Introduction – COVID fears may be peaking
One of the few uses I have for Zero Hedge, a haven for short sellers, is to track when truly bad news is reaching its “sell by” date. As of Sunday, ZH, which had comprehensive coverage of the pandemic, is reduced to reporting that apparently Hong Kong let in some infected travelers (why would it do that?) and has a surge in cases. But as far as the US, all it did was publish a state-by-state COVID heat map from Goldman. I examined the “hottest” larger states, and almost all look to me to be stabilizing or, even, improving. California remains a wild card, however, given its lack of a truly bad epidemic so far and thus the possibility of breaking bad.
Noting that financial analysis is forward-looking, and that the novel coronavirus that causes COVID is dangerous and should be feared by all readers, I will present evidence in this section that the financial community has at the very least fully discounted the likely effects of COVID on the economy. In the next section, I will give some reasons for optimism on the economy, then discuss specific investment opportunities.
The following are all taken from a blog published Friday from a mainstream investment advisor, and various veterans could hardly be more cautious:
“We believe the corona crisis is the most disruptive global event since World War II and far surpasses the trauma of the 2007-2009 Great Recession.”
– A. Gary Shilling, financial analyst and commentator, Insight
“… the 10-year expected return [from the S&P 500 (SPY)] is -0.18% per year [blogger’s comments].
“May and June will prove to be the easy bumps in terms of this recovery. And now we’re really hitting the moment of truth, I think, in the months ahead.”
– Jennifer Piepszak, CFO, JPMorgan
“Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter.”
– Charlie Scharf, CEO, Wells Fargo
“I don’t think anybody should leave any bank earnings call this quarter simply feeling like the worst is absolutely behind us and it’s a rosy path ahead.”
– Mike Corbat, CEO, Citigroup
I will comment on sentiment surveys later.
But, when bankers are this cautious, and a chronic mild but not fire-and-brimstone bear says that COVID is the most disruptive event in 75 years, I see that as a long-side opportunity.
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The next section discusses data points that support a constructive view of the economy.
Better times ahead?
The Citigroup Economic Surprise Index has Consistent with the sentiments shown in the first section, note that consumer confidence is back to the levels of late 2016, but trending upward. That level was associated with a massive stock market rally. Then note that mortgage purchase applications are at new cyclical highs. A classic leading indicator of the beginning of a cyclical recovery from recession now exists. Note Dr. Lazar is a bull on the US economy and of course is able to cherry-pick her charts.
Moving on, we have an interesting and counter-intuitive correlation.
Michael Kantrowitz – a colleague of Dr. Lazar – observes that the June NFIB survey of small-/medium-sized business correlates with the ISM survey of larger companies, then notes that the ratio of optimism about the future to current earnings has soared in the NFIB survey. It turns out that this is an end-of-recession, end-of-bear-market finding going back to 1980 (see red line in the bottom panel spiking as it is doing now):
Thus I conclude that as usual, expert pessimism lingers as economies recover, as the experts look backwards to the cause of the recession even as real world participants look past the mess to better times tomorrow.
As the single best real-time indicator, the stock market’s uptrend is supportive of better economic times coming soon.
But, as always, hindsight is going to be 20-20, and there are no guarantees on this sort of analysis.
Before getting to specifics, the speed of the recovery of SPY and the surge of the NASDAQ 100 (QQQ) to all-time highs require a discussion of the technicals.
Confusing technicals may provide a clue to what to do
There are some technical warnings regarding froth. These include the widely-followed Fear & Greed Index, which has nudged into Greed territory at 63, and Citi’s Panic/Euphoria Model, which has been in Euphoria for about 10 weeks.
On the other hand, several sentiment surveys that also have reasonable records favor bulls. Market Vane bulls remain depressed, and Consensus Inc. bullish percentage is also low. Ned Davis Research weekly and daily sentiment indicators are both at constructive levels, typically priced for average to good positive returns.
My sense is that investors are worried about COVID, valuations and politics and just do not “get” so much strength in so many stocks.
Finally, I would note that the stock market is about to enter a seasonally week period, namely the August-September period, and that a re-election campaign year typically poses extra difficulties for stocks right now.
All in all, the lesson I take from the cross-currents is that it makes sense to be long stocks that are working both technically and fundamentally, while rolling out of those that have reached extreme valuation levels that pass one’s “sleep well at night” threshold. This strategy worked well coming out of the sharp and scary summer 1998 levels. After that almost 20% drop in SPY and 30% drop in the NASDAQ, the Fed became easy and those stocks that met the above criteria rewarded investors.
