Treasury Bonds

Medical Science

April was a remarkable month in the stock market.  After March delivered one of the worst months in recent memory, stock prices as measured by the S&P 500 recovered dramatically, with a 12.8% total return in April.  Year to date, prices remain down 9.3%, and the trailing twelve-month return for stocks is 0.8%, essentially unchanged

Just to refresh your memory as to what has happened this year, the stock market hit an all-time high February 19th (S&P 500 closed at 3,385).  Prices then plunged over 33% in only 20 trading days and the market hit its low point on March 23rd (S&P 500 closed at 2,237).  Believe it or not, since the March low, prices have surged over 23%.  In prior instances (there have been nine) when the market has risen in excess of 20% in a 25-day window, prices over the ensuing 3 and 6 month periods are all positive (Bespoke).

A lot of people are struggling with the profound disconnect between the economic data and what stock prices have been doing – it is extremely difficult to connect the dots here.  Not that it is ever easy, but more often than not we at least think we can make sense of things.  Q1 GDP was down 4.8% (annualized).  When Q2 GDP comes out, it may well be the worst drop in GDP, ever.  Yet the stock market taken as a whole does not reflect anything as extreme as these figures might portend.

Medical science is the solution, simple as that.  An important distinction is that it matters far less what the people in Washington DC say, as opposed to what the people in the community do.  Curve flattening is working and the number of new cases and mortalities are on the decline.  Just the same, going back to something close to “normal” will require a vaccine.  There is optimistic news from several companies, including Pfizer, which has initiated a trial, and the much appreciated Dr. Anthony Fauci who said he thinks a vaccine will be completed in a historically short time frame. 

On our end, our work hangs on our ability to analyze data, fundamentals, quantitative factors, technical patterns and relationships.  Macro data often sets the table, but we buy stocks based on specific attributes.  As earnings are released, we are seeing patterns emerge: importantly, the earnings of many of the companies we own will not be overly impacted by the economic fallout from the virus.  Industries such as cell towers, social media, online retail, cloud-based businesses, software, med tech and utilities are posting encouraging results.  On the other hand, many companies (airlines, hotels, restaurants) are essentially closed.  Job loss has spiked and unemployment is at levels never seen before.  This is optically a challenge.  We are experiencing the fallout from the virus in ways notably different than how the stock market is pricing in the anticipated earnings disruption.

In my opinion, stock prices at this point in time reflect a cup-half-full outcome.  The Federal Reserve has done an exceptional job steering the financial system clear of another financial crisis.  Congress has delivered firehose fiscal spending that will no doubt give the economy a life sustaining jolt.  Stock investors now appear to be assuming 2020 is simply a wash, and have fixed their attention on the potential earnings outlook for 2021.  I am concerned over the risk of a recurrence in stock market volatility if the goldilocks recovery does not arrive on time, and according to plan.

Our focus is to continue to own high-quality growth stocks which have served us so well over the years.  Large-cap growth stocks were up 14.5% in April, and are off a modest 2.2% year to date. They have held up extremely well as the pandemic has circled the globe.  We are now looking to add in cyclical companies, whose share prices have come under extreme selling pressure, and as the recovery takes hold, I expect there to be considerably greater price appreciation.  As we have discussed in the past, holding adequate cash and other liquid reserves in times like this is critical to riding out the storm.  I’m optimistic that medical science will get us out of this, and a vaccine and effective anti-viral will bring us back to life as we knew it.  To get there, I also think we will need to be even more patient than we are generally accustomed to being.  Please do not hesitate to call – we are working from home but connected, on-line and available.


Bruce Hotaling, CFA

Managing Partner

Like a Lion

March was one of the most challenging months I’ve experienced as an investor.  As measured by the S&P 500 stock prices fell 12.35% for the month.  In ordinary times, a daily price move greater than 1% is worth paying attention to.  There were 22 trading days in March, and on all but one, prices moved up or down by more than 1%.   March 16th was the champion down day, with an eye popping 11.98% drop.  March 24th won the up-day trophy with a 9.38% positive move.  Year to date, stock prices are down 19.6%, the first time the S&P has been down three successive months since 2008.

The coronavirus is dominating the lives of most people around the world at this moment.  It is extremely difficult to estimate the scope of the virus’ impact and the immediate concern is its containment.  Social distancing clearly has a positive impact.  The virus is however putting immense pressure on the health care system across the globe.  We anticipate the day when our doctors and researchers will be able to accelerate a therapeutic or a vaccine.

A second lesser known crisis is the oil price war.  On its own, this would be wreaking havoc in the markets.  On March 10th, Saudi Aramco announced it would dramatically raise crude production, pushing Russia to take similar measures as the Russian Ruble tanked in value.  As seen in 2016, low oil prices imperil countries and businesses dependent on oil revenues.   With the global economy on idle, the resultant demand shock has forced prices to lows not seen in 20 years.  S&P 500 earnings from the energy sector will likely go to zero.

