First Long Island Investors 2021 Market Outlook: Where Do We Go From Here?

February 24th, 2021

2020 was a most unusual year and the COVID-19 pandemic as well as a new administration taking office will have vast impacts on 2021 and beyond. On February 11th the First Long Island Investors team reviewed the economic and investment landscape with an eye towards the future in a web seminar.

February 17th, 2021

December 31, 2020

“Invest for the long haul.  Don’t get too greedy and don’t get too scared.” 

-Shelby M.C. Davis

We achieved strong performance in the fourth quarter and for the years 2019 and 2020.  Our thought piece, which was recently issued, described many of the factors that contributed to our performance.  These include substantially increased liquidity from both the Fed and Congress; closure on an election met with much anticipation; the early but inadequate distribution of two efficacious vaccines; a strong rebound in the economy; and continued low interest rates and low inflation—all of which gave investors cause for optimism.  At the same time, concerns still abound from the ravages of the spreading coronavirus, the upcoming legislative and regulatory changes from the new administration, the recent attack on the Capitol and the impeachment of President Trump, as well as somewhat stretched equity valuations in general (as well as some valuations for IPO’s and Bitcoin that do not make sense to us).

Our quote puts in perspective the view we believe investors should have looking forward.  “Don’t get too greedy” suggests to us that returns could be muted in the near future recognizing that substantial gains have already been made in anticipation of a growing economy coming out of the pandemic.  If hyper stimulus is achieved by the Biden administration it is possible that equity gains can continue.  However, valuations, which have been somewhat dependent on low interest rates, could see pressure if rates were to go up from all of the stimulus and inflation that is likely to result therefrom, as well as the heavy debt burden the country faces.

Our quote also reminds us to not be too afraid.  As we invest in select high-quality companies with either substantially growing earnings or growing dividends from solid business models, time is on our side.  Even if the pandemic delays some improving results for our companies, we believe our investments have the ability to continue to make progress over time.  We believe we will achieve reasonable returns or even better over time. 

Maintaining a prudent and diversified asset allocation with the primary focus on our defensive and traditional strategies remains a prescription for long-term success, in our opinion.  Patience has always been required for successful investors.  Additionally, given the stated concerns, both economic and political, we continue to urge all clients to retain a buffer of cash or very short-term high-quality bonds to give comfort if there is a bump in the road.  Investment history suggests that the patient investor reaps rewards while being pretty much fully invested if they can give their advisor, First Long Island Investors, the gift of time.

We continue to be cautiously optimistic as we await new policies from the Biden administration and the defeat of the COVID-19 pandemic with ramped up vaccinations from two vaccines with more on the immediate horizon.  As we have said many times in the past, never bet against America!

Best regards,

Robert D. Rosenthal

Chairman, Chief Executive Officer,

and Chief Investment Officer

*The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance. Actual results may differ materially. Past performance statistics may not be indicative of future results. Partnership returns are estimated and are subject to change without notice. Performance information for Dividend Growth, FLI Core and AB Concentrated US Growth strategies represent the performance of their respective composites. FLI average performance figures are dollar weighted based on assets.  

The views expressed are the views of Robert D. Rosenthal through the period ending January 29, 2021, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such.

References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Content may not be reproduced, distributed, or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC.

Copyright © 2021 by First Long Island Investors, LLC. All rights reserved.

January 19th, 2021

2021: Our Thoughtful View – January 14, 2021

“Invest for the long haul.  Don’t get too greedy and don’t get too scared.” 

-Shelby M.C. Davis

2019-2020

In assessing the future, one can learn from the immediate past.  2019 was a year of financial optimism fueled by improving earnings, in part due to ongoing benefits of recent tax reform, low unemployment, low interest rates, and deregulation.  The result was a strong year in most traditional asset classes with the laggard being the average hedge fund investment.  Our clients did well following a diversified asset allocation tailored to their individual goals, but in all cases with an underweight to fixed income and heavier allocations to our defensive and traditional equity strategies.  Meanwhile, beneath the surface, wealth and income inequality simmered.

2020 was a year to never forget.  It started with great optimism based on record low unemployment, low interest rates, rising personal incomes, an accommodative Fed, and a rising stock market.  However, early on, commencing in March, we and the entire world were confronted with a global pandemic emanating from a region in China that has foisted on us sickness and is approaching a death toll not seen for the last hundred years (other than HIV/AIDS), as well as the economic impacts of such.  As the extent of this pandemic became better known lockdowns forced business closures; hospitals became inundated; and unabashed fear led to unimaginable number of deaths and a downward spiral of global stock markets (e.g. the S&P 500 Index fell 34% from its peak just prior to the pandemic).  A recession/near depression was forced on our economy and others around the world as governments and medical professionals struggled to find treatments and vaccines for this unknown virus.

Enter the words “warp speed.”  With accelerating speed our equity markets declined in the February-March period.  Office real estate and many retail and restaurant locations became empty, planes and hotels had utilization drop by upwards of 90%.   Unemployment rose to almost 15% at the peak.  Oil usage plummeted and spot oil pricing at one point was negative!  The key thing to remember with all of these disastrous circumstances is that they were self-inflicted by our federal and state governments, trying to deal with this unknown and hideous virus.  The financial crisis of 2008/09 was dwarfed by the economic and human despair caused by this pandemic.

Enter the words “warp speed” yet again.  In the spring, the Federal Reserve and the Federal Government took unprecedented and bold actions to bolster the financial system through monetary policy (expanded the balance sheet by three trillion dollars) and the government (in a bipartisan manner) acted to pass the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and other programs which infused more than three trillion dollars to individuals, businesses, hospitals, and local governments.  This was followed up in very late December with another nine hundred billion dollars which has yet to be distributed.  These monetary and fiscal actions dwarf the actions taken by the Fed and the Federal Government during the financial crisis of 2008/09.  

Growth in Money Supply

The U.S. government also initiated a ambitious partnership between government and private businesses called “Operation Warp Speed” to provide for the seeding of pharmaceutical companies to create therapies and vaccines to conquer this virus as well as other public-private sector partnerships to develop and administer new methods of testing, domestically manufacture personal protective equipment (PPE), build temporary hospitals, add ventilators, etc.  The intention was great but something of this magnitude was bound to have inefficiencies and political discourse, both of which were experienced.  But hope sprang eternal and a vaccine was developed through Operation Warp Speed by year-end (an unimaginable record) and the development of certain therapies gave both our citizens and businesses hope for the future.  The following charts depict the course of employment, gross domestic product (GDP), monetary growth, and the S&P 500 during 2019-2020 which demonstrates the violent downturn and miraculous economic recovery:

These charts demonstrate both the economic volatility as well as the unprecedented resilience of the domestic stock market and our economy.  Of course, not all stocks reacted with such a rebound as growth-oriented shares led the market by a wide margin (given our bias to growth, almost all of our strategies delivered double digit appreciation).  Certain sectors of the equity markets (Energy and Financials) were significant laggards.  Interest rates dropped to record lows, so today cash and quality bonds offer little or virtually no return — in most cases (money markets and U.S. 10-year Treasuries) provide a negative return after inflation.   2020 ended with the S&P 500, Dow Jones Industrial Average, and NASDAQ setting new records.  Who would ever have thought that was possible?  But the prospects of vaccines, therapies, record amounts of monetary relief and stimulus from the government, and the Fed’s expanding balance sheet provided the impetus for these mind boggling results.

