Thankfulness

I started the first draft of this edition of Exencial Views on Veteran’s Day.  A day that we should all be thankful for and inspired by.  Thank you, Veterans, for your sacrifice and devotion to duty and country.

My plan is to send this out a few days before Thanksgiving, to share all that I am thankful for, before being consumed with football and overeating.  So here goes –    

I am thankful for my amazing friends who have supported me over the years, who have tolerated my faults, encouraged my dreams, and laughed with me during this journey toward old age.

I am thankful for my family, for the unconditional love they share so freely.

I am thankful for my spiritual warriors who pray for me and with me, and for the hope they give to even the darkest moments we face.

I am thankful for the words of John F. Kennedy, “that one man can make a difference, and every man should try.”

And for the words from John Wooden, “It is amazing what a team can accomplish when no one cares who gets the credit.”

And from Abraham Lincoln, “I like to see a man proud of the place in which he lives.  I like to see a man live so that his place will be proud of him.”

It is good for the soul to reflect upon that which we are thankful.  It is also good for the soul to be inspired and to offer inspiration to others.

It is good for the soul to serve somebody, to offer a word of encouragement at just the right time.  To believe in people when they doubt themselves. 

Of all this, I am thankful.

With the election virtually over, and vaccines seemingly on the way, it seems appropriate at this time, to look ahead and perhaps make a list of things I hope we can all be thankful for one year from today.  So here goes –

On Thanksgiving Day, 2021, I hope we are all thankful that we have put our masks away.  That we can once again shake hands and hug each other.  I don’t know about you, but there are days I really need a hug.

I hope we can be thankful that with new leadership, our political process has become more effective and less polarized.

From a market perspective, hope really isn’t part of the equation.  Let me try to explain.  As most investors know, the stock market is a discounting mechanism.  It looks ahead, driven by future expectations for earnings, cash flow, and valuation drivers like interest rates and inflation.  As reality exceeds or falls short of these expectations, stock prices move accordingly.  The never-ending comparison of expectations to eventual reality is what drives stock prices.  While hope might be a good thing, as Andy Dufresne explained in The Shawshank Redemption, it can be dangerous when it comes to predicting future stock prices.  Essentially, analysts and portfolio managers must separate what they hope will happen from what they think will happen.  In short, removing emotion from the process is critical to long-term investment success.  No small task, especially in today’s environment.

Here are three positive developments that should unfold as we move into the New Year –

  1. At least one effective vaccine will arrive sometime in the first half of 2021.  By the end of 2021, Covid-19 will still be around, but we will be well on our way toward defeating it.
  2. Corporate earnings will accelerate in 2021 as the economy continues to recover.    
  3. Political vitriol will reside as divided government and legislative gridlock settles in.

As in most years, unpredictable events will occur.  Some will be positive, some not so.  As an investment team, we will remain vigilant in our disciplined, analytical process.  Searching for opportunities, adapting to changes, avoiding emotional extremes as best we can.  All while remaining thankful for the many blessings we receive each day.     

Michael Kayes, CFA

Wisdom of the Elders

I’ve always been a remote kind of guy. Ever since I read the book “My side of the mountain” when I was a kid, I’ve longed for the wilderness. Many years ago. I penned this poem about solitude…

What is calling way out there?

Beyond the desk we sit and stare.
What is calling way out there?

A freedom search, quite possibly.
In wilderness we long to be.

Where all around the boundaries gone.
In solitude from dusk ‘til dawn.

In quiet search for self-reliance.
To continue on – no small defiance.

Our choice to make, should we turn back?
Not from fear nor courage lack.

But search we must, inside the lines.
For freedom lies within our minds.

What is calling way out there?
An echo from a calling near.

Today, I can’t help but be concerned about the undeniable trend toward a permanent remote workforce. Many companies, particularly in the tech industry, are moving in this direction, taking advantage of this trend to reduce salaries for employees who move from high-cost areas like Silicon Valley to lower cost cities and towns. Corporations also see great opportunity to reduce expenses for office space. What’s not to like?

When I started in the business, in the dark ages of the early 1980s, I went to lunch every day with my colleagues. Since I was the rookie, I took advantage of this time to ask as many questions as I could without being annoying. Over time, these and many other face-to-face, informal conversations, provided valuable insight into how these seasoned portfolio managers and analysts approached their profession. This hanging-around-apprenticeship taught me the nuances of stock picking. If the chatter around the coffee pot centered around a stock that had been doing particularly well, I learned that most of the news was already discounted in the stock price. Conversely, if the buzz around the office was decidedly negative, that might be a name to dig into as a potential buying opportunity. I also learned to read the body language of my peers which gave me instant feedback as to the persuasiveness of my arguments during our daily debates on the economy, markets, and individual stocks.

In a nutshell, there is no effective substitute for face-to-face communication, especially when it comes to transferring the wisdom of the elders to the next generation. While reduced overall expenses for payroll and office space may enhance the bottom line in the short run, the loss of this informal training and mentoring will be an issue companies will have to deal with well into the future. Companies that can right-size cost structures, while preserving all-important, face-to-face mentoring, will have a leg up on their competition.

