Back to Quarterly Letters

Back to Quarterly Letters || Previous Letter || Next Letter

Quarterly Letter to Clients

July, 2020

Indices at quarter-end (June 30, 2020):

Dow Jones Industrials: 25,812.88 2Q'20 +17.77% YTD -9.55%

Standard & Poor's 500: 3,100.29 2Q'20 +19.95% YTD -4.04%

Even those of us who remain cautious feel ebullience at seeing the economy re-open. Whatever apprehension we may have, it still is good to see stocks rebound and people getting back to work.

In the stock market, the bounce back from the depths of the coronavirus selloff has been nothing short of incredible. We can attribute this to a few factors, but two most importantly: the multi-trillion dollar cash injection by the Fed, and the re-opening of the economy. Each of these factors comes with ramifications (discussed below.)

Are these developments enough to sustain stock and bond prices at the levels they have reached? The Street usually looks out six to twelve months in trying to assess corporate earnings, the figure against which we value securities. Today we must look further out than normal, perhaps 12-24 months or more. (They call this “looking across the valley.”) But the further out you look the less certainty you will have. Theoretically, at least, the less certainty on earnings, the less you should be willing to pay for an investment. After all, we can’t tell what difficulties we might encounter crossing that valley trying to reach the next summit.

The Street is also anticipating that unemployment, which reached depression-era levels, will rebound dramatically. It is a certainty that as businesses re-open more people will find work. What is not certain is how many businesses will shutter and never re-open or find that they simply need fewer employees. My guess is that unemployment will probably remain notably higher than the very low levels of recent years. I make that guess assuming that the second wave of the virus, which may already be upon us, can be contained.

There are two elephants in the room, one being the government’s printing presses. The Fed apparently stands ready to continue to flood the economy with cash and to keep rates abnormally low. I can’t argue. You take whatever steps you must in order to keep the patient alive. There will be side effects: inflation and a huge spike in debt. The timing as to when inflation might become a problem and when the debt level might become untenable is unpredictable. Both of these things are anathema to the bond market, and they are not normally friendly to stocks, either. But as long as the Fed is willing to print money you cannot bet against the stock market--though you might bet against the dollar.

It has been forty years since the United States experienced inflation above an acceptable, targeted level. If ever inflation could be expected to attack us again, it would seem that time would be near at hand. If it does gain hold, it will be difficult and economically painful to rein in.

I must point out that there are real-world parallels (witness Japan) where large cash infusions did not result in the currency losing value (which is another way of saying “inflation”), so perhaps we will be lucky on that front. We shall see. We will also prepare as best we can.

The second elephant would be the possibility of a resurgence of the coronavirus. In the Spanish Flu pandemic of 1918-1919, it was the second wave that was the big killer. Today we are seeing that states that have reopened are experiencing a surge in virus cases (so please be careful). Maybe people are looking at the absolute number and seeing that it is only a very small percentage of the population that is getting sick and dying. Or perhaps they feel that re-opening means “all clear,” which it certainly does not. In any event, we are seeing irresponsible behavior, especially among the younger contingent, and the price is the spike in infections.

Perhaps because I am in the demographic most vulnerable to the virus I am overly cautious from a health standpoint. I am cautious in my investment stance as well. My demographic is the group that has the money, and for the most part we are all being cautious. We may venture out a bit more than a month or two ago, but we’re doing so carefully. We want to live and we want to hang on to what we have earned over the years, so we are behaving and investing carefully.

For someone who invests as I do, who looks for a conservative balance sheet, growth, dividends, and a relatively attractive price, it is a difficult time. The difficulty is not in finding places to invest, but rather that I do not have the itchy trigger finger that seems a requisite to investing today. I invest for the longer term, and I prefer to ponder, to research, to investigate before I invest. Without solid estimates against which to value stocks, I find myself being extra cautious. Is this not appropriate?

Money comes hard and goes all too easily. Hanging on to it might not put you in first place, but it will keep you from being out of the race entirely. As Warren Buffett once said, “money flows from the active to the patient.”

Jim Pappas