However, during the course of the year, political division, an upcoming Presidential election, and civil unrest prompted by the heinous murder of George Floyd in Minneapolis led to numerous peaceful and many tumultuously violent protests throughout the country.  Cries for a political solution to wealth inequality were important to many of the Democratic candidates for various offices.  The fear of socialism became the common fear of those on the right of the political spectrum.  Finally, in a Presidential election besieged with controversy, former Vice President Joe Biden was elected President.  The President-elect has promised a more progressive approach to many of the country’s challenges.

What Do We Know As We Commence 2021?

The horrors of COVID-19 remain with death counts being a daily reminder.  The infection rate in certain parts of the country is growing coming out of the holiday season.  Yet there is reason for optimism based on:

1. The emergency use authorization of two vaccines, as of this writing, with an efficacy of 94 and 95%.  Operation Warp Speed is delivering on its promise of 300 million vaccine doses with the first delivered by January 2021.  In fact, they beat that initial delivery target and vaccines started being given out in December 2020.  However, the administering of the vaccines has been disappointing based on both federal and state inefficiencies.

2. The flood of liquidity from the Fed and stimulus from Congress continues to bolster financial markets. Stock markets hit records, IPO’s achieved incredible valuations (unreasonable to us), Special Purpose Acquisition Companies (SPACs) achieved record “blank check” sums of money, and cryptocurrency appreciated by over 300%! (Not our cup of tea.)

3. Unemployment continues to come down (albeit some people have left the workforce) and businesses have adapted to these draconian circumstances by innovating products and delivery systems.  We expect this will boost profits and profit margins for many companies.  S&P 500 earnings are projected to achieve pre-pandemic levels this year and exceed them in 2022.

4. The latest round of relief, $900 billion just approved and reluctantly signed by President Trump (who at the last minute sought higher direct payments), should be a bridge to struggling individuals and businesses while vaccines help to return our economy to normal.

5. The Fed has promised to let the economy run “hot” until full employment is achieved through low interest rates and Fed purchases of debt instruments.

Where Does This Leave Us?

There is much optimism that lies in the hope that the virus will succumb to massive numbers of people being vaccinated sometime this year. A “new normalcy” will evolve during the course of the year and we believe that our economy will continue to recover robustly.  Many market pundits are optimistic that another positive year for the stock market is possible.  This is based on increasing corporate earnings, GDP growth, improved employment, continued low interest rates, and new business startups to replace many of those that failed through no fault of their own.  In addition, the Fed just conducted another surprise stress test for major banks and they all passed!   It is quite possible that loan loss reserves taken in prior quarters will be returned as higher profits in 2021.   We believe that all of these factors will in time take place.

Yet another characteristic of the last several years that has not been focused on — our national debt which will now approach a concerning level of $28 trillion dollars. At least eight trillion resulting from the tax cuts of 2017 and roughly three trillion in additional debt for the needed relief and stimulus from the pandemic.  This is a reality that needs to be thought out and brought under control.  Our best guess is that both tax increases in the future and inflation will be needed to stem the tide and reduce the effective cost of this level of debt.

We would be remiss in not again mentioning our concerns regarding the speculation that seems to be surrounding IPO’s, SPACs, P/E’s for certain public companies not supported by earnings or earnings growth, home price appreciation, and the overall market optimism that prevails despite the suffering that continues to plague us.  Additionally the big unknown, which could impact these assets and other asset classes is the new policies of President-elect Biden and his progressive agenda.

The run offs in Georgia earlier this month resulted in a slim margin in which the two Democrat candidates were elected in what has been a red state for quite some time.  The consequence of these two elections results in a tie in the Senate. When there is a deadlock on votes the tie is broken by the vote of the President of the Senate, the Vice President of the United States.  In this case, that will be Vice President elect Kamala Harris, a Democrat. This could lead to a more progressive changes resulting in higher corporate and individual taxes as well as possible expensive policies on climate change (the Green New Deal) could impact corporate earnings and consumer spending.  Infrastructure and immigration changes could also be possible.  Additionally possible major changes to our medical delivery system could take place leading to fears of a single payer system.  However, a moderate Democrat Senator, Senator Joe Manchin of West Virginia, has indicated that he will not support such transformational moves by progressive Democrats. This situation requires close scrutiny by us if this should lead to major tax and regulatory changes impacting investors.

Additionally, less consequential from a financial standpoint, but more shocking from a political and moral standpoint, was the riot and breaching of our Capitol last week after a speech/rally led by President Trump. This mass gathering boiled over and attempted to stop the constitutional congressional vote to confirm the states certification of the election of Joe Biden as President and Kamala Harris as Vice President. The Capitol was ransacked, congressional members were moved to secure locations and/or hidden for protection, and five people died.  Fortunately, later that day, the business was completed and the election was certified.

However, it is alleged that President Trump fomented the rally that led to this atrocity. Democrats have impeached the President as the Vice President refused to remove him from office under the 25th Amendment (which would have required a vote of at least half of the President’s cabinet) and the President has not resigned.  Now (as of January 14, 2021) we await a trial in the Senate, likely after President Biden is sworn into office.  If this plays out, the divided country will continue to suffer from extreme political discourse.

The impeachment in the House of Representatives and subsequent trial in the Senate as well as how an evenly split Senate will impact the legislative agenda (amongst COVID and other things) hangs over us as Americans and investors.  We will be watching all of this closely and will report to you as it impacts our approach and advice as your wealth manager. 

Where Do We Stand?

After two years of robust gains for our clients’ portfolios, despite most recently a horrific global pandemic, civil unrest, and a politically divided country, it is hard for us to be too optimistic about gains this year despite the many positive factors outlined throughout this lengthy writing.  We do believe that corporate America will be more efficient; consumers are more adept at how they purchase goods; there is pent up desire to return to normalcy and all that goes with it.  This could lead to increased velocity of money from pent up savings by consumers.  The declining dollar will benefit some of our multi-national companies leading to an earnings tail wind that has not existed for several years and can somewhat mitigate proposed corporate tax increases like those being suggested by the incoming administration. 

So, it is fair to say there are a lot of moving parts to this investment puzzle.  For those reasons we cite our opening quote.  Invest for the long haul while not being too greedy or too fearful as set-backs in equity markets and real estate are common factors of long-term investing.   Collectibles might be a safe haven while offering appreciation opportunity (Google “art returns during recessions”). This time is no different for hoping for reasonable returns over a five-year time frame driven by earnings and dividend growth.  The obvious “below inflation” returns from cash and bonds make us shy away from them other than as a buffer for each client to keep them sleeping at night.   Appropriate levels of cash and bonds of shorter duration will be client dependent.   Our defensive and traditional strategies still, in our opinion, offer long-term appeal tailored to each client’s risk appetite.  We continue to think high quality in every asset class we invest in.   Our preference for U.S. investing remains with modest allocations to other parts of the world.  This bias to quality and the U.S. is what has helped us to achieve meaningful appreciation for our clients last year, despite what turned out to be the “exogenous event” that we cited in last year’s thought piece that could derail the best of investment plans as the result of some unknown event.

