3rd Quarter 2020 Letter to Investors

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.

Copyright © 2020 by First Long Island Investors, LLC. All rights reserved.

September 30th, 2020

2020 has been a very interesting year thus far across many fronts.  The investment markets have been volatile as the domestic economy, as well as the global economy, adjusts to a new normal.  The markets are doing well, but many investors are concerned it may not last. In a recent web seminar the FLI team reviewed the economic and investment landscape with an eye towards the future.

May 26th, 2020

The COVID-19 pandemic has created many questions in the minds of investors. In a recent web seminar members of the FLI team shared some perspective on the health crisis, economic environment, our current investment approach, and a variety of wealth management considerations.

A transcript of the session is also available.

May 14th, 2020

Karen Weiskopf, Vice President, Marketing at First Long Island Investors and several long-time friends got creative during quarantine and created a virtual BINGO game to support local businesses and Long Island charities engaged in COVID-19 relief efforts.  The group has raised over $33,000 so far and even had Academy Award Winner Natalie Portman call some numbers. CBS New York recently featured their efforts. 

April 27th, 2020

March 31, 2020

“Do not judge me by my successes, judge me by how many times I fell down and got back up again.” Nelson Mandela

The first quarter, following an excellent year in 2019, commenced with reasonably strong results consistent with what was a strong economy characterized by near record employment, low interest rates, and low inflation.  And then, “out of the blue,” came the coronavirus leading to what could be the greatest medical crisis, a global pandemic, the world has seen since the H1N1 pandemic (Spanish flu) of 1918.  Emanating from a region in China, this disease, now known as COVID-19, has cast its horror on over 180 countries with the United States being hit the hardest.  To boot, the epicenter, for now, is New York accounting for more than a third of the cases in our country.

The response by the President, the House and Senate, and the Federal Reserve has been rapid and bold, although many believe that our testing capability was slow to ramp up and that the Chinese were not as transparent and forthcoming as they could have been.  Despite some missteps, the collective clout of the Administration and its task force, our Congress people, the vast majority of Americans, a resilient private sector including numerous leading companies, and research centers at hospitals and universities around the world, gives us optimism that we will defeat this invisible enemy in time.

However, without a vaccine (which scientists around the globe are working to develop) and treatment for the symptoms of the dreadful virus, the only prescription for stemming the tide of this scourge is social distancing and staying in our homes.  This prescription has an obvious side effect, the crippling of our economy and that of the world economy.  Despite our economic strength coming into 2020, we are now faced with an economic contraction that could take us from a 50-year low unemployment rate of 3.5% to potentially an unemployment rate as high as 20% or more.  Small businesses shuttered, hotels nearly empty, airlines with drastically reduced flights and millions unemployed, our domestic economy and that of the world have fallen off a cliff for now.

Domestically, several bipartisan laws and the actions of the Federal Reserve will infuse trillions of dollars into our economy to aid the unemployed, small businesses, and various industries that have been crippled.  This is to buy time for so many while waiting for the defeat of the virus and a return to some normalcy.  (At some point we will have to deal with the potential of inflation given the mountain of debt being created.)  Will it be like it was before or will it be a “new” normal?  Only time will tell.  Will most buying and traveling habits of Americans return to what they were?  Only time will tell.  Will Americans be comfortable attending sporting events, the theater, and the movies again?  Only time will tell.  We just do not know, except, if history is a guide, we as Americans will get up again and return to some significant level of normalcy.

When one thinks of all of the tragic events, market disruptions, and medical crises of the past we can think of two World Wars, the Spanish flu of 1918, the polio epidemic of the 1950’s, the oil crisis of the mid 1970’s, the hyper-inflation of the early 1980’s, the AIDS pandemic, the stock market crash of 1987, the implosion of Long Term Capital Management and the currency crisis of 1997, the tech bubble and collapse of 2001-2, the 9/11 terrorist attacks on the U.S., and the financial crisis (the “decession”) of 2008-9 as well as the Korean and Vietnam Wars.  In most of these instances, financial markets fell dramatically or even crashed.  Behavioral patterns for many Americans changed for a period of time.  Yet at the beginning of this year, America was enjoying its possibly greatest period of prosperity with employment and the stock market at historic levels.  In addition, housing prices were at or near their highest.  And then “out of the blue.”

So, it is our opinion at FLI that once this virus is beaten (and we believe it will be), Americans and our businesses, with the help of the federal and state governments along with our strong private sector, will pick themselves up yet again!

How Do We Invest?

Let us be candid, we face an ugly medical crisis and a severe recession that we believe will be short lived.  The ultimate numbers in terms of Americans and others falling prey to this virus will be horrifying.  The number of unemployed will be startling and the number of shuttered businesses, despite help from the government, will be incredibly sad.  We might also see empty hotels and dry docked cruise liners for quite some time.  I sometimes speak of looking over the valley to the other side when overcoming economic hardships.  This time we might be looking over the Grand Canyon, but just for what we believe will be a relatively short period of time.  It could be six months or a year.  Perhaps even longer.

If there is one thing that we have seen over all of the sad events in the last hundred or so years, is never ever count out Americans and American business.  We always pick ourselves back up thanks to the resolve, ingenuity, creativity, and entrepreneurialism of the American people and our capitalistic system coupled with our democracy.

Our customized, prudent asset allocation for our clients today has, and always has had, security and defensive components.  I am glad to say that our security and defensive baskets, although down, have for the most part preserved our clients’ capital better than the larger losses experienced in many of the traditional equity indices.  All of our traditional equity strategies except one are outpacing their respective indices.  We have always focused on quality companies with strong balance sheets.  In several of our strategies we have made modest changes to further strengthen the quality where we could.  We have not sold out or gone to cash trying to predict the bottom and then having to decide when to jump back in.  Our experience over the years has suggested that selling into a panic is typically a big mistake, so we have not.

Where we could increase our equity weightings in secular growth trends like online purchasing, cloud computing, high-quality pharmaceuticals and medical instruments, or 5G technology we have.  Social media companies and online search engines are also areas we believe will experience growth.  Additionally, we should not forget electronic payments (especially important while being at home).  Our goal is to preserve capital by owning strong companies that are well managed and look to the future.  At the same time, in our Dividend Growth strategy we have focused on the balance sheets of our portfolio companies to increase the probability that dividends will at least be paid, and in many instances be increased, as they have for so many years.

The bottom line is that we are staying the course with our allocations to the baskets of security, defensive, and traditional equity strategies.  Also, our mezzanine loan strategies seem to be weathering this period of stress as the properties we lend to are all very well located.

We have not included any charts showing macro- and micro-economic trends or valuation graphs based on earnings and interest rates because they would not mean much at this point as it is virtually impossible to predict much of anything economically this year.  Our focus is on 2021 and beyond when we believe much will return to some normalcy.  Our strong belief is that the prices we are seeing now for the companies we are investing in will be higher in a year or two.  If anything, we view this as a long-term buying opportunity for the highest quality companies that have durable growth prospects, strong balance sheets, and/or the ability to pay meaningful dividends. 

We believe that America and its companies will again pick themselves up as they have following periods of extreme stress in the past.  We would ask you to judge us the way Nelson Mandela has suggested– by the way we pick ourselves up along with your entrusted funds.

Please do not hesitate to call any of us at First Long Island and most importantly stay safe and practice social distancing, and if possible just stay at home for now.

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 April 23, 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.

Copyright © 2020 by First Long Island Investors, LLC. All rights reserved.