Doubling Down on the New Normal Winners
The number of coronavirus cases has risen beyond past peak levels reached in April. As we all know, states and individuals have not remained vigilant. The death rate has not risen commensurate with the new number of cases as the average age of the people getting the virus has dropped materially and doctors have learned practices to better care for the patients. Finally, states are starting to mandate masks, social distancing, and some have stopped further openings although it won’t change the near-term path of the virus. Not good!
While none of this affects our 12 to 24-month view of the market, it is reasonable to pause and reflect, and reconsider appropriate asset allocations and stock selection for the period just ahead. The Fed and government will continue to aggressively provide huge amounts of liquidity to the financial markets and to individuals and companies of all sizes.
The trajectory of economic growth will moderate after a fast take-off from the bottom as many states will not open further. Nonetheless, incremental growth from this point will still be pretty good. Businesses that are opening have turned to companies like Salesforce to provide the proper tools to manage during this period. Where would we be today without all these tech companies who have basically helped us manage our lives during the lockdown and now, again, as we open? They will benefit on the other side, too. That’s why we are doubling down on the winners in the new normal. No problems regarding their demand, growing profitability, and huge positive cash flow.
We remain optimistic that there will be therapeutics by the fall and vaccines before year-end which is one of the primary reasons supporting our thesis that 2021 may be a surprisingly good year. The government continues to fund research and production of potential vaccines so there will be millions of doses available when we complete Phase 3 testing. We are strategizing on where we expect the pandemic, and hence, the markets to be next year which we believe to be a huge incremental positive.
The financial markets continue to wage in a tug of war between excess liquidity and a relatively weak current economic environment, although improving off the bottom. The Federal Reserve has expanded its balance sheet by over $3 trillion since mid-March to more than $7 trillion and it is likely to exceed $10 trillion by the end of the year. Remember that the Fed can leverage its balance sheet, too. Right now, virtually all companies can raise funds to stay in business. It is simply amazing to see companies with huge demand problems raising billions of dollars at decent terms. Spreads, too, have become compressed which means little stress in the system. The Fed is making sure that banks have sufficient capital even in the worst possible scenarios as evidenced by their comments Thursday when they published the results of the most recent bank stress tests. Banks cannot raise their dividends nor buy back stocks until the Fed says so. On the other hand, the Fed eased the Volcker rule allowing banks to avoid setting cash aside for derivative trades between different units of the same firm, freeing up billions in capital. The bottom line is that the banks are in strong shape no matter how bad the economy may get.
We fully expect the Federal government to pass a stimulus plan within a few weeks before the Cares Act expires on July 31st. Right now, it appears that Trump will support a plan around $1.5 trillion which should be enough to carry us through the November elections. We doubt whether there will be any program passed this year that would stimulate the demand, which is so sorely needed, but we do expect one next year, regardless of who is in office. The current stimulus plan should keep the economy moving forward.
The financial markets are already concerned that Biden will not only win the Presidency but that the Democrats will take control of the Senate. If so, we would expect taxes to go up, but we see some offsets, too. Consumer spending is likely to be helped as taxes are raised on the wealthy and cut for the medium to lower-income earners who have a very high propensity to spend. Also, we expect corporate margins to surprisingly improve next year. This is ironically a byproduct of the pandemic as S, G, and A will be maintained at current lower levels as corporations now realize that they can be just as productive with fewer people, space, travel, and entertainment. Here again, technology plays a major role in making all of this work so well.
While the market could always have corrections like now, we fully expect the stock market to be higher over the next year due to the huge amount of liquidity in the system, the likelihood of therapeutics and vaccines available before the end of the year, and an improving economy.
The key to outperform will be and always has been stock selection. The surge in cases has reinforced our belief that the winners in the new normal are the companies tied not only to the internet but who are also providing solutions for businesses as they reopen.
Defensive companies with high and sustainable yields will do well too as well as those companies benefitting from people spending more time outdoors like boating, bicycling, camping, gardening, home building, construction, recreational vehicles and even, autos as people no longer carpool. Then there are the at-home activities such as gaming and crafts which will benefit too. Clearly, there are many opportunities to consider investing in the new normal. Continue to avoid those companies with demand issues due to the pandemic like airlines, hotels, casinos, and restaurants.
We also would continue to avoid bonds as we expect the yield curve to slowly steepen as the economy improves and inflation moves up from its current 0.5% annual rate over the next year.
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Remember to review all the facts; pause, reflect, and consider current mindsets; look at your asset mix with risk controls; turn off cable news; do independent research and …
Paix et Prospérité LLC