Stay safe, wear a mask, get vaccinated (consult your own physician as I am only a JD not an MD), socially distance, and wash your hands.  We appreciate your loyalty and confidence in our team. We look forward to when we can meet in person again!  However, we remain available to you by phone, email, video call, etc. to always guide you in your wealth management needs.

We hope you will join us for our web seminar on February 11, 2021 at 11AM EST where we will dig deeper into many of the items covered here as well as take questions from attendees. 

Best regards,

Robert D. Rosenthal

Chairman, Chief Executive Officer,

and Chief Investment Officer

The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance.  Actual results may differ materially.  Past performance statistics may not be indicative of future results.  The views expressed are the views of Robert D. Rosenthal through the period ending January 14, 2021, and are subject to change at any time based on market and other conditions.  This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such.  References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.  Content may not be reproduced, distributed, or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC.

FLI average performance figures are dollar weighted based on assets. 

All performance data presented throughout this communication is net of fees, expenses, and incentive allocation through or as of December 31, 2020, as the case may be, unless otherwise noted.

FLI believes the information contained herein to be reliable as of the date hereof, but does not warrant its accuracy or completeness.  This communication is subject to modification, change, or supplement without prior notice to you.  Some of the data presented in and relied upon in this document are based upon data and information provided by unaffiliated third-parties and is subject to change without notice.

NO ASSURANCE CAN BE MADE THAT PROFITS WILL BE ACHIEVED OR THAT SUBSTANTIAL LOSSES WILL NOT BE INCURRED.

Copyright © 2021 by First Long Island Investors, LLC.  All rights reserved.

November 2nd, 2020

On October 27, 2020, just one week before the 2020 general election, First Long Island Investors hosted an online event for clients and friends of the firm.  Although the format was different from our typical Leadership Breakfast Events, it was wonderful to connect with clients and gain some insights into the election. 

Daniel Clifton is a Partner and Head of Policy Research for Strategas Securities. In this capacity, Mr. Clifton evaluates the financial market implications of policy and political developments. This includes analyzing trade, tax, healthcare, energy, and other policy initiatives to determine how public policy changes impact the economy and financial markets for institutional investors.
 
Daniel leads the #1 ranked Washington policy team on Wall Street according to Institutional Investor magazine. Mr. Clifton has been ranked as a top Washington policy analyst in each of the past eleven years. Daniel is also a top ranked analyst in the category of Tax and Accounting Policy.
 
During the session, First Long Island Investor’s Chairman, CEO, and Chief Investment Officer asked Dan a series of questions.  Below is a summarization of the responses. 

Q:  In your view, what is the political backdrop to this year’s US elections?

Our big theme has been that economic volatility is resulting in political volatility. We’ve really had that view since the financial crisis in 2008.  Following the financial crisis of ‘08, the U.S. economy, which historically has grown at about a 3% rate after inflation, transitioned from a 3% to a 2% growth rate and we’ve largely stayed there for the last 12 years.

Putting that in context, if the US economy was growing at about a 3% growth rate for the last 12 years, the US economy would be 3.5 trillion dollars larger today than otherwise is the case; the average American household would have $40,000 to $50,000 of additional wealth.  It is my belief is that voters know there’s something inherently wrong, that policy is not working and that their standard of living is not rising as fast as it should be.

We think that this has been important for the US political landscape.  We’ve had seven federal elections since the financial crisis and the voters of this country have removed the party in power in six of the seven elections.  We had all Republican, all Democrat, we mixed it up, and in 2016 we rolled the dice with Trump. All with basically the same growth rate. So, even before COVID hit here in the United States we were in an extraordinarily volatile political situation that admittedly was getting better because income growth was going up.  But, COVID basically threw cold water on that.

I would actually argue that COVID took gasoline and poured it on the fire of our political situation, think about where we are today in 2020 – we have four super transformational events happening at once.   We have a recession, a pandemic, mass protests, and an election all happening in the same year.  We went back 100 years and said, have we ever had these four events happen in one year?  The answer is no.  In the modern US political system, we’ve never had four of these events happen at the same time.  We can find three times where we had three of these four events happen, the last being 1968, so you’re talking over 50 years ago. The implication of that background is that that means the range of outcomes here are larger.  I think that’s why it’s important that investors be in touch with their financial advisors at a time like this.

In 2016, we spent most of the year trying to encourage our clients that Trump had a better chance of winning than the consensus was giving him credit for.  This year it’s less about Trump, Biden, or who’s going to run the Senate. I think that’s important because we are talking about contested elections, we’re talking about possibly having the House of Representatives vote to make somebody president for the first time since 1876. And while that’s not the base case, it’s not a 0% probability, like it had been my whole life. 

Q:  What is the current outlook for the presidential and Senate races? What metrics are you watching to see if the race is changing in this final week?

We’re at the final week here and because of this very disruptive environment that we’re in, we created a framework early in the pandemic around how do we evaluate this election?  I would put it in three buckets. 

The first question which I think is the most important question: is this a referendum on Trump or is this a choice between Donald Trump and Joe Biden?  I think that is a very, very important question because most presidents never want it to be a referendum on them. They want to make it a choice.

Think about 2012, President Obama, running for re-election against Mitt Romney, argued that if we give the keys to Mitt Romney, he’ll drive us back in the economic ditch that caused the financial crisis in 2008.  It was very effective in making the race a choice.  Thinking about George W. Bush, in 2004, running for re-election after the horrific attacks on our country from 911.  George W. Bush argued that if we elected John Kerry, we would be putting at risk the progress we’ve made on homeland and national security since those attacks occurred.  In both of those instances, the incumbent President made it a choice.

For most of this year, you didn’t see that. In fact, think about Mike Pence’s debate.  That was the first time where you started to see, oh, you’re against fracking. Oh, you’re for court packing? Right? That’s the debate the Republicans wanted all summer, but they really couldn’t get it because the country was so consumed with COVID-19 and the implications of COVID-19, so it had become a referendum on Trump for most of the summer.  At the beginning of July, Trump was losing Florida by seven points.  About an hour ago, the polling went positive for Trump in Florida. So that’s a pretty dramatic change over the last few months.  But it was a referendum.  So why did it change?  It changed because COVID began to wane, the economy began to re-open, and then we started talking about law and order, our healthcare, and taxes. The nature of the issues began to change. It became less of a referendum and more of a choice.

