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.
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.
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.
“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.
We as a firm, had an excellent 2019 in absolute returns, making up for a downturn in the fourth quarter of 2018 caused by the premature Fed tightening and an evolving trade war with China. 2020 began with gains in the U.S. markets supported by the expectation of domestic growth fueled by almost record employment and strong consumers buttressed by low interest rates and low inflation. Corporate earnings were projected to increase modestly over 2019. Domestic GDP growth projections for 2020 and 2021 were between 1.8% and 2.2%. Stocks looked reasonably attractive to us especially when compared to low-yielding bonds. However, this level of valuation was attractive only if the projected earnings growth materialized.
Coronavirus
Reality interfered with our plans when “out of the blue,” a vicious virus emanated out of Wuhan, China in December 2019. It is believed the Chinese delayed disclosing the true nature of this coronavirus and the critically important fact that the virus was spreading from human to human – community spread. This element gave rise to what would become a global pandemic as Chinese nationals and visitors to and from China became lethal carriers of the virus. Unsuspecting nations including the U.S. and all European countries became victims, both victims of disease and the ensuing economic contraction necessary to stem the tide of the growth of this heinous virus. Social distancing and “shelter in place,” both prescriptions for killing the virus as well as killing the economy, have become part of the norm!
Unfolding Impact
What is now occurring is a two-pronged war. The first is a medical war against the virus. Our soldiers are healthcare forces made up of frontline doctors, nurses, physician assistants, and all others on the front lines in all medical facilities. They are battling day and night with the beginnings of a surge of patients as testing for the virus ramps up. The virus remains highly contagious and some carriers have no symptoms. Unprecedented amounts of testing are now being undertaken, but at a slower pace than required. The best prescription to stem the tide of disease spread is social distancing which has become the cause of our second war, the economic one.
Social distancing has required the shutdown of an unprecedented amount of commerce. Cruise lines, airlines, hotels, casinos, all professional sports, and live events (including concerts) began the economic contraction. Now given the disease spread, government at both the Federal and state levels have created guidelines limiting groups to no more than ten or even worse “sheltering at home.” Businesses have had to adapt to having employees primarily working remotely. Virtually all restaurants, bars, and clubs throughout the country have temporarily closed. Tens of thousands of workers are being let go or furloughed on a daily basis. Most automobile production facilities have closed. Schools, kindergarten through twelfth grade, across the country as well as many universities have sent students home indefinitely.
This unprecedented dislocation of our way of life appears to be necessary to limit the spread of the disease and keep the fatality level down by spacing out hospital admissions in an attempt to deal with the capacity of our hospitals. Additionally, this disease is particularly severe for seniors and people with preexisting health conditions. There is really no way to adequately describe this challenge although it is one we believe that we as a nation will beat in time.
Economic Impact
Clearly, this “out of the blue” global pandemic has already brought an end to our 11-year bull market and will cause a recession. A recession that a month ago seemed very unlikely to us. It has also brought incredibly rapid government action along with decisive and bold Fed action lowering interest rates and using the Fed balance sheet in many developing ways. It is expected that well in excess of a trillion dollars will be earmarked for afflicted workers, small businesses, and certain major industries. Hopefully our elected officials can come together in the next few days and leave behind partisan politics.
Investment Implications
As we write this, the S&P 500 Index has declined 30.4% year-to-date and declined 33.8% from its high in mid-February. With so many industries and companies, big and small, curtailed or closed for an unknown period of time, corporate earnings and GDP will substantially decline. Thus we are undoubtedly in recession and the stock market is declining. High-quality bonds have performed better than high-yield, low quality bonds. Real estate values will likely decline as commercial tenants defer or renege on rents. Shopping centers are closed as stores have been forced to close, waiting out the hoped-for decline in disease spread.
In addition to this debacle, our economy also is digesting an oil war resulting from the failure of OPEC countries to reach agreement on limiting supply, primarily between the Russians and OPEC countries led by the Saudis. The good news for now (for consumers and businesses) are lower oil and gasoline prices. The bad news is the impact of collapsing prices on America’s oil and oil shale businesses. This could also impact debt arrangements with many domestic banks.
Looking Across the Valley
As long-term investors, we have experienced other periods when unexpected events led to substantial market declines. October 1987, the dotcom crash of 2000-2002, and the financial crisis of 2008-2009 were other periods where we faced dramatic market routs. Our advice then was the same as it is now: stay the course in high-quality companies, bonds, and real estate. Valuations have become quite attractive assuming that the companies we invest in will at some point in the not too distant future return to “normalized earnings.” Some companies that we invest in might even benefit in the short- and long-term from this crisis including Amazon.com, Facebook, and Alphabet (Google’s parent company). Additionally, other companies that we have an interest in will ultimately benefit from new 5G technology like QUALCOMM, or the continued move towards cloud computing such as Adobe and Microsoft. We believe there is a certain inevitability of a return to normal where great companies will prevail. Look to 2021 for more normal earnings and economic conditions.
However, for the time being the equity markets are falling quickly. To make matters worse, high-quality companies are falling along with lower-quality ones. Future earnings and dividends do not seem to matter in the short term but our experience tells us that they will matter in time. Vitally needed pharmaceutical companies are trading at what we believe will be viewed as bargain prices with many paying high dividends based on the reduced share prices of these companies. Banks that are well capitalized are also in free fall despite rock solid balance sheets. Technology companies, as mentioned above, with great prospects also have fallen victim to the panic selling. Every sector of the S&P 500 is down at least 20% with more than half of them down more than 25%. There appears to be a disregard for a future that is brighter than the gloom and uncertainty of today.
As we have often said, we own interests in real companies that have assets and almost always make a profit. In today’s world, that does not seem to matter, but it will. We believe many of these companies are cheap and deserve to be held for the long term.
The consumer, who is the backbone of our domestic economy, has suffered a vicious gut punch. A punch that has temporarily stopped many from working, shopping, eating at restaurants, and participating in activities that were always taken for granted. Unemployment will soar in the weeks to come. Many smaller businesses will close. This is war. We need the Federal government to come to the aid of the consumer, worker, and business. We expect that to happen shortly. This will make a difference and the sooner the better.
How to Invest
Our adherence to a prudent asset allocation has worked for us to a degree. Many of our defensive and traditional equity strategies are outperforming their benchmarks despite being sharply down. Quality will ultimately prevail. Diversification in having some bonds and defensive strategies is keeping our clients in the battle.
We do not know where the bottom is as we have no crystal ball. However, we believe we know good prices for solid companies, and those of today seem like good prices for many. However, they could get even better. That said, if one has additional liquid assets (beyond what is needed to either live on or sleep at night) we would consider deploying in stages to what we believe is an exceptional long-term opportunity for the future.
Hold on and let’s beat this invisible enemy, the coronavirus. Once we as a society and government do that, you can count on America as consumers and businesses to come back. We always do.
Thank you for your confidence in us and the kind words many of you have said to us as we have reached out to you during this surreal period of time. Please do not hesitate to call.
Stay safe and practice social distancing and good hygiene.
In good health,
Robert D. Rosenthal, Chairman, CEO, and Chief Investment Officer
and
Ralph F. Palleschi, President and Chief Operating 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 March 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.
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