“How can the market be at these levels?!” That is easily the most often fielded question that we have received from clients over the past quarter. A few of you may recall televangelist Benny Hinn’s Miracle Crusades from years past. For those unfamiliar, Mr. Hinn would often heal (through the power of God, persuasion, peer pressure, or all of the above) those with severe physical/emotional/spiritual wounds. The results seemed astounding…almost too good to be true.
Fast forward to today, our world has suffered a “once in a lifetime” health and economic crisis. Yet, U.S. stock indices are only down modestly for the year. We would suggest the “why” and “how” of it comes back to today’s Economic Miracle Crusaders — the leaders of global central banks and government policymakers.
In the U.S. alone, over $6 trillion in monetary and fiscal stimulus has already been allocated to thwart the economic damage from Covid-19. By the end of the year, most economists expect that number to approach $10 trillion. Amidst the panic, the market capitalization of U.S. stocks bottomed at approximately $23.5 trillion on March 23rd and reached $33.5 trillion in June (hmmm…a $10 trillion difference…what are the chances?!).
We will leave it to others to debate whether the massive void following shutdowns of economies across the globe was over, under, or misfilled by governments and central banks, but it seems that stocks were one of the larger beneficiaries for the short-term. As with Mr. Hinn’s healings, we cannot vouch for the permanency of the cure once the healer has left the stage, and the afflicted are on their own.
Low Rates, High Debt…Who Cares?
With regard to the eye-popping stimulus programs in place around the globe, we have written numerous newsletters about how many countries have avoided tough choices (in good times) with regard to tax and spending policies. Our February 2015 newsletter “Miles and Miles of Taxes” talks of how we could imagine that governments must increase taxes and fees in the future to make ends meet — and this was before the Covid-19 pandemic response.
We must point out the sad irony we see in recent headlines like, “Taxpayer Money Goes to Bailout…” Which taxpayers are these journalists referring to exactly? Perhaps they are implying, as we pointed out in our February 2015 newsletter, that governments must get creative if debt and deficits ever do matter in the financial markets. Ideas such as new fees on digital commerce, wealth taxes and engineered inflation will likely be debated to pay for some of this spending. Until politicians agree though on the methods to bring the budget into balance, in the interest of journalistic integrity, we suggest these authors change this oft-repeated phrase to “Future taxpayer money goes to bailout…”
What remains remarkable is how low global interest rates remain despite the deteriorating credit standings of governments. There are numerous reasons for this phenomenon including lack of inflation, lack of safe investable alternatives and central bank purchases to name a few. Nonetheless, it’s possible that the calculus changes at some point in the future and upsets the magic behind the current “low interest rates = unlimited borrowing” paradigm.
A Contaminated Global Petri Dish
Global connections are a double-edged sword which have created potential for both immense opportunity and disruption. The annual number of passenger flights on airplanes grew from 2.7 billion in 2010 to 4.5 billion in 2019.1 Post-Covid-19 estimates of airline travel have dropped to just 2.2 billion for 2020, showing the magnitude of global economic disruption. While the number of passenger flights may increase over time, we suspect peak figures will not be reached for years to come due to a combination of fear and technological advancement which is fundamentally changing how businesses operate.
As we look back from a purely economic (not a human tragedy) standpoint, we see similarities between the Covid-19 pandemic and the Y2K hysteria. As a reminder, in 1999 experts worried that as of midnight 1/1/2000, older computers would be unable to handle a date-related programming glitch that might cause cars, power plants, and office computers to freeze at year end. Consumers, businesses and governments responded by upgrading internet infrastructure and buying new computers which were better at handling high speed internet connections (remember dial up?). This incremental connectedness and accompanying boom in online commerce arguably accelerated global growth in ways that were ultimately reflected in stats like the airline passenger growth noted above.
Similarly, despite the extraordinarily disruptive nature of the Covid-19 pandemic, tremendous opportunity has been created for companies addressing needs to work from home, hold multilocation meetings, practice telemedicine, or feed and entertain families in the home. We own and have purchased a number of growing companies which recognize these changes in behavior as an opportunity to grow even faster. In particular, companies with strong balance sheets will be able to pursue both internal investments as well as complementary acquisitions, positioning themselves for the next decade of technological growth.
As discussed earlier, the unprecedented response by our Economic Miracle Crusaders is astounding. To that end, some argue the rally is bound to fade since it is built upon stimulus magic. While possible, we view the rally through a more holistic lens. The stimulus provided real loans to businesses, payments to unemployed workers and food to families — not simply hocus pocus to be ignored in the economic equation. Providing these benefits though, required our country’s future taxpayers to take on considerably more debt. More debt does not necessarily cripple a country’s, business’s or family’s finances — but it does increase the variability of financial outcomes. Consequently, we believe more volatility in the financial markets will be one of the longer lasting effects of this crisis.
Against this backdrop, we go to the playbook of what we believe has worked extraordinarily well over many decades — buying high-quality companies with strong balance sheets which consistently produce solid shareholder returns. Hamilton Point has emphasized for years the importance of owning such companies with the flexibility to respond to changing environments and be opportunistic in those circumstances. 2020 has provided a perfect case study into why we think this investment philosophy is so important to follow.
Since there are a number of high-quality companies doing well, we find ourselves differentiating between those which are profiting from transient factors (people are not eating in restaurants right now) versus adapting to longer-lasting trends likely to persist long after Covid-19 is behind us (there will be more meetings conducted electronically for years to come). In doing so, we hope to see our portfolio companies continue to thrive…even after the healers have exited the stage.