How do we know that? You asked what indicators we’re watching.  We watch the President’s approval rate, we think it’s a far better indicator than watching the polls.  It’s 85% correlated to what the President gets in re-election.  For most of the summer, Trump was hanging out with Jimmy Carter and George Herbert Walker Bush’s approval rating, that’s not the place you’ll want to be.  By the time we got to the first debate, Trump was almost where Barack Obama and George W. Bush were when they won re-election. So he had made tremendous progress, he’s given up some of those gains.  Today he’s sitting somewhere, a no man’s land, above the losers but below the winners.  The direction of that over the next couple of days will be absolutely critical. You say well, we’re a week away, 60 million people voted, what can actually change between now and then?  What is happening is you’re getting the first round of polling since last week’s debate and the president’s numbers seem to be getting better.  Some of that is just that his supporters are now re-energized, like Trump assured his voters “hey, I’m up for this job,” something that he did not do in the beginning of October, particularly with his COVID diagnosis.  Second, the President got more money from fundraising. That means that you can advertise more.  I just see the race starting to tighten up here a little bit. We’re watching it because you know the president is gaining a lot of momentum going into the close of the election. And four years ago that was a big change. So that’s number one.

Number two is that we watch the economy, every President that had a recession two years before their re-election went on to lose and every President that avoided one went on to win.  It’s a very simple model.  If you want to get re-elected, avoid a recession, Trump had a recession.  If I can give you a controversial data point right now, it is that if this election was about the economy, Trump would actually win, not only the Electoral College, but the popular vote.

We’re going to get the first quarter GDP number on Thursday morning, it’s likely to show that the US economy expanded somewhere between 35% and 40% in the third quarter. I’ve never seen numbers like this.  Now, we had a 31% contraction in the second quarter, but nobody expected that the growth rate in the third quarter would exceed the contraction in the second quarter. If I am the President, I would stand up there and say we had this horrific event happen, and you know what? We fixed it. We’re getting it better. The economy is coming back.  We’re close to a vaccine and therapeutics are filling the gap. We’re learning to live with the virus.

That’s a positive closing message that the President can bring in.  And if Joe Biden has any dirt on Donald Trump, he should really say that 8:28 AM before that economic number comes out at 8:30 AM, right.

The economy has actually turned into an asset for Trump despite the big contraction where there’s been a liability for the President, and the reason why he’s down in the polls and down quite a lot in the national polls, is that COVID-19 has become the big X factor of this election.

We love Charts. We have a simple chart that shows the number of swing state voters and the percentage of swing state voters worried about COVID and Biden’s lead in the swing states. It’s the same chart.  As voters got worried about COVID, Biden’s lead went up in the swing states and as voters get less worried about it, Biden’s lead comes down.  Despite the recent surge in cases that we’re seeing in the mid-west, the actual number of voters worried about COVID went down last week.  That’s why the race is starting to tighten up in the swing states.

I want to be clear here, there’s a huge difference between the swing states, which Biden is winning by four points in the polls, and the national average where Biden is winning by nine points.  Nine points is not close, but 4 is, particularly when the polling error in 2016 was about 3.7%. If Trump makes a little bit of progress in Florida, Pennsylvania, North Carolina, and Arizona this race is going to be in the margin of error.

As the last 60, or 70, or 80 million Americans go into the polls over the last few days, and I still believe despite all the early voting, that the weekend going into the election is the most critical for all campaigns. As it creates the last-minute surge, it determines whether people are going to leave their house and go wait in line at a polling place. 

Q:  There are two very different styles in this last week of campaigning: the President, despite recovering from COVID is conducting numerous rallies where irrespective of masking and social distancing, which they are trying to get better at but still not very good, he’s engendering great enthusiasm.  Whereas Vice President Biden is taking a much more laid back approach. Do you think that makes a difference in these swing states in the final week?

There’s no doubt about it.  There’s a couple of things going on.  Biden has $430 million and the President might have $40 million, like 1/10 of what Biden has.  Biden is running what’s called an air game, he is running advertising.  What Biden sees is a nine point national lead; he sees a five point lead in Michigan; a five point lead in Pennsylvania. He should call Hillary and ask how good that five point lead is.  If you remember, Hillary did not go to Wisconsin; Hillary had Beyonce and Jay Z in Philadelphia rather than herself.  Sometimes a candidate has to go out and do the work.  I think there’s scenario planning in government building going on a half-a-day in Joe Biden’s life and maybe one campaign event somewhere.  The Biden campaign made a very important decision today that they are going to go to Texas and to Georgia.  I just want to be clear that if Biden loses the election it is going to be viewed as this trip is what killed his election because it’s so far out of the 270. You don’t need it.  Go to North Carolina; go to Arizona, go to Florida!  You don’t even have a competitive Senate race in Texas.  They want to kill Trumpism. They want 400 electoral votes and a mandate for their agenda and they think they’ve got a big enough lead to do it because the odds makers are saying they have an 80, 90% chance. Now, that’s the Biden strategy. 

The Trump strategy is totally different.  Think about if you’re a political science professor, the lesson that you can teach your students afterwards because Trump is saying, I am going to launch a ground war rather than an air war and I’m going to win this on the ground.  That’s why he’s going into rallies, but it’s more than that.  He’s going to have two million, three million door knockers this weekend going to people’s homes. Have you voted yet? Do you need a ballot? Do you need ride to the polling place?  They are going and doing the grassroots, because Trump’s campaign manager is the person who ran Pennsylvania, Michigan, and Wisconsin in 2016.  He won that on the ground there.  And that is a very different strategy.  It’s also one that could have higher effectiveness, because they literally took the Obama-Biden campaign strategy of 2008 and 2012 and they are applying it to the Trump campaign.  Biden is not matching that ground game really in a meaningful way.  If there is a surprise it’s going to be that they have different strategies and one was superior to the other.  I think that’s very important.  Now to Trump, there’s a guy who’s 75 years old, he just had COVID, and he’s doing like five campaign events a day. By the way, I’m 30 years younger, I would be tired doing five campaign events a day.  I would also say that he’s got the benefit of Air Force one, but this is not easy.

What he’s doing reminds me of the lesson that I learned playing baseball. I was never going to be the best baseball player, but I will never let anybody outhustle me on the field. That’s what Trump is saying is “I’m the hustler; I’m the one who’s working; and I’m going to work hard.  It’s trying to remind voters what that contrast is going into the final election, where the enthusiasm is.  Joe Biden’s doing an event in Texas, there’ll be 15 people.  So it’s a very different strategy and you know, I just think it makes a great political science experiment.  Trump is not leaving anything on the table given that he’s down in the polls right now.

Q:  So given this transition from almost leads that were not able to be taken away from Vice President Biden, both nationally and in the swing states, to Trump’s low favorability rating to now where we see some tightening based on what you’re saying, particularly in the swing states what probability do you put on a contested election and what are you watching most closely for clues on election night?

