The St. Nicholas Viewpoint: April 2020
by Tim Cebulko CFA/CFP, President, Chief Investment Strategist April 10, 2020
Before we get to the economic and financial aspects of the current coronavirus crisis, we need to address priority number one. We have many clients, family, and friends that are in the high-risk group – specifically, those over the age of 70. We have a fair number of clients, family, and friends who are at even greater risk because, not only are they in the first group, they have other health-related issues such as immune system deficiencies, lung or respiratory maladies, or heart concerns. We want to stress that all of these folks should be concerned first and foremost with their health. Stay isolated, stay clean, and preserve your well-being. It doesn’t stop there. The rest of us have a responsibility as well. Without exception, we all have friends and family in those high-risk groups and we must take steps on our own to ensure that we maintain separation from those most susceptible to this disease. We should certainly be available to help those in need, but we need to do it with a very cautious approach. St. Nicolas clients are truly our family, and we want to come out of this mess with the same number of family and friends with which we began.
Our second priority is to reassure all St. Nicholas clients that we are safe, their accounts are safe, and we continue to monitor our investment approaches on a daily basis. We are still working from the office every day, and consider ourselves an exception to the stay-at-home order because we are a related financial institution, and we have legal compliance measures that must continually be met. However, we are not putting ourselves or anyone else at risk. A day at the office involves no interaction with any other citizens, and we adhere strongly to the distancing rules and continue to not only wash our hands, but sanitize shared spaces in the office. If we ultimately have to work from home, that is not an issue. Anything we can do from the office, we can also do at home. The point we are driving at is that there is no need to worry about the ongoing continuity of St. Nicholas Private Asset Management. We are extremely solid from a financial basis – we own our office so there is no rent, our overhead is very low, and we have prepared ourselves to endure periods of substantial declines in revenue. We are physically healthy, and there are no obstacles to prevent us from continuing to do what we’ve been doing for the past 16 years. St. Nicholas is here for all of you, and we’re here for the long haul. We will continue to excel and very likely continue our extremely long record of substantial relative investment outperformance.
There is no pressing third priority, but there are two other very important matters to further recognize and address. We are extremely humbled by the reaction of our clients. Obviously, we have experienced a much higher than average volume of client interaction. Almost without exception, these calls/texts/emails had the same initial concern. Clients did not begin with market or account worries. Pretty much every conversation started the same – “How are you doing and is your family safe?” God bless you all. Our priorities lay where they should. Thoughts like these bring us hope and faith at a time when we all need it the most. The market reaction will be but a small blip on the long-term map of our lives, but your thoughtfulness and genuine concern will remain always in our hearts. Thank you all for being part of our family.
We recognize too that the worst of times often brings out the best in people. And here we are speaking about large corporations as well. The amount of aid, grants, contributions, and financial assistance that is coming directly from the private sector is like nothing we’ve ever seen. Large companies are coming out of the woodwork and donating money, products, and services to communities and businesses that need it the most. Billions of dollars are literally being given away by extremely large companies to help those in need. We are duly impressed with the number of large companies that are stepping up to the plate. Specific examples are too numerous to list here, but we thank them all. Individually, we can do our part as well. We hear endless stories of families making sure they order out at least once a week, if not more. Everyone wants the businesses that are hurt the most – small businesses, and especially restaurants – to survive. Regardless of the stay at home discipline, we encourage individuals to continue to patronize the businesses that remain open. We also encourage companies and individuals to continue to look for opportunities to help individuals that are especially in need. Again, these individual efforts are far too numerous to list, but they need to continue. Order out from the restaurants that remain open. Tip and tip big. When everything else eventually re-opens, maintain your generosity. St. Nicholas has already attempted to contact both the State of Florida and the Treasury Department to suggest that donations to private businesses and exorbitant tips be declared tax deductible for 2020, and we encourage everyone to write your congressional representatives and suggest likewise. There will be just as much need for overboard generosity after the initial ramp-up in business activity as there is today. Continue to pay it forward. The positive contribution to your individual psyche will be immeasurable.
