Market Commentary

July 2020 Update

Birds build nests because they cannot fly forever. – Matshona Dhliwayo


Markets
This month I watched three incredible stories unfold.

First, a popular day trader pulled three scrabble letters out of a bag to form a stock symbol, which he and his hundreds of thousands of online followers bought without batting an eye. The stock finished up several percent that day. Second, the stock of bankrupt auto-rental company Hertz rallied several hundred percent as day traders chased blistering momentum higher after a short squeeze. Hertz attempted to issue new stock to take advantage of the popularity, which would offset losses exclusively for the benefit of the company’s bond holders. The only problem is that the stock is patently worthless – even the bond holders have minimal recovery value. However this did not stop the SEC from approving the stock issue. After rigorous public shaming, Hertz withdrew the stock issue. Third, the US Federal Reserve purchased junk-rated bonds in the open market from otherwise trapped investors, a clear violation of the law which restricts the Fed from owning non-investment grade securities. Junk bonds have a higher credit risk than investment grade, which means they are more probable to default (miss interest payments, file for bankruptcy, or restructure). With about a week left in June as I write this note, maybe we’ll see more of these incredible stories…

To find one thing in common here, I think we can agree these events smack of speculation and frenzy. Another, their roots sprout from a common seed: While the promise of central banks to support otherwise frozen markets was a necessity in the darkest days of March, the secondary and tertiary effects of that promise have spun markets into a speculative feedback loop. “Investors”, emboldened by the Fed’s own foray into speculation, believe they too can disregard risk because the Fed will bail them out. The perception of fast and riskless money draws in those with a limited understanding of markets, which in turn draws in even more novice participants. It is not surprising to see a record number of do-it-yourself trading accounts opened since March, with anecdotes of bored work-from-homers trading in their spare time, and even high schoolers getting in on “hot stocks” in lieu of summer jobs. Although I had correctly reasoned in March that stocks could reach new highs by year end, I had no idea it would be on the back of this type of unbridled zeal.

Meanwhile, the vast majority of stocks will struggle to generate sufficient profit to break even for several years, or even something close. Economic data shows consumer spending down between 15% to 30% depending on the sector, and unemployment spreading faster than covid. Despite the near constant repetition of an economic “v-shaped recovery”, there is scant evidence supporting the idea. Most people, it seems, are confusing diffusion indices (measuring rate of change) with absolute value indices. Loan arrears continue to pile up at various financial institutions, and consumer credit remains tight.

This is not to say we’ve abandoned all hope and run for the hills, only that I remain skeptical of the indices’ ability to preserve lasting gains at these levels. Therefore our cash balances are at record highs in the Growth, American Growth, and Small Cap Value Portfolios, and we maintain an outright defensive posture in the Income Portfolio. The few stocks we choose to own represent exceptionally run businesses with real growing sales and earnings, and our bonds are of the highest quality, government and investment grade. Rest assured that if we see more stocks meeting our strict buying criteria, and the data supports that it is reasonable to do so, we will buy them. If positions don’t work out, as always our systematic selling criteria will kick in to sell them. While these characteristics will not lead to doubling our money overnight, I can sleep soundly knowing that when this frenzy unwinds, as they all do, our capital will still be stewarded by system and discipline, as opposed to yolo and fomo (for the uninitiated, “You Only Live Once” and “Fear Of Missing Out” are the euphoric rallying cries of today’s day traders).

Financial Planning
Life insurance sales in North America are going through the roof. It looks like inter-generational wealth plans, including the transition of family businesses and estate protection have taken on a new importance, if not a new sense of urgency. Focusing on tax minimization has also been a key topic lately, with tax rates likely to increase next year on account of increased government spending. If you have questions about your particular plan or would like to review with our team here, please be in touch.

Recommended reading
Legendary investor Howard Marks explains the dueling forces inside this market rally  https://www.oaktreecapital.com/docs/default-source/memos/the-anatomy-of-a-rally.pdf

An interesting article questioning the value of information, and signal vs noise. Highly applicable outside of investing https://ma.tt/2017/11/adam-robinson-on-understanding/

Should government adjust how stimulus is being delivered to maximize benefit? https://www.project-syndicate.org/commentary/stimulus-policies-must-benefit-real-economy-not-financial-speculation-by-joseph-e-stiglitz-and-hamid-rashid-2020-06?

 

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