Awesome question.  Let me just start off by saying if Trump loses Florida by two points or more it’s going to be an early night because there really is little path to 270 electoral votes without Florida included.  The reason why I’m pointing out Florida, is that they had a major failure in their election administration 20 years ago, Bush versus Gore.  They are so good at what they do today.  We’re going to have two weeks of open early voting numbers that get released right away; there’s a little bit of a delay from Miami-Dade; and the panhandle is actually an hour different time zone than the rest of Florida, so you’ve got to wait an extra hour before you get those numbers.  But, when you get those numbers, you’re going to learn whether Trump won Florida, which is important.  He wins Florida we’re going up north to Pennsylvania, Michigan, and Wisconsin which have different rules and clearly you’re not going to have the election results if it’s close, but also you’re going to learn so much from Florida that can be extrapolated to the rest of the country.  There is a county called Sumter County, and in that county is something called the Villages.  There are about 80,000 senior citizens that live in the Villages.  Trump won that county by 67% in 2016.  Political analysts are going to be watching that county very closely to see if there’s a Senior COVID revolt.  Seniors are most affected by COVID-19.  Seniors voted in a majority for Donald Trump in 2016 and they had been leaving him.  If you see Trump really underperform there that will not be a good sign for Trump in Arizona, Maine, and Pennsylvania, places where he needs to win.

The Panhandle is the tollgate.  When Trump reported his numbers in the Panhandle in 2016 it flipped our model to suggest that Trump was going to win Minnesota.  We literally can take areas of the country and extrapolate how they vote one way or another to how the rest of the country is going to vote.  I had never seen numbers like that.  People forget how great Hillary Clinton ran between Tampa and Orlando.  That corridor makes Presidents.  When she reported her numbers, I was like “Oh, Trump us not going to beat these numbers, and he did.  So that’s going to tell you if Trump is getting his vote.  OK, those are really important indicators.  By the time you hit Miami-Dade County, you’re going to see how Biden is doing with African American and Latino voters, which is a big question mark about whether they’re going to be enthused. 

So now Trump wins Florida; assume that he also wins Ohio and North Carolina.  We’ll know all three of those early.  Then we go up to the mid-west.  The States in the mid-west do not have the experience that Florida has, which means that those ballots will not be opened until the polls close.  If the Democrats are really voting, 60% vote by mail, that means Trump is going to win big on election night, in those states and over the course of the next week, his lead will go down.  That’s where the first contested election comes from because Trump is going to try and stop Pennsylvania from collecting ballots 3-4 days after Election Day.  Our new Supreme Court justice will be put right on the hot seat almost immediately.  As I expect there will be court cases falling to the Supreme Court.  But thinking about the Democrats, the Democrats are also going to go to court.

Mail in ballots have a high error rate.  You don’t fill out the ballot correctly; you don’t include the secret ballot; there’s all sorts of mistakes you can make with it.  Democratic pollsters are shaving one or 2% off Biden’s numbers in these states because of that high error rate.  Trump won Wisconsin by 22,000 votes in 2016.

It is possible that you are going to have more mail in ballots that get thrown out than Trump wins that state by.  The Democrats are going to go to court and try and get every single one of those ballots re-introduced into the count.  Just by the nature of not being able to count those mail-in votes, leaves the piñata hanging out there, which then brings lawsuits.  And so I think the probability goes up if Trump closes the gap here in the last couple of days.  He locks in North Carolina, Florida, and Ohio.  We’re going to have some real fight going on in the mid-west when that happens.  If all the undecided voters break to Biden, which normally is what happens.  I’ve never met anybody, and I mean this, that says to me “Trump is OK.”

People love him or hate him, right? Even if you don’t like style, but you like his policies.  Some people like his style but don’t like his policies, some people just hate him.  But it’s pretty binary if you don’t know if you’re going to vote for Trump at this point, you probably won’t.  How the contested election doesn’t happen is that a lot of people just move away from Trump here and the bottom falls out for the Republicans which is why he’s doing those rallies that you asked about- he’s trying to keep the bottom from falling out.  I think it will be successful in preventing that.

Q:  What do you think are the starkest policy differences between Trump and Biden and where’s that showing up in our financial markets?

That’s a great question. The starkest policy difference is on trade policy and international relations.  What has struck me the most this election cycle, and I’ve been working in politics since 1996, is how much the international stock markets are trading on this election.  It’s pretty awesome to watch, but it’s all driven by a stark difference in trade policy.  As you know, the President has been very tough with trading partners around the world, whether they’re our allies in Europe, or our adversaries in China.  Biden is representing a different view and that is that we need to have diplomatic pressure on China and try and operate in a rules based system, so the market sees less economic warfare with China if Biden wins.

How do we know this?  First, the US dollar is depreciating almost perfectly with Trump’s odds of winning. As Trump’s odds of winning have come down the dollar has started to fall almost identical with that.  That’s the America First trade coming out of the market that Trump had.  US stock markets outperformed non-US stock markets by 50% since January 1, 2018.  You can watch the China stock market and the Vietnam stock market relative to each other. As Biden’s odds go up China outperforms Vietnam.  As Trump odds go up, Vietnam outperforms China.  That is the market saying decoupling of the US from China will happen faster under Trump than it will under Biden.  You can do this for emerging markets; you can do this for Germany; you can do this with the Mexican Peso.  So, non-US over US because of trade policy if Biden wins, and US companies with high foreign revenue exposure benefit from that dollar depreciation.  That’s not the only reason why the dollar is depreciating, but raising corporate income taxes and raising taxes on foreign source profits, and more government spending all that’s dollar negative.  And so the market is treating Biden as a weak dollar president, Trump as a strong dollar president. That’s where it’s showing up the most and it doesn’t matter what happens with Congress, because it’s really an executive power on trade. 

Q:  Putting aside all the political rhetoric that we hear from both sides, what do you think are the top policy priorities for an incoming Biden administration versus a Trump second term?

It’s a great question because what they campaign on is very different once they get in.  There is a positive view of this election amongst investors.  Regardless of who wins the race, you’re probably going to get a vaccine, and you’re probably going to get some level of fiscal stimulus.  These are such big events that it transcends some of their policies itself, but if the Democrat’s sweep they are going to be very focused on a larger stimulus package, possibly in the range of two to three trillion dollars.  Their focus within that stimulus package is really in four key areas.  First is climate change.  Climate change, while an important goal, is ranking 13th in our polling data of voter priorities right now.  It is the Democrat’s number one priority because we were warned about a pandemic and we weren’t ready for it.  Our economy collapsed.  We’re being warned about climate change and so we need to be ready on that.  Lots of spending on wind, solar, and electric vehicles.  Number two is on highway infrastructure.  Nancy Pelosi, the Speaker of the House, has passed a trillion infrastructure package this summer.  42% of it went to highways, roads, sewers, waters, etc.  Third is healthcare, getting more people health insurance, and fourth is more money for state governments. 

I will tell you that I don’t expect any bill to pass until the state and local deduction is re-instated.  You’re going to have a Senate Majority Leader from New York and a Speaker of the House from California. They are not going to let any bill pass unless they get that state and local tax deduction re-instated.  There will also be money for education and COVID relief, which I think will also be critical, but those are the priorities of the Democrats. 