Now to translate all the above to general market strategy.
The Goldilocks scenario arises yet again – but it’s an unattractive mutant of the old version
Back in the impressive run for the US economy and markets, from late 1982 into 2000, “Goldilocks” referred to an economy that functioned well, but did not run so hot as to set off an inflationary spiral. Thus, using the language of the children’s story, the economy was “just right.” Given the starting point of very high inflation and interest rates, and very low P/Es, both stock and bond prices rose in a secular fashion. (Rising bond prices create lower interest rates).
The trend of rising stock prices and ever-lower bond yields continued into 2020 before COVID hit, and I suggest it is happening again.
Now, I think there are multiple reasons to expect a structurally weak US economy which will paradoxically create or sustain multiple ongoing bull markets – but only in select, strong asset classes. The reasons for trouble getting rapid growth or much inflation going again include the following:
- Damage done by the burst housing/banking bubble and resulting Great Recession.
- Damage done by the Yellen Fed’s excessive, lengthy tightening cycle which began as soon as Donald Trump was elected and only began to end at the end of July 2019 and never really ended before COVID hit.
- Ongoing and permanent effects from COVID, both the recession/depression and changing behavioral patterns.
- Ongoing decline in fertility rates in the US.
- General economic malaise in many parts of the world.
- “Good deflation” due to advances in technology.
Except for the last bullet point – which is a clear positive and offers important investing opportunities – most of what I am looking at is not “growth-y.”
Next, I will make a few comments on the four major asset classes I typically examine and choose from, ending with stocks which will be discussed in more granular detail.
The Federal Reserve is flooding the zone with cash. In the current crisis, it is again working closely with the Treasury Department, creating the “Treserve.”
The Treserve has nearly infinite capabilities to make cash trash. In my view, speaking only of money set aside for investing, cash is only useful for timing entry into longer-lived assets.
In this category, I generally mean fixed income with maturities of 10-100 years. Further, given an ultimately dodgy, debt-ridden group of richer countries that have sub-replacement birth rates, my only real interest is in very high quality bonds. The coupon is not terribly important, because for these longer term bonds, my thesis is that total return is what matters, and for price appreciation, duration is key. Regular readers will know that the secular decline in rates has been a theme of mine since I began contributing to Seeking Alpha in Q1 2013. The largest fund that offers investors exposure to these sorts of bonds is an iShares fund with an average maturity of about 25 years (TLT). I do think that 1.0-1.1% on the 30-year bond is a realistic target, perhaps sooner rather than later, so some capital gains would accrue to owners of TLT as well as guaranteed though low interest income.
However, higher yields and sometimes more capital gains potential can come from owning corporates, which have higher yields (I will omit a discussion of junk bonds (HYG) for now).
Here are three taxable corporates I have purchased and own, with commentary, to show that safe bonds can give meaningful total returns if sold before maturity.
1. Florida Power & Light, CUSIP 341081EX1
These are 6.2% bonds maturing in 2036. FPL is a wholly-owned subsidiary of NextEra Energy (NEE).
Moody’s has the bond rating at AA, while S&P rates it as A+.
They were purchased 10/7/18 at $121 (per bond) and are quoted (Friday data) at $146.80.
At that point in 2018, I was shouting in my articles that the Fed had overdone the tightening and was putting my money where my authorial mouth was by buying bonds (see, e.g., from 10/15/18 Yep, The Fed’s Going Too Far, And Trump Has A Point: Analysis).
The FPL bond purchase has far outperformed SPY just in price, not to mention the generous coupon, and with less volatility.
2. Microsoft (MSFT), CUSIP 594918CB8 (rated AAA)
These are 4.5% bonds maturing in 2057.
They were purchased in June 2019 at $1.18. Current quote is $151. Price appreciation is 27%.
Is the current yield to maturity of about 2.3% “too low?” That’s a good question. I bought more just last month at $142 on a back-up in rates. Compared to a 30-year Treasury trading near 1.3%, and which may drop in yield, who knows where this bond will and “should” trade.
3. Massachusetts Institute of Technology, CUSIP 575718AB7 (rated AAA)
These are 4.678% bonds maturing in 2114.
I purchased them in September 2016 at $1.22 and again in June 2017 at $1.13.
They are now quoted at $152.
Recent yields to maturity of these bonds are down to 2.9%. They still may be attractive, as I think long Treasury yields may decline further, and I envision that yield-starved investors may take the yields on these bonds to 2.5% or below. No guarantee, and remember, these are not liquid and cannot simply be flipped as a stock or a Treasury bond can.
