the markets have recovered is the multiple trillions of dollars that has rained down upon the nation. That money had to find a home, and with bond yields where they are, stocks were the only apparent option.
Now the government is poised to shower more cash upon the economy, and we can again expect that action to be supportive of stock prices. The Fed has also promised to maintain low interest rates, which will prop up bond prices, though how long they can hold that line is a big question.
This government largess has had, and will continue to have, consequences. The immediate consequence has been the stabilization and recovery of the economy. Longer term we can expect inflation, and probably higher interest rates. The hope is that the benefits will balance out the negatives, and I feel that we have a relatively good chance of that being the case.
The year 2020 was marked by a number of IPOs, with companies serving new markets coming public at often-ridiculous valuations. As in past manias, these stocks are selling on promises, and some may deliver, but most will eventually return to price levels more closely related to reality.
A new twist is the SPAC, or special purpose acquisition company, where you buy stock in a newly-formed shell company that then goes hunting for a business to buy. A number of these companies have come public lately. If you read this as an indication of speculative excess, we are in agreement. In the past, such excesses have often preceded periods of volatility. Thus, as we rush headlong into the new normal, we must be selective in allocating our assets.
It is a time to focus on balance sheets, to invest in companies that have the wherewithal, the agility, and the positioning to survive and thrive. Many companies have borrowed heavily to make it past this crisis; they will be paying that debt out of future profits for years to come, and their stock prices may very well reflect that, so stock selection will be paramount. The hope is that, in 2021, the economy can catch up to the stock market.
I wish you a Happy, Healthy New Year.
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