Now, let’s go over to Trump.  Let’s just say Trump wins.  This is a person who won and had the Mueller investigation, had impeachment, had a recession, had a pandemic, had COVID himself and still won.  He is going to believe that he can do anything if he wins.  Larry Kudlow, his advisor, is putting together a tax reform plan that is two income tax brackets and 15% capital gains dividends bracket.  Why they don’t present this on the campaign blows my mind.  They can say, “I’m for lower taxes, he’s pro taxes.”  I would expect to see infrastructure as a big part of the Trump plan.  And then, again, focusing on realigning world trade patterns to get more domestic production of manufacturing activity here in the United States. So those are the priorities. 

What I will tell you is that in 2016 I wrote a report on October 28th, I said we’re raising our probability of Trump winning and here’s the Republican agenda.  It was one of the least read reports in Strategas’s history at the time and on election night, at about 10 o’clock, everybody was like, “whoa, OK, can you resend that report?”  You need to be prepared for all scenarios. 

Q:  If Biden and the Democrats sweep do you believe the tax increases that the Vice President continually talks about will be as of January 1, 2021 or do you think the Democrats will consider the impact of a major tax increase on the economic recovery and hold up?

If Congress passed a fiscal stimulus bill on August 1st or September 1st the question you asked would be the single most important question for investors today. Either way it’s still really important, but what the Biden advisors have done is that they’ve come to Wall Street, and they’ve made this pitch saying, “we know you’re worried about the tax increases and their impact they’re going to have on growth.  We want to assure you that we’re going to spend two trillion in one year, and raise taxes by $400 billion, or $300 billion.”

By the way, that would be the largest tax increase since 1968.  We keep going back to this theme of 1968.  OK, but people say, oh you know, Obama raised taxes and George Herbert Walker Bush raised taxes.  They were two, three, four tenths of a percent of GDP. We’re talking 1.5% of the nation’s economy in tax increases, and it’s still smaller than all the government spending that they’re doing.  So, from a macro-economic perspective, the Biden Administration is saying: “we’ll be net accretive to fiscal policy and minimizing the tax impact.”  That works for 2021. I worry about 2022, 2023 and the impact that can have on earnings. 

I did an interview with one of Biden’s top economic advisers for all my clients last month.  I refer to the tax increases as spinach and I refer to the government spending as candy — well you’re going to have candy, so how much spinach are you going to have?  It’s a cute little analogy.  The adviser said, “I’m not sure that I would call it spinach.  I may call it popcorn because I’m going to watch those tax rates go up.”  I mean he’s making a reference to watching a Netflix movie while we’re putting taxes on savings and investments.  It was like, Whoa!  I immediately was like “he does not believe that raising taxes on the wealthy is going to impact economic growth in a meaningful way.”  It impacts how I can answer your question about whether they’re going to sit back on the economy.

Here’s the way I envision it.  They’re going to come in, if they sweep, and they’re going to want to do one fiscal policy stimulus with unemployment insurance, money to states, food stamps, and all other COVID money.  Emergency money gets the economy on a better footing, and then come back for infrastructure and climate change, with tax increases in it.  By the way, there is not a unanimous decision amongst Biden folks about the way to do it. Some people want to do it all one shot.  I don’t want you to think that you have until June before taxes go up, it could be March if they choose a different direction.  I’m setting all that up for retroactive.  So I say to the Biden adivisor, are taxes going to be retroactive? 

The last time we raised taxes was January 1, 2013.  We passed that bill on New Year’s Eve, so it was calendar year.  In December of 1990 we did it right around Christmas so it went into effect for the new calendar year.  In August of 1993 the Bill Clinton tax increases passed and were retroactive to January 1st on income, and on corporate.  In 1968, again we go back to 1968, the increase passed in July and was retroactive.  So there is a chance that there will be a retroactive tax increase to January 1st on individual income.

The bigger question is whether that will be retroactive on capital gains.  We went back in history and we tried to see if there has ever been a retroactive capital gains tax increase.  The answer is no, because that would be just crazy.  By the way we’re in a crazy world, so maybe it happens.  In fact, in the 1969 tax increase they said that if you’re involved in the transaction before the capital gains rate went up, you will still have the lower capital gains rate before.  That’s really interesting to us, because we’re having a surge of private companies being bought out.  We’re having a surge here of M&A – I woke up today and Advanced Micro Devices was buying another semiconductor company.  And, Sheldon Adelson, the owner of Las Vegas Sands, was talking about selling.  That’s not a surprise that with the capital gains rate being proposed to go from 20% to 40%.  That’s a meaningful change.  Do you want to dump it out at 20?  So, I think there could be some precautions in there, some safety provisions to make sure capital gains and dividends are not retroactive.

It’s hard to do on the estate tax.  Biden’s estate tax proposal, which is brand new (it just came out last week), raises the rate, lowers the exemption level, changes the basis from a step-up to carryover basis when you transfer to your heirs, but then imposes an unrealized capital gain on the heir when they inherit the asset.  The thing about it is if you inherit farmland you’re going to have to sell the farmland just to pay the tax.  I don’t think that will pass in the law.  These are huge changes in tax policy– things that we haven’t seen in 50 years.  I do think that much of the Biden tax plan is based on the ‘68 tax plan which was retroactive on income and corporate.

Q:  It sounds like that’s a pretty big agenda of tax increases.  Do you believe that the likelihood is that he can get that passed through Congress, even a Congress that is all blue?

If there are 51 Democrats, which is what the current consensus forecast is, it will be tough.  It will have to get watered down to pass that tax plan.  You are going to have to get votes from Democrats in square states out west.  Square states out west have a lot of property owners who are going to get killed by the estate tax.  You’re going to have senators in areas where a high capital gains tax really impacts their industries, so my guess is it gets watered down.  If you get 54-55 Democrats, it’s probably going to be a little bit more aggressive because they’re going to claim a mandate to solve income inequality with that.  So my sense is that it will get watered down.  We’re looking at a corporate tax rate that gets phased in to 25% over three years.  We’re looking at a 30% capital gains and dividend tax rate. We’re talking about a top marginal tax rate at 39.6%.  I think there are two key issues that I would watch outside the rates.  The first is that in the 2017 tax reform recreated a small business deduction where small businesses can deduct 20% of their income.  Biden is proposing to repeal that for anybody with income over $400,000.  And the second is that he tries to limit what your itemized deduction could be by limiting it to 28% if you’re in the 39.6% bracket.  So, there are other issues there besides the rate that they’re playing around with them. The direction I think you should watch closely.

After Bob and Dan discussed the above, we took questions from the audience. 

Q:  Dan, obviously you’ve talked a lot about the presidential race and what a sweep looks like in the different scenarios. What are your thoughts on some of the key Senate races? 

Yeah, great question.  The Democrats need four seats to get to 51.  If they get three seats and win the Presidency, they’ll still have control of the Senate.  That would look a lot like 2000 where George Bush won.  We had a contested election at the President level and we didn’t know who ran the Senate.  We ended up with a 50/50 Senate.   So, three seats for 50/50, four seats for takeover.  The reason why the consensus believes the Democrats are going to take the Senate is because the Democrats are likely going to lose the Alabama Senate seats but they’re likely to gain a couple of other seats from Republicans.  The first would be Colorado. Cory Gardner’s running against a very popular former governor and the Republicans are likely going to lose that seat.