Note: The main point of mentioning these bonds is to prove that long-term bonds can offer attractive current yield and attractive price appreciation. So, given greater safety, they can be superior investments to stocks.
The appreciation in price of a high-quality bonds is not dissimilar to a rising P/E of a stock. Keep that point in mind while I make a bond disclaimer:
Buying individual bonds is not necessarily easy, and selling them can be even more difficult. MSFT bonds are generally liquid, but FPL and MIT bonds are generally not. Please do not suddenly become a buyer of individual bond issues if you are inexperienced.
Now to the oldest enduring store of wealth.
Gold looks to be in a steady, potentially powerful bull market
Gold (IAU) began to re-enter its bull phase at the end of May last year. I believe that was because investors finally sniffed out that the Fed could not restore the money supply to lower levels, but would reverse course as it ended up announcing first at the end of July last year, then again in October when it resumed QE.
Now that we have QE to infinity, and unending Federal deficits no matter how the November election goes, the USD is in my view going to be devalued for years to come against hard money.
The decline in interest rates, and associated decline in real interest rates, are music to the ears of gold bulls. Much higher prices may be in order.
I also am long major miners (GDX), along with Barrick (GOLD) and Newmont (NEM).
Now to stocks.
Goldilocks may still be the right paradigm for many (but not all) stocks
I rate SPY as less attractive than either TLT or IAU (or other gold ETF) at this moment, but longer term, the picture could well change.
More important to me, since I do not do much with stock funds, is the interesting opportunity in high-quality stocks that have bond-like characteristics. If things go right with these companies, they can provide longer-term investors the double-barreled advantage that the pure plays such as bonds or gold bullion do not, namely a higher valuation on steadily higher earnings.
Some sector comments follow.
In a low inflation, low growth, very low interest rate world, medical technology stocks that can grow volumes and therefore increase their margins can in my view carry much higher valuations than they do now. I own many such high-quality biotechs and will comment as I can as earnings come in.
One I have been back and forth on based on price and P/E has been J&J (JNJ). I liked it on valuation grounds when it dropped below $140 recently and initiated a position. I ended up buying at higher prices before earnings and also after the beat-and-raise, so I continue to like it up to about $152. My one-year target price is to a new high, at around $175-180.
All the biotechs I have revealed owning over the past months remain in my portfolio in significant dollar amounts. Both the large caps (IBB) and small caps (XBI) appear attractive to me.
Many techs have a 1997-9 feel to them, meaning not bizarrely valued, but overvalued (and headed higher). Even my largest tech holding, MSFT, was one I sold down considerably when it passed $210, strictly on valuation (and largely out of IRAs so there was no tax effect).
But Taiwan Semiconductor (TSM) had a very interesting quarter, revealing substantial market share gains. TSM is one of my long-time favorites; I began discussing it in 2014 when it was around $20.
The theme of market share gains is key to any play in tech growth stocks given high valuations. TSM noted that the chip sector is relatively stagnant, and its projected rapid growth this year is coming from taking share, not sector growth.
In that spirit, I remain long NVIDIA (NVDA) as well as some pure plays on the rapid digital transformation of societies globally, namely the powerhouses Adobe (ADBE) and PayPal (PYPL).
I am also long Intel (INTC) as a bet that CEO Robert Swan will do for INTC what Robert Bradway did for Amgen (AMGN) years ago: get it in better fighting trim and back in Wall Street’s good graces. It is so well-known that INTC has lost at least one step technologically to its major competitors that an awful lot of bad news may now be priced in.
Finally among the very large caps is a stock I wrote one bullish article on 15 months ago, Accenture (ACN). This is mostly a tech stock. I view it as a beautifully run growth engine. As with all the other techs named above, it is important to be realistic about total returns given valuations of all these names.
Finally, Marvell (MRVL) has transformed itself into what could be a multi-year chip stock with well-known growth in the data center and in the 5G transformation, and a potentially very large opportunity in the automotive sector that is less well known or accepted as likely by the Street. I am in the mode of accumulating MRVL on dips within what I posit to be a rising channel.
Moving on to the other major sector I like:
I recently spoke well of 4 big box names. Of them, I took profits on Home Depot (HD) near its highs last week to focus on Lowe’s (LOW). LOW is upping its game and could have a lot of margin expansion to gain, whereas HD’s margins are so optimized that I wonder how it can expand them much further.
Walmart (WMT) has surged since I mentioned that a tag team of it and MSFT looked like a better bet than Amazon (AMZN); so far so good on that idea. I took profits on AMZN at $2,400 and do not regret it.