Finally, we struggled with our decision as to whether to include performance numbers in this quarter’s reports based on our perception that this is a terribly distorted market on a day-to-day basis, and that a single number on any given day was insignificant and could not be extrapolated into any meaningful return expectation. More simply put, why accentuate the short-term negative? If it causes pain and damage to look at the sun…don’t look at the sun! In the end, our decision was to include the numbers and leave it up to you, the client. Our best advice is to remove this letter from your statement envelope and take what remains and creatively destroy it. A grill…a firepit…a fireplace…a shredder…douse it in gravy and let the dog chew on it. It will do your mental constitution no good to absorb the numbers that are in this report. Apart from the fact that things have changed materially since the end of the quarter, there will be much better times to peruse your investments. Looking at it now – or frankly anytime in the next several weeks – is not advisable. Watching over your assets is our job and we are doing that with propitious diligence every day. Let us agonize on your behalf and you can focus on staying safe and looking forward to all the fun things you’ll be able to do once we get this COVID virus under control. The ultimate decision as to whether you put on temporary blinders lays with you. We can only suggest that looking past this quarter is the best path to choose. All that said, it is very difficult to transition to a professional dissection of the economy and financial markets, but we will do our best and plod forward.
First Quarter Performance Review
We also waffled on whether to report and discuss index numbers in this quarter’s letter for the same reasons cited above. We decided that we all know what is going on and these return numbers are not only not a secret, they are numbers that most intelligent investors have already seen time and time again. Given that rationale, here’s the damage that the markets have endured – and remember that this is an incredibly volatile market and all of these numbers vacillate greatly on a daily basis.
As is typical in global calamities, overseas markets fared the worst in the quarter, with Emerging Markets falling 23.5% and Developed International (MSCI-EAFE) dropping 22.7%. US Markets did not fare much better, with the Dow Jones also falling 22.7 %, the S&P 500 declining 19.6%, and NASDAQ sinking 14.2%. St. Nicholas clients, on average, stayed ahead of the S&P 500 by a couple hundred basis points, and total account returns were even better considering we had recently raised cash levels in most accounts. What remains critical, however, is continued caution and patience that will benefit accounts as this situation plays out. While we may begin to see much better virus-related case statistics, the economic damage is deep and our emergence to normalcy may be longer than we originally thought and fraught with many obstacles affecting not only specific stocks, but sometimes entire sectors.
The Fed
There’s very little to add regarding the Fed. They’ve acted quickly and they’ve acted with great magnitude. The Fed’s immediate action was to cut interest rates to zero. This was followed by injections of about $4 trillion of liquidity into financial markets. They continue to monitor financial markets and have vowed to keep the liquidity coming. The Fed has probably made the biggest strides in keeping a health crisis from developing into a financial crisis. Obviously, the business shutdowns will result in some degree of a short-term recession, but the Fed is working very hard to keep us from a prolonged downturn similar to 2008-09. That particular recession involved the potential collapse of banks, breaking the financial backbone of the entire world. The Fed had a healthy banking sector entering today’s crisis, and continues to work diligently to ensure banks remain strong, thus enabling the rest of the country to recover and strengthen. Finally, the Fed has the tremendous advantage of hindsight and can avoid the mistakes of prior recessions and depressions. This time they are acting very early and very big, and the end result will be not only survival, but a quicker return to positive economic growth.