To stem the impact of the economic fallout, on the corporate level and on the individual level, both the Federal Reserve and Congress have acted with unprecedented speed and intensity.  Congress has approved $2.3 trillion in bills to enhance unemployment benefits, paid sick leave, and direct payments to families, in addition to payroll support for small businesses.  Separately, the Fed has slashed interest rates, flooded banks with liquidity, opened unlimited quantitative easing and opened U.S. dollar facilities for other central banks.

Our immediate work centers on several important matters.  Foremost, we have to make sure you have enough cash on hand to manage your household for roughly 9 months.  If we need to raise more cash, there will be opportunities along the way.  Patience at this point is imperative; this will not be an aspirin and a good night sleep event.  It’s going to take a good deal of time and focus to work through what is likely to be more challenging news.  The markets will continue to be volatile and driven more by fear than fundamentals.  Our main effort is to screen for any hidden risks or credit issues among the companies we own.  Our focus is on high quality stocks and bonds, ones that can continue to maintain a high level of earnings through the economic downturn.  These are the types of companies, and there are many of them, that have successfully come through prior economic crises.

When the virus is stabilized, we will be able to better assess earnings and the guidance companies put forward.  At that time, our fundamental analytical tools will regain focus.  This will help us establish a new baseline, and get a better sense for the potential returns for stocks for the remainder of 2020, and more importantly 2021.  We are expecting there to be some interesting changes to the economic fabric.

While stock and bond prices today represent far better values than they have over the prior 10 years, prudence has us putting money to work judiciously at this time.  We are seeing signs of a potential transition to more value stocks, stocks that perform best in a cyclical upturn.  In my opinion it is too early to make this move.  We will continue to own stocks that will emerge from the economic downturn earliest with strong profitability and liquidity.  These have been our bread and butter factors for some time now.

Finally, we want to talk with you, if we have not already, to review your asset allocation, your cash needs and to share our views on the unfolding health and economic crises.  We do not have all the answers but we do have a breadth of experience in traumatic points in time for the stock market.  Please feel free to reach out to us.  We are as busy as ever at work every day from our home offices.  Please be safe.


Bruce Hotaling, CFA

Managing Partner

Ignoring Bad News

Stock prices, measured by the S&P 500, fell 7.48% in February.  This leaves them down 7.52% year to date.  While a difficult start to the year, these figures mask the true story.  On February 19th stocks set a record high and by month end had dropped nearly 13%.  According to Bespoke Research, the S&P 500 fell over 12% in the six sessions ending on Thursday February 27th, its fastest drop from all-time highs, ever.  The selling volume was the highest since August 2011, when Standard & Poor’s rating agency cut the U.S’s credit rating to AA+ partly due to dysfunctional policymaking in Washington.

As you know, the panic in the markets is tied to the coronavirus.  A dozen epidemics have struck, dating back to the HIV/AIDs crisis in June 1981.  All induced immense fear and reciprocal selling on Wall Street, but within 6-months the stock-related implications of the epidemics had been resolved.  What we saw in February is a market that had gotten ahead of itself, largely through ignoring bad news, forced to re-price as the fear of the epidemic to both the supply side and the demand side of the economic equation began to pencil out.

It is interesting that over the last two years, stock prices have produced some alarming volatility.  Back in the early days of 2018, prices fell roughly 10% due to the imposition of Trump’s tariffs.  Beginning that fall, prices began an extended downslide, falling nearly 19% by Christmas.  This was primarily attributable to the Federal Reserve as it was attempting to normalizing interest rates.  Then, just last week, prices fell nearly 13% in less than a two week span over fears of the global spread of the coronavirus.  The volatility does not seem as though it will abate any time soon, and investors will likely begin to lower stock exposure, or demand higher returns, if these dramatic price swings remain this challenging.

The recent price swings are investor’s attempts to price in the longer-term impact of the virus.  Investors overcome with fear are using worst case assumptions.  On Wall Street, fear is contagious.  There are several things we can observe from the market’s recent behavior.  First, stock prices tend to rise gradually and fall quickly.  We are in a computer driven world and much of the trading that takes place on Wall Street is handled by algorithms, versus pencils and green eyeshades.  Also, the recent prevalence of ETF’s creates a flywheel effect and both selling and buying become accentuated well beyond what the market might normally dictate.  It’s impossible to accurately link the potential severity of the coronavirus with future stock market levels.