Then you have Arizona.  It’s very rare for a Republican senator to be running behind the President. Usually the Republican Senators are running above the President.  Martha McSally is running behind Mark Kelly who is a great candidate and a former astronaut.  So Arizona is the second one in play.  The third in play is Maine and Susan Collins.  Maine is a Democratic state. I always believed that Susan Collins would be able to win that race and be able to fight it out but she just hasn’t been in the lead, so you have to assume that Democrats are going to win that seat. And then you have what I call the big two that are going to decide the senate – North Carolina and Iowa.  North Carolina was solidly Democratic all cycle.  The democratic candidate got caught in multiple affairs and mocking one of his mistress’ husband, who’s a veteran, for contemplating suicide.  It’s not a good scenario there and you’ve seen the Republican close the gap.  Then you have Iowa.  Senator Joni Ernst, a Republican, is in a really in a tough fight.  Saturday night will be critical.  The Des Moines, Iowa Register poll is the single most accurate poll in America and we’ll be watching for clues on the Senate race in Iowa, but more importantly how Trump does in Iowa.  That poll is Saturday night.  Before the 2016 election, out of nowhere it said Trump was going to win Iowa by seven.  Trump is winning Iowa by 7, he’s gonna win Ohio by 10, He’s going to be close in Minnesota, it is going to be more competitive in Wisconsin.  That was our big take-away from that. So, that’s going to be a very important data point.

Those are the core races: Iowa, North Carolina, Maine, Arizona, and Colorado.  Democrats are making progress in Montana, because COVID is starting to surge there.  Watch the Montana Senate race.  Democrats also think they got a shot in Kansas.  I doubt it.  Then you have the Georgia Senate races, you have two of them, one of which could go to run-off.  That’s the Democrat chance. 

Last week we saw two polls in Minnesota and Michigan where the Republican candidates had closed the gap.  I wrote a note on Thursday of last week informing our clients that the Republicans were starting to make progress and that the consensus view would likely tighten up and I think that’s starting to play out here in the last couple of days.  The key to the Senate outlook is how Trump does over the next couple of days.  The Republicans were wild underdogs to win the Senate in 2016, yet as Trump’s numbers improved the Republican senator numbers improved.  As I mentioned before, most of those Republican senators run ahead of Trump.  I often joke with the Trump folks that Marco Rubio carried Trump over the finish line in Florida and Pat Toomey carried Trump over the finish line In Pennsylvania. They don’t believe it.  They all ran better than Trump, except for Roy Blunt in Missouri.  Those senators are still running ahead of Trump right now.  If Trump improves by two or three points I think you’ll see Arizona and North Carolina flip to the Republicans and that means that the Republicans would keep the Senate.  The market is not really priced for that scenario. There’s a lot of ifs there to get there, but that’s kind of how the Senate races would change from where the current consensus view is.

Alternatively, there is the blue wave scenario which says all these races break in one direction, as they broke for Republicans in 2016. They break for the Democrats in 2020.  Then the Democrats win Iowa, win North Carolina, win Georgia, win Montana, and come close in Texas.  Those and possibly South Carolina.  That would be a really big deal if something like that happened because they would give the Democrats a true mandate to break the filibuster and pass very large legislative package right at the beginning of their term.

Q:  Is anybody talking about or caring about the deficit?

A:  I’ve been touring the country for 12 years and usually it’s the first question, not the second question.  But it’s usually the first question.  And it’s about the deficit. I get it in every city in America that I speak in, except for Washington, DC, where I sit right now.  People in Washington, DC, don’t care about the deficit.

I started as a budget analyst 25 years ago in New Jersey politics and I have never seen both parties believing that deficits don’t matter like I do today.  The 10-year Treasury is like 0.8% today, with a three trillion budget deficit.  That’s astonishing.  What you see happening here is that the green light is being sent to the financial markets that it’s OK not to worry about deficit.  That’s why Biden keeps talking about four trillion, three trillion. We’re going to do all this spending. We’re not going to have to pay for it.  That all works until it doesn’t work.  And I would argue that there are three areas to watch.  There’s a politics catalyst, an economic catalyst, and a budget catalyst.  The political catalysts will come first.  I watched Ted Cruz, on TV this weekend, Republican Senator from Texas say he’s worried about Trump’s deficit.  Now?  Trump has like seven days left to be President, if you believe the current polling.  And now you’re worried?  That’s Ted Cruz sending a message of “I oppose Trump’s deficits, so I’m going to oppose the Biden deficits when he takes over.”  I believe that sets the stage. 

Mark the day on your calendar- July 31, 2021.  That’s the day the US debt ceiling needs to be raised for the first time since we accrued all this COVID debt.  That will be the political catalyst, which is different than the economic and budget catalysts.  The economic catalyst will come in a scenario of good news.  That good news is, that America has crushed COVID-19.  I can’t wait for that day to come but there will be side effects when that day comes in the larger victory itself.  The Federal Reserve balance sheet has expanded by trillions of dollars.

Pandemics don’t end suddenly.  They end gradually and that vaccine is not the end of the war.  There’s going to be fits and starts.  But as we begin to come back to some semblance of normalcy, as Americans are getting back, going in their car, going to work, getting on mass transit the economy is going to grow at a faster rate than it is right now.  The Fed and the Federal Government are going to have to pull back some of the Punch bowl.  By the way, it’s easy to deliver the punch. It’s really hard to take away the punch.  And you may have higher interest rates that are caused by that.  By the way, I think that’s reason to celebrate.  When you get higher interest rates you’re also going to have higher debt service costs.  So, what we’re watching is something called net interest as a percent of tax revenue.  How much is coming in from tax revenue and how much does it cost to service your debt?

We can increase the deficit by trillions of dollars and have a lower debt service cost because interest rates are low.  That all changes if interest rates start to rise.  You throw in a couple of trillion dollars of fiscal stimulus on top of all that and people are going to start talking about things that I haven’t heard in years like inflation.  I’m not saying inflation is immediate, but that is where the conversations are going to go.  Where it starts to become a concern is being driven by good things happening in society, not bad things.  And, it’s necessary changes that we’ll have to make once we get there.

Q:  Under the Biden Tax plan, is there any discussion regarding 401 K’s, meaning are there going to be limits on the amount a person can have saved in a retirement fund?

A:  Yes.  The Biden plan has a pretty expansive retirement policy, and I would argue that 401(k) policy is part of that.

Right now, under a traditional IRA you get to make a deduction on your income.  Put the money into your 401(k) or IRA and then it accrues over time.  You pull it out, you’re taxed.  Biden is trying to change that and move to a saver’s credit.  That saver’s credit will try and equalize what a high income and low-income payer gets in a dollar amount of that credit.