I also like Costco (COST) and am holding some without trading it and trading others as it moves up and down within its rising channel.
The point of big boxes is that these companies have seen lots of competitors either disappear or be weakened. In a world of omnichannel retailing, I believe they have significant staying power in tough times and growth opportunities in improving or robust times.
All the above names have, in my humble opinion, the opportunity to grow indefinitely and see their P/Es expand in absolute terms if investors turn more fundamentally bullish on growth prospects for the US and global economies. If not, then their dividend growth may certainly provide adequate returns for patient investors.
Utilities (XLU) and Tesla (TSLA)
The major utilities I am long are WEC Energy (NYSE:WEC), NextEra Energy and Xcel Energy (XEL). The latter is a leader along with NEE in renewables. If the economy continues to rebound from the COVID devastation, then it will require more energy. If that is combined with a continued very low interest rate structure, all the above may well provide total returns at least equal to their dividend growth rate plus the current dividend yield. No guarantees in this sector, but the rise of electric vehicles could finally give them a fundamental lift.
I have stuck TSLA here because Elon Musk has said more than once that investors are overlooking the massive growth potential of its energy production and storage division. TSLA is more than a vehicle manufacturer. Having bought in around $330 just last December and then at somewhat higher prices soon after, I am realistic about today’s $1,500 price. But I think that TSLA is going to have a love-hate relationship with incumbents utilities that it will compete with them via the Solar Roof and other products, but help them with storage batteries and help them again with vehicles that need the utilities to provide electricity at least on the roads and possibly at home.
Having aggressively gone long Apple (AAPL) in 2010 and 2011 when the Street was full of skeptics that MSFT with the Windows Phone, and Android, would destroy the iPhone’s market share just as MSFT had destroyed the Mac’s market share many years earlier, I see the same inappropriate views about TSLA that I saw about AAPL a decade or so ago.
Before summing up, a word on risk is necessary.
Risks are unquantifiable
The more that the world, and markets, move into very strange and often worrisome areas, the more I think that a lot of humility and caution are needed in dealing with one’s savings, whether the saver/investor is an individual or a professional dealing with other people’s money.
So I present the above set of views for people to think about, but with nothing close to certitude.
Please do your own thinking in these difficult times while considering carefully as many points of view as you think appropriate. For myself, I am trying to stay flexible given the many uncertainties about the current state of affairs and the many changes that may lie ahead on all time frames.
Summary and concluding comments
It is possible that COVID is already peaking. As of Sunday, the COVID Tracking Project shows the following four-day trend for active hospitalizations in the US:
- July 16: 57,369
- July 17: 57,705
- July 18: 57,562
- July 19: 57,247
It is way too soon to declare victory this summer, even ignoring what could be a nasty resurgence when autumn and winter return. But this is an investment article, and the above trend break supports my basic thesis to begin to invest more normally than when this viral plague hit us so hard and unexpectedly.
That point made, the broader point of the article is that just as when COVID reaches a level of infection in the lungs that a strong immune response is set off, the Treserve complex has now been activated in a very strong manner. Investors have been scared for both their money and their lives, and now it is possible that in the very strange way of economies and markets, the worst may be behind us.
If so, then all the money the Fed has printed – which I expect it to never, ever “unprint” – may turn out to juice more markets more ways than would have been thought likely just a few months ago. Winners could include the trio of long-term bonds, gold and different types of stocks. Losers amongst stocks might include spread lender such as banks that do not do well in low interest rate environments, commercial real estate as work-from-home becomes more mainstream, certain weak Main Street establishments, and oil & gas names as the world goes green. That I see so many core sectors of the “Old Economy” as so challenged explains why I am not a fan of SPY, but am broadly exposed to equities I like in sectors I like. Overall, though, you can see why I call my latest Goldilocks analogy a mutant one, not a cheery one as in the Reagan and Clinton eras.
Many, many uncertainties exist. Please be careful, both re COVID and when allocating money. When interest rates are near zero, losing money may be permanent as passive income may simply not exist in any safe, predictable manner.
Thanks for reading and sharing any comments you may wish to contribute.
Submitted Sunday night.
S&P futures 3,221, gold futures $1,810/ounce.
10-year Treasury 0.62%, 30-year 1.33%.
Disclosure: I am/we are long ACN, ADBE, COST, GDX, GOLD, IAU, INTC, JNJ, LOW, MRVL, MSFT, NEE, NEM, NVDA, PYPL, TLT, TSLA, TSM, WMT, XEL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser. May buy or sell some or all of any of the above securities without notice.