As we get into mid-August, we are seeing some very positive data points. Hospitalizations and ICU utilization for Covid-19 are plummeting fast, particularly in the sunbelt, where there was so much concern. Tragically deaths lag and are likely at their peak right now, although this is a far lower peak than what we saw in April when the Northeast was so heavily inflicted. Keep in mind that the deaths we see reported daily are not all occurring on that day. Many are death certificate matching deaths, and can span back days, weeks, or even months. Covid-like illnesses are at extremely low levels across the country and this has served to be the best forward indicator for future hospitalizations. This is very good news. Keep in mind when we see infections or cases these tests are often picking up previous infections. We are seeing this in Europe for example and we saw the same thing in 2009 for H1N1. If you test enough you’ll find cases, but what are most important are hospitalizations, ICUs, and obviously keeping fatalities as low as possible, without devastating other aspects of life. If we get cases but not a corresponding rise in Covid hospitalizations, it isn’t some dire situation.
Congress is still debating on the next stimulus bill. Republicans so far say they want to spend $1 trillion, while Democrats say they want to spend $3 trillion, so a big package seems likely. The economy definitely needs a lot of help so hopefully both sides can work together and compromise. The biggest difference in the proposals outside the amount of cash, is the amount of support given to states and municipalities. Of course all this is made more challenging due to it being an election year, but I think we do see a deal get done at the last minute. I certainly hope so because the pandemic and lock-down strategy has hurt so many people, that in my opinion, they deserve to be supported, but also incentivized to get back to work when able.
Economic data has been much better than expected. Job growth has impressed, despite many large states still being very much shutdown. In my home state of California we are still very limited, and even in states like NY and NJ where Covid-19 numbers are extremely low after the toughest outbreaks things remain shutdown to a large extent. Suffice it to say that when things open up the economy should see a massive jolt, which if it coincides with stimulus and an accommodative Federal Reserve, we could see some special numbers.
Our stocks perform best when we get an inkling that the economy is improving and things are opening up. The overall market indices have been dominated by Amazon, Facebook, Microsoft, Apple, and Google. While these are great companies, the valuations on several of them are 2-4 times their historical averages, despite slower growth prospects than in the past. Other stocks like Tesla, Shopify, and Netflix, are even more expensive despite very little in profitability.
Our focus has always been on maximizing risk-adjusted returns over the long-term. Not outperforming every month or even year necessarily, as nobody can do that. We have a ton of unearned premium reserve from our options, most of which should serve to our benefit by late January of 2021. For those positions time is working on our side. Many of the stocks we own are trading at 4-5 times normalized earnings, pay dividends between 3.5%-8%, and have 50-100% upside. These are as attractive of a profile as we have ever had and bodes very well for the future.
Growth trades at the largest premium to value in history. Any mean reversion, would be massively beneficial to us. The market seems unlikely to perform that great, but simply dollars shifting from growth to value, could provide many years of outperformance. We saw the same phenomenon in 2000 and the following years, as the Nasdaq crashed 80% peak to trough, but value stocks went on a massive 7-year run.
After 2 quarters, our key positions have held steady in terms of book value per share and intrinsic value, despite many of the cyclical stocks being lower. Those are the most important metrics. We’ve endured an extremely sharp and unexpected recession but most of these companies have remained profitable, and only face short-term earnings headwinds. That puts them in great position for future returns. We’ve benefited from our tech positions such as Facebook and Google, but we are not heavily exposed to that sector, which has hurt us up until now, but will help us when the tides turn.
Lastly, keep your eye out on inflation. Inflation numbers have been exceeding expectations and government data always seems to understate the real numbers. Remember the 10-year Treasury is only yielding around 0.6%. If inflation is 2% per annum, you are losing 1.4% a year in real dollars. In addition, if interest rates rise just 1%, the rule of thumb is that the 10-year would lose about 7%, which if you check the math, is more than all of the interest you earn on the bond over 10-years.
Whenever we are in a period of volatility and market extremes, people crave stability. They think they can time when things will change for the better or for the worse for that matter. It is these times of extreme dislocations though, which offer the best opportunities for investment. We can’t take a myopic view of this bizarre time we are going through and extrapolate that into the future. People will fly again, they will travel, and stay at hotels. Interest rates won’t be near zero forever. Remember, the best real hedge on inflation is stocks, and financial stocks in particular benefit as rates rise.