I expect the fear factor will crest and countries will better implement mechanisms to defend their populations.  Sadly, this may exacerbate the already anti-globalist tendencies.  There will be an impact on the stock market, separate from the recent emotional rash of selling; analysts’ earnings forecasts will come down as expectations are lowered.  This will be due to supply chain disruption and demand reduction (airlines, for example), putting a fundamental cap on expected returns from stocks in 2020. 

Going forward, we should anticipate increased pressure on the Federal Reserve to lower interest rates in an attempt to spur economic growth –primarily by boosting stock prices.  As we saw in 2019, forced liquidity can artificially lift the market multiple, pulling prices up, without any underlying change in business economics.  Investors had been hoping a 10% surge in corporate earnings would drive stock prices to new highs.  Now, with the unknown scope of the virus weighing on investors, the market is discounting low to no growth and the focus will shift outward to 2021.

Our efforts are focused on identifying and owning companies that can thrive in the current investment landscape.  The strength and momentum of US high growth, high free cash flow companies has been impressive.  Further, the gap in returns to growth stocks over value stocks supports our work going back years.  We are also seeing strong market interest in ESG-type stocks which includes certain utilities, and stocks of companies in pursuit of global environmental sustainability.  We are pleased to see this evolution of the application of technology finally beginning to take hold. 

Please do not hesitate to check in if we have not been in touch recently.   


Bruce Hotaling, CFA

Managing Partner

The New Normal

                Talk of the “new normal” developed several years back, in the wake of the financial crisis. Mohamed A. El-Erain, a widely regarded voice in the world of finance and investments, is often given credit for originating the idea.  He began using the term to describe the then struggling low growth economy, the resultant quantitative easing (monetary policy enacted by the Federal Reserve), and the persistent low interest rate environment. 

Today, we are thankfully well beyond the financial crisis.  One important point El-Erain made was there were limitations, and notable downside risk, to perpetual reliance on central bank intervention.  Traditionally, monetary policy was intended to either stimulate economic growth or tamp down inflation.  My concern is that the new “new normal” is the politicization of the Federal Reserve.  What we are seeing is Washington commanding monetary policy intending to influence stock prices.  The downside of this new normal is the risk that stimulus stops working to spur economic growth.  Higher stock prices allow politicians to lay claim, but they do not correlate with the general economic well-being.

The question on my mind is how long can the party last?  We are in the late stages of an economic upcycle and Wall Street seems to be on a liquidity driven sugar high.  There are many investors who hope an extension of the current demagogic regime in Washington will perpetuate the good times.  And, the flip side of that coin is that if reasonable adults are brought into the nation’s capital once again, there will be a huge let down as all the excess will have to be accounted for.  In my opinion, either scenario ultimately gets us to the same place, just passing across vastly different landscapes.

At the moment, a wave of complacency is dominating investor behavior.  After a robust 2019, stocks have taken a breather in the first month of the new year – prices ended down 0.2% to start the year.  Stocks had been over-bought, so this down blip is not overly important.  For some context, this was only the third down month in the last 12 (fourth in the last 14).  At one point in January, stocks were up over 3%.  The long-term uptrend remains in place, and most investors are uncritically deflecting any bad news that comes along. 

The coronavirus is the most recent speed-bump for the stock market.  Uncertainty over the virus and its potential negative impact on travel, tourism, trade, supply-chains and retail sales (Apple stores, for example) is causing investors to take pause.  The worry is that economic growth will suffer, and thus earnings will come down.   If the SAARs outbreak in 2002 is any indicator, the impact of the coronavirus will hopefully be only temporary.

One of the byproducts of episodes such as the coronavirus is that it led investors to take safe haven in US Treasury bonds.  This buying has pushed the yield on the benchmark 10-Year US Treasury bond down near its lows, in the 1.5% range.  A temporary move like this will only invite political pressure on the Federal Reserve to lower the Federal Funds rate.  This in turn will likely perpetuate the liquidity driven stock market rally.

We are roughly half way through 4Q 2019 earnings -the reports and outlooks for the coming year are pivotal.   Thus far, the spectrum of results has been dramatic, with some clear disappointments (Caterpillar) and some surpassing already high expectations (Amazon).  The potential for a true inflection in earnings this year remains firmly in place.  From the beginning of each year, analysts typically lower their earnings forecast as we move deeper into the year.  For now, the call is for a nearly 10% jump in earnings in 2020.

Looking ahead, we need to see some robust earnings.  The market’s multiple is in the high end of a range.  Strong earnings will allow stock prices to move higher for more fundamental reasons, those which provide greater staying power and are more reliable than external factors.  There are other cautionary signs which may cause trouble but nothing clearly imminent.  My expectation is that improved earnings reconnect stock prices to their fundamentals.  This will enable our growth oriented domestic stocks to continue to generate returns.  Please look for a call from us to schedule a review if we have not been in touch recently.


Bruce Hotaling, CFA

Managing Partner