As you know, the stock market has sometimes moved more in a day recently than in an entire year. The 30 percent drop beginning on February 19 was the fastest ever according to Bank of America, and the worst quarter for the Dow in its 135 year history. We have done our best to protect while keeping our eye on the long term. There is a light at the end of the tunnel, and there is good reason to believe that in a year from now we will be glad that we did not overreact. That may not make the short-term any easier.
We have done our best to communicate with you, without being overbearing. We will try not to repeat much of what we said in the last two interim letters. Some brief observations:
- The market fell more than it did during the 1918 flu pandemic, which coincided with World War I. Medicine was not nearly as advanced then.
- It seems as though a lot of “smart money” was waiting for the S&P 500 Index to fall below 2000 in March – or proportionally as much as the crashes of ’29 and ’87 – before buying. While a re-test of the lows is certainly possible, it is likely that opportunistic buyers are lurking.
- Other countries have shown that this pandemic can be severely limited by disciplined social distancing – for about two months.
- The $2 trillion of fiscal stimulus is unprecedented; it amounts to about 10% of GDP. Monetary stimulus from the Fed will likely be even greater.
- There are some signs of a light at the end of the tunnel. Cuomo expects the virus to peak in his state in mid-April. Abbot Labs, one of our holdings, just announced a test that gives quick results and can be mass produced. Separately, a blood plasma treatment shows early promise (search convalescent plasma on twitter). J&J has a vaccine candidate, and there are at least 54 different vaccine candidates in development worldwide.
- Offsetting these potential bright spots, corporate buybacks have been a major bullish factor in recent years, and there are likely to be restrictions on them in at least some industries.
- Experts differ on what is ahead. Morgan Stanley says the worst is behind us and the risk-reward hasn’t been this attractive in years. On the other hand, Guggenheim’s Scott Minerd feels that the S&P could plunge to 1500 in the worst case as earnings continue to fall.
Meanwhile, we have been able to limit the damage. Our stock selection has on balance been quite good. I am particularly pleased that our largest holding, Amazon, was actually UP 5.5% for the quarter! It makes sense – shopping from home and more use of the cloud. Our second largest holding, Microsoft, was unchanged. We own very little in energy, which was the hardest hit sector. We have been hurt by unanticipated weakness in certain of the closed end bond funds we have used. We are optimistic that total returns from these funds will be good over time as wide discounts to net asset value narrow and generous yields make up for price declines. We are concentrated in large cap stocks, and they did far better than mid and small cap stocks. The S&P 500 was down 19.6% but their mid-cap index lost 29.6% and their small cap index was down over 30%. Our pure equity accounts were all down less than these indices – unless there were substantial positions requested by clients that are outside of our model portfolio.
The main exception on stock selection is that we held on to some travel and leisure related positions for too long. Stocks ranging from airlines to booking.com have done poorly and we have cut back substantially on our exposures there. Needless to say, we wish we had done more sooner.
One major frustration was that even some supposedly defensive stocks fell sharply. Utility stocks in particular are supposed to be defensive and they’re supposed to do well as interest rates decline, but utilities did not do particularly well on a relative basis in March. Dominion Energy, our largest utility holding, declined less than the other major utilities this year.
We have used tactical asset allocation to trim exposure during the quarter. Such defensive selling saved money, but it does involve the risk of some sales that turn out to be at or near the market lows. But some minor opportunity loss in order to avoid larger actual losses strikes us as worthwhile within limits. We are not selling too much, because we have seen that market rebounds can be so sudden as to not allow one to easily get back in. On March 24 alone, the market opened sharply higher and rallied nearly 10% in a day. Hard to know when it’s the real thing, but the market will likely rocket once there is a credible vaccine.
Most importantly, an intelligent asset allocation is the most effective tool to optimize returns consistent with a tolerable level of risk. We are always available to review and re-assess such plans. When we have an appropriate allocation to stocks, we don’t want to deviate too much from a long-term plan.
Having said that we continually monitor our holdings to make sure each one makes sense in the current environment. Most technology stocks have fared reasonably well through this, and the fears of supply chain interruptions in Asia are already diminishing as China and other parts of Asia seem well past the peak of the virus and are indeed returning to work. Amazon, Microsoft, Apple, Google and Adobe have all outperformed the S&P 500 this year and are among our largest holdings.
We have a small amount of client money in gold. There is some risk of the debasement in our currency as the government prints more and more money. Moreover, gold tends to do well during periods of negative real interest rates like we have now. However, the demand for dollars is a negative influence on gold.
We have also recently added Berkshire Hathaway partly because Warren Buffett has a reported $128 billion worth of cash. If the market goes down, Berkshire will use this cash to buy assets even more cheaply. If the market goes up, Berkshire will participate on the upside.
In the last 60 years, the S&P 500 has seen a drawdown — the percentage retracement from the previous high — exceeding 25% only seven times. It has always come back and made new highs, but the amount of time to recovery has varied considerably. There are reasons for optimism about a good ending to this mess, and we believe that intelligent and carefully monitored stock selection can improve upon such results. We will closely monitor earnings estimates for 2021, which remain highly uncertain.
We have done our best to communicate and inform through this crisis and remain available at any time, and appreciate the confidence you have shown in us.