The Equity Markets
Our equity discussion this quarter will be a bit different. We typically spend a lot of time discussing valuations, but there are no logical valuations to consider in an irrational and unstable market. Valuation considerations are typically based on ratios like Price/Earnings (PE), Price/Sales, Price/Book, PE to Growth (PEG), Return on Equity (ROE), and Earnings Growth. Valuation considerations are temporarily useless given that most of them employ two very distorted and/or questionable factors: price and earnings. Any price-related metric carries the distortion of unstable prices, influenced mainly by institutional trading and short selling speculators – reliable price levels won’t be found for weeks or perhaps months. Earnings-related metrics carry the distortion of trailing earnings that have been altered by temporary changes/closures/layoffs, and estimated earnings that can’t accurately be measured until normal business resumes. Our choice then is to pick several of our biggest positions and share our insights:
Apple – Like most high-quality tech stocks, Apple appears to have found a bottom. While business and production interruptions will continue throughout the lockdown, Apple has a product line that will remain in demand and continues to see growth in other divisions like iCloud, wearables, apps, and streaming services. Like all of the stocks mentioned below, Apple is a name that smart investors flock to when it declines, providing not only downside price support, but also fuel for continuing upside long-term. Investors are figuring out when to buy or add to these types of stocks, not when to sell them.
Amazon – Amazon actually proves to be a winner in a stay-at-home environment. Amazon was already growing its footprint, and that only speeds up when consumers are now forced to shop from home. Amazon Web Services is also seeing a spike in growth from businesses that now need to expand their abilities to provide at-home services. The safety of Amazon’s businesses is being adequately reflected in its stock price which has barely moved and is only about 5% off of its all-time high.
Home Depot – Home Depot is considered an essential retailer and, although it has reduced its operating hours and limits customer counts in stores, it has committed to keep all of its stores open. Despite losing part of the profitable spring planting season and a slowdown in home improvement as income/jobs are in limbo, HD is a survivor and will benefit from a resurgence in demand as the economy rebounds.
Mastercard/Visa – Both companies are essentially payment processors and both have experienced a decline in transactional activity with most malls, stores, and restaurants closed. However, they are also experiencing increases in on-line transactional activity, and the stall in spending for a quarter or two will not be enough to alter the high double-digit long-term growth that both companies will continue to see.
McDonalds/Starbucks – Both of these restaurant chains continue to operate as take-out or drive-thru only, and have been able to keep principally all of their drive-thru stores in the US open. Conveniently, McDonalds historically does about 70% of its business from its drive-thru windows anyway. Starbucks only has drive-thru service at about 60% of its locations, but they have such good market penetration that they can direct customers to alternate drive-thru locations in circumstances where their nearest store is closed. It also doesn’t hurt that Starbucks is routinely named as the second most favorite food brand for teens (behind only Chick-fil-A), or that its main competitor in China (Luckin Brands) is presently going through massive corporate accounting fraud issues similar to those that brought down Enron years ago.
Old Dominion Freight Lines –Trucking is certainly an essential business, and even though ODFL was already seeing a small reduction in revenues, we don’t anticipate that they will experience further material reductions going forward. The stock just split 3 for 2 (which, by itself inherently means little, but splits are often viewed as positives by investors), and the apparent comfort level in its base line of revenues is evident in its stock performance, with its price only about 8% off of all-time highs.
We also have the luxury of having cash available in most accounts from selective selling that we’ve done over the course of the past several weeks. We will use this cash to opportunistically buy names that are much cheaper now, or even buy back names we’ve sold that have continued to sell-off. It’s all about having the right names going into a recession, and fine-tuning portfolio structure coming out. We will not, however, be bottom-fishing. There are simply too many stocks that will take much longer to recover, like airlines or cruise ship companies. In that same vein, we can’t chase Boeing, which is hard to not do. Boeing is one of the most essential businesses in the US (it contributes upwards of 0.5% of GDP), it is extremely cheap by any measure, and I can realistically envision a stock price of $400-$500 in a few years. Unfortunately, BA remains in dire straits and may have to eventually consider bankruptcy, and one doesn’t want to be an equity holder (and last in line) going into bankruptcy. There may very well be fantastic opportunities in oil stocks, but the secular decline in their business will continue and they will ultimately return to the materially underperforming stocks that they’ve been for over the past ten years. Finally, we’ll avoid adding to the beaten-down bank sector. Banks were just beginning to see daylight but will now instead be faced with failing loans, increased defaults, and the likely onset of a secular decline in commercial real estate.