It’s a pretty expansive change to the way that we would do 401(k)’s and IRAs.  But, if your administration is driven by the idea that you want to get income inequality down you’ve got to change how Americans save for retirement.  The Biden advisors believe the current system of incentives make the rich richer and provide very few incentives for lower and moderate income workers to save.  So I would anticipate to see a proposal to change the 401(k) and IRA. I think their ability to have that success will be limited given that it is a pretty engrained institution with many stakeholders who do not want to see that change.  Maybe we do a credit on top of it.  I just don’t want you to be caught off guard if you start to see some headlines around possible changes to the 401(k) system, which is something I would anticipate we’d see in the Democratic sweep sometime in mid-January.

October 27th, 2020

September 30, 2020

 “In the middle of every difficulty lies opportunity.”  – Albert Einstein

We as investors face a complex investment environment as we seek to preserve and grow our capital.  We maintained our commitment to long-term investing and it proved especially prescient as for nearly all of our strategies we have not only recovered all of our capital, but have created some meaningful gains for the year after navigating a shutdown of our economy with domestic GDP falling a stunning 31% in the second quarter.  This economic collapse was caused by a global pandemic which initially baffled scientists — a pandemic which we are still struggling with, and nervously await a potential second wave.  We hope a vaccine is on its way.

Adding to this uncertainty is an election in a few weeks pitting two warring Presidential candidates, in a very divided country.  At stake are potential economic, tax, and regulatory actions that could transform not only our economy, but also our environment as well as our approach to society.

While we struggle with this deadly coronavirus, civil strife, and a contentious election, we face a historically unprecedented interest rate environment, a recovering economy, and valuations that seem stretched.  Add to this picture that the record stock market, while emerging from a near depression, has been fueled by a small number of “growth stocks” while leaving most stocks, especially “value stocks” in the dust (see Chart 1).

growth vs. values

The companies fueling the appreciation in the Russell 1000 Growth Index have also led to the majority of the gains in the S&P 500.  These companies include: NVIDIA, PayPal Holdings, Amazon.com, Apple, and Netflix.  These gains were accomplished despite the COVID-19 pandemic.  Meanwhile other asset classes including segments of commercial real estate have suffered from defaulting tenants, while some residential real estate suffers from the high levels of unemployment (record unemployment which is now recovering, as shown in Chart 2), and non-paying tenants.  These real estate travails have also impacted many banks which hold increased reserves for potential loan losses.

Civilian Unemployment Rate

As we write this commentary, the following indices year-to-date through September 30, 2020 have achieved results:

Index Total Returns

As you can see, not all equity and hedge fund results are created equal.  The good news is that the majority of our equity and hedged strategies exceeded their respective benchmarks for the quarter.  All of our equity and hedged strategies had strong absolute results for the quarter.  Good news indeed, but where do we go from here?

As stated earlier, valuations seem stretched for the S&P 500 Index but buttressed, in our opinion, by historically low interest rates (as shown in Chart 4):

S&P 500 NTM P/E vs. 10 Year US Treasury Yield

As you can see from the chart above, the higher than average P/E ratio is accompanied by the lowest interest rates in my lifetime.  We believe there is a direct relationship between the higher P/E and historically low interest rates.  If we are to believe Fed Chair Powell, these very low interest rates will be with us for a number of years.  We view that as good news for equity investors.

So, our environment is laced with fear of coronavirus, the pace of economic recovery (V shaped?), seemingly lofty stock market valuations, and an incredibly contentious election.  All of this requires investors to really reflect on how to invest.  This is no time for auto pilot investing.  Preservation of capital and avoiding losses that detract from compounding of returns should always be paramount in the minds of prudent investors (and their wealth managers).

We believe that as our quote states, “in the middle of every difficulty lies opportunity.”  Our job is to advise you in a way to find those opportunities overcoming the uncertainties enumerated in the paragraphs above.

The Path Forward

In our view, we cannot ignore in the short term the serious challenges we face.  We believe that the economy is recovering.  Some parts in a V shape, but others not nearly recovering without a vaccine or therapeutics to mitigate the effect of the deadly virus.  Even if a vaccine or vaccines do materialize in the next few months, it will take upwards of a year for it to be administered to the majority of the U.S. population that is willing to take it.

The key is the companies that we continue to invest in— companies that reflect the core characteristics we require: quality, financial strength, dividends, secular earnings growth, and responsible and ethical managements.  As for bonds, we only own investment grade, but yields are pitifully low.  They are below the rate of inflation, so we remain underweight.  Additionally in real estate, prime location and extreme patience are required.

Our current advice is to overweight our defensive strategies with continued, but somewhat below typical, exposure to traditional equities.  While we have been biased to domestic large-cap growth we are starting to increase our value exposure, but slowly.  Between FLI Dividend Growth, a defensive strategy of primarily value companies, and exposure to our growth-biased FLI Core strategy or other traditional equity strategies, we have a barbell approach giving clients exposure to both growth and value.  Of course, we customize the asset allocation for each client.

Our bias to FLI Dividend Growth gives our clients a robust stream of absolute dividends (currently 2.6%) with the average dividend increase (over last year as of September 30th) of 7.4%!  This vastly exceeds the S&P 500 Index which currently yields 1.7% and is projected to have very little dividend growth this year given the pandemic (by contrast, the 10-year U.S. Treasury only yields about seven tenths of one percent).  In addition, most of our traditional equity strategies include leading growth companies which have fueled the appreciation in the S&P 500 Index this year.

Finally, given investor anxiety over fear of the coronavirus and a vicious political landscape, we urge clients to have some cash reserves, especially if one is not currently working or does not have an active business.  This provides the ability to wait out any unforeseen volatility and to “sleep at night.”  We will counsel you on what is an appropriate amount of cash to hold on a case by case basis.  This should also reflect any liquid assets you might have outside of FLI.

We do believe that there is the ability for our clients to find opportunity to grow one’s capital notwithstanding the difficult environment we are currently navigating.

Also, we invite you to join us on Tuesday, October 27th at 1:30 PM for our online seminar in which Dan Clifton, a top Washington Analyst and the Head of Policy Research at Strategas Securities, will explore the upcoming election and the tax and regulatory changes that might occur if there are major political changes.  A Democratic sweep, which is a possibility, will most likely lead to disadvantageous tax consequences, both income and estate tax, for high net worth investors (based on specific statements by the Democratic Presidential nominee, Joe Biden).  Please email events@fliinvestors.com for registration information. 

Please stay safe, wear masks, socially distance, and wash hands!  Also, we at FLI are always available to discuss your asset allocation and wealth management needs.  Given the uncertainty that we are currently navigating, it might be timely for us to have a conversation.

Best regards,

Robert D. Rosenthal

Chairman, Chief Executive Officer,

and Chief Investment Officer

*The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance. Actual results may differ materially. Past performance statistics may not be indicative of future results. Partnership returns are estimated and are subject to change without notice. Performance information for Dividend Growth, FLI Core and AB Concentrated US Growth strategies represent the performance of their respective composites. FLI average performance figures are dollar weighted based on assets.  

The views expressed are the views of Robert D. Rosenthal through the period ending October 22, 2020, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such.

References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Content may not be reproduced, distributed, or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC.

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