Break on Through to the Other Side

The greatest question facing the financial markets is what the economy here and abroad will look like until we get to the other side–meaning a vaccine protecting us from COVID-19. While we remain confident that there will be many therapeutics and much more testing by the fall, we still believe that the recovery will be an elongated U resulting in many companies, big and small, remaining under severe pressure, with some even filing bankruptcy, which would create another set of problems for the markets.  Clearly the unemployment rate will remain incredibly high throughout the next 18+ months maintaining pressure on The Fed to continue to inject more liquidity into the financial markets and the government to introduce several new phases of support, including more stimulus checks to help individuals and companies make it to the other side. These actions support moving out on the risk curve owning financial assets.  The economy will not return to any semblance of normal until we are all vaccinated which takes us into 2022 at the earliest. We want to emphasize that this is a pandemic that is impacting our economy, not a financial problem. Our banking system is strong. This too shall pass.


Other areas of concern for the markets will be our relationship with China which is frayed and the upcoming Presidential election in the fall. The financial markets will face a continual tug of war between incredible liquidity, a weak economy, potential problems with China, and the election.


We continue to focus on the winners in the new normal and recommend avoiding all companies in need of government assistance as demand for their products/services have fallen off a cliff and won’t return anything close to normal levels until 2021/22 at the earliest. Many won’t make it!


We are concerned that many states are not adhering to government guidelines maintaining social distancing and requiring people to wear masks. We need to open, but let it be done judiciously. We are watching China to see what guidelines they are using. They are utilizing contact tracing, temperature checks, thermal imagining, face masks, and social distancing. China’s economy is gradually improving as evidenced by a 3.8% gain in factory output in April. While consumer spending remained depressed in April, it did improve sequentially from March and will continue to get better in the months ahead. China’s growth this year is reliant on domestic demand as exports will remain weak due to a total lack of demand abroad. We need to follow the same script as China as we open but that may be difficult in a democracy protecting individual freedoms.


The most important event of the week was Powell’s speech last Wednesday where he mentioned that the U.S economy could remain mired in a recession if Congress and the White House did not provide more aid to address the effects of the virus. He mentioned that the recovery is dependent on how long it will take treatments to rise, whether the end of social distancing will spur new outbreaks, and when consumer and business confidence will return. He went on to say that answers to these questions will go a long way toward setting the timing and pace of the economic recovery. He concluded that the Fed will bring all its power to bear on stabilizing the economy and financial markets. He does not want negative rates and believes that fiscal support, while costly, is needed to avoid further economic damage. We concur on all counts…


While we have many concerns, we remain confident that we will have enough testing by the fall, several therapeutics by mid-summer, and a vaccine within 18 months. All good news!  We can move forward now opening up if the number of cases keeps falling and we adhere to the rules as any large outbreak would clearly push the economy back down.  The bottom line is that the economy is bottoming but the effects of the coronavirus will linger for a long time until we are all vaccinated. S & P profits are not likely to reach a new high until the end of 2022, if then, but on the other hand, interest rates will remain unusually low.


We believe that the markets are within a trading range as the Fed will continue to provide all the liquidity needed to support the economy and financial markets providing wind to our back for profitable investing in the winners. Our investments remain concentrated in those companies whose business models are built around the internet as well as tied to growth in the cloud, data centers, and 5G. Consumer and business mindsets are changed forever. Chuck Robbins, head of Cisco, mentioned on their earnings’ call that corporations are racing to expand their internet/security capabilities which is an investable trend for many years. Yes, we are there.  Individuals are doing the same buying smart devices and adding web accounts like Amazon.  Google mentioned that they are unable to get a sufficient number of laptops for their employees working at home. On the other hand, there are so many industries/companies that will struggle until demand moves above 80% utilization which may not be for several years. Just avoid them.


While it is early, we have started to think about the other side. We do not think that there will be any reversal in fiscal and monetary policies until the economy is on firm footing which takes us out to sometime in 2022 at the earliest, regardless of who wins the Presidency.  During the interim period, we expect all hands-on board to keep our economy, businesses, and individuals afloat. There is a possibility of a tax bill down the road that is revenue neutral raising taxes on the wealthy giving all the benefits to the lower/middle class. We do not expect corporate taxes to go up and there may even be additional corporate tax benefits to move plants here from abroad, especially in healthcare.


We are concerned about our relationship with China. We are believers in globalization but also recognize the need to protect IP and deal on a level playing field. This, not the time to have a trade conflict with our largest trading partner. Hopefully, cooler heads prevail.


The bottom line is that this is a market of stocks, not a stock market. We see a two-tier market where the number of winners is limited to companies that will improve their earnings over the next few years. While we have focused on the internet beneficiaries, we also believe that healthcare and some defensive consumer names will outperform for another year or so until the economy is more broadly expanding. We decided to exit our one financial investment as we see low-interest rates and narrow spreads extending for at least another year which will penalize profitability. We also sold our one industrial, a great company, as we see earnings pressure for at least another year. Listen to as many earnings calls as possible and avoid any company with financial risk.


We do not own any bonds, are flat the dollar, have no commodity positions, and do not have any ownership in private equity funds.


Let’s be careful as we open up, maintain social distancing, do contact tracing, wear masks, and stay healthy.


Our weekly webinar will be held on Monday, May 18th at 8:30 am EST. You can join the webinar by typing into your browser or dialing+14086380968 or +16465588656.


Remember to review all the facts; pause, reflect, and consider mindset shifts; turn off cable news; do independent research and…


Invest Accordingly!


Bill Ehrman

Paix et Prospérité LLC


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