Good News for IRA Investors
Two recent law changes by Congress will directly impact St. Nicholas clients and involve RMDs (Required Minimum Distributions). First, The SECURE (Setting Every Community Up for Retirement Enhancement) Act increased the age at which RMDs are required to begin from 70.5 to 72. If you are already over the age of 72 and taking RMDs, this change will not affect you. The Act is effective January 1, 2020, and has no grandfathering provisions, so if you turned 70.5 in 2019, you must still continue RMDs even though you’re not yet 72. The CARES (Coronavirus Aid, Relief, and Economic Stability) Act, signed into law on March 27th, was designed to provide up to $2.2 trillion in virus-related aid. The Act’s material RMD change was the complete elimination of the RMD requirement for 2020. If you have not yet taken your 2020 RMD, you are free to skip it this year. In doing so, you not only preserve the value of the IRA, you would also reduce your taxable income for 2020. Thus far, there was no language regarding the reversal of RMDs already taken in 2020, but we expect Congress to address this at some point later this year.
In Conclusion
Be patient and the reward will come. This will be the most difficult time in our careers, but it pales in comparison to the death and destruction of a true war – military conflicts like the Civil War, both World Wars, Korea, Vietnam, and the Middle East, not only demolished entire cities and countries, they also devastated families through massive levels of human destruction. Combined, well over 100 million lives were lost…a much, much, much higher number than we’ll ever see from this pandemic…’apples-to-oranges’ to the extreme. This is a different kind of war and the ammunition is simple – handwashing and social distancing…and time. Unlike being in the midst of any of the other armed conflicts, in the midst of this one, we can be assured that it will end. We can be fairly assured that it will end soon. It ends with the creation of therapeutic treatments for those stricken with the virus, followed by the creation of a vaccine. We know both of those will come and we know that both of those will come in short time. When they come, this particular war is over.
What happens in the meantime won’t be pleasant to watch. Expect massively negative headlines predicting “no end” to this crisis. News will undoubtedly be focused on what’s wrong everywhere than on what’s right. Media outlets consistently report new cases and new deaths, but none report recoveries. There will be constant banter that the relief money is too hard to get; that the $2.2 trillion is nowhere near enough; that President Trump isn’t doing enough. Unbelievably, the political finger-pointing and infighting has returned. At a time when partisan politics is at its most dangerous, there is still non-stop bickering and accusations thrown between our highest levels of leadership, and the media just eats it up. The news is very difficult to read and/or watch, and our advice here is again to tune it out. Find a distraction. Do some gardening; try a jigsaw puzzle; binge-watch your favorite TV show or one that you’ve missed; teach yourself a musical instrument…anything but the news! Let us filter through the headlines and process it as necessary. There are so many fantastic stories out there, but negative sensationalism draws the most viewers and readers, so that’s where the media will overdo it in the next several weeks.
This is a test…a test of our faith, our confidence, and our perseverance. Please don’t carry the angst of market declines too heavily – they will pass and recovery will follow. Recovery will follow! This has become a massive health crisis, and our concerns should fall with the health and safety of ourselves, our families, and our friends. If you have trouble putting this in perspective, ask yourself this: Would I trade returning to prior market/account highs for actually catching the COVID-19 virus and suffering the consequences? We can’t imagine that any of our clients answer that question “yes”, and there’s your perspective – our accounts will recover from this temporary set-back; if we catch the virus, recovery carries no such guarantee.
P.S. We would like to remind clients that all of our written Policies and Procedures are available upon request at any time. We are also required to notify clients of the availability of our regulatory Investment Advisor Brochure/Form ADV on an annual basis, so please contact us at 904-470-0102 with any requests.