With only a couple weeks to go before the election, the stock market is very close to an all-time high, baffling pundits and market strategists of both political persuasions. As I have previously written, both sides fear disaster for the markets and for our country if the other side wins. I suspect reality will land somewhere in the middle. What does this mean from an investment perspective? It means the election is likely to create winners and losers across our economy and markets. Some will be short term, driven by fear and over-reactions, and some will be more substantive and long term. It will be important to distinguish the latter from the former. Maintaining valuation discipline will be critically important to take advantage of opportunities that may result from political or legislative change. As has become our motto, internally – we will do our best to control what we can control.

While many of us would like to control the election outcome on the state and national level, none of us can. We can all vote and should. We can all support whoever wins, and that perhaps is our civic duty. And when science solves the pandemic, which it will, we should hang around with our neighbors and loved ones, and marvel at the wisdom of the elders among us.

Michael Kayes, CFA

A Balanced Approach

Ah, The Big 10 has decided to play football this season, reversing its decision to cancel all fall sports.  What a relief to football fans all over the country who were having a difficult time imagining an autumn without college football, which represents the heart and soul of campus communities all over the nation.  Like almost everything else, this season won’t be a normal one, with no fans in the stands, no non-conference games, and athletes and coaches living in a protective bubble, whatever that means.

The “Great Virus Crisis,” as noted economist Dr. Ed Yardeni has called it, is still impacting virtually every aspect of our lives.  Nevertheless, every day we get closer to a solution, as research labs around the world are working diligently to discover an effective vaccine.  It’s only a matter of time until science solves this problem. 

In the meantime, the GVC’s impact on the stock market has pretty much run its course.  Unless every potential vaccine currently in clinical trials fails, I don’t envision another significant downturn driven by Covid-19 developments.  In a nutshell, the market has discounted the economic impact.  The speed and magnitude of the recovery is now going to be more of a driving factor for the market.  On that note, the recovery will be far from a smooth one.  Even within industries, the rate at which earnings recover will vary depending on how well companies have adapted to the challenges caused by the pandemic. 

Will the stock market continue to be led by the same familiar names – Facebook, Amazon, Netflix, Google, Tesla, Microsoft, and Apple?  Or will out of favor sectors – Financial, Energy, and Cyclicals drive a reversion to the mean?  The recent performance gap between the aforementioned leading “growth stocks” and the underperforming “value stocks” has never been greater.  Large Cap Growth stocks have appreciated 33% over the past year, while Large Cap Value stocks have actually depreciated over 3%.  Like the eventuality of an effective vaccine, reversion to the mean will happen eventually.  What does this all mean for investors?

It seems reasonable for investors who own substantial positions in these highly successful, leading growth names (FANGTMA) to continue to do so, but it would be a valuable exercise to limit the percentage held in these names in relation to the size of one’s overall portfolio, particularly if they continue to appreciate at the same pace.  One of the most challenging investment decisions to make is when to sell a stock that keeps going up.  Invariably, few investors do this well, primarily because they become too emotionally attached.  A better approach is to set a target price and then manage the position incrementally within predetermined active-bet limits.  In other words, compare the percentage weight of the holding relative to your overall portfolio v the percentage weight of that stock in the benchmark.  In essence, easing into a stock, then easing out of a stock in phases, can be an effective way to remove the emotional attachment which so often prevents prudent investment decision making.

What might cause this “growth” v “value” reversion to the mean?…  As we saw briefly earlier this month, a sharp market correction is often led by the same stocks that led the prior advance.  Most of the FANGTMA names fell more than the market during the pull-back in early September.  An extended market correction, if one occurred, would most likely spur further profit taking in this group, causing these stocks to lead on the downside.

Additionally, should any other geopolitical event cause an economic downturn, value stocks would likely hold up better.  While the Fed is doing all they can to extend the economic recovery, the potential for higher taxes and onerous regulation is always a threat to global economic growth. 

Balance seems warranted… From an equity portfolio perspective, it makes sense to have a balanced approach.  Maintain reasonable exposure to the leading growth names, while steadily and deliberately adding exposure to high quality, out-of-favor value names.  Your investment team is focused on doing exactly that. 

Michael Kayes, CFA

The Whole Truth and the Path to Fairness

I am getting asked a lot lately if I watched any of the speeches at either political convention. A corollary question often follows – How is the election outcome likely to impact the economy and markets? I didn’t watch a single minute of either convention, on purpose. None of it, on neither side. Reminds me of this story…

A teenager borrows his dad’s car to attend his senior prom in high school. The evening goes particularly well. In fact, he falls in love, has the romantic evening of his life, but on the way home he sideswipes another car putting a big dent along the passenger side of his dad’s car. When he gets home, his dad asks, “How was your evening?” His son replies, “The prom was amazing, I had a great time.” Then he goes upstairs to bed.

Was he being honest? Technically, yes. Comprehensively and morally? Of course not.

That, in a nutshell, is why I don’t listen to political speeches or sound bites, especially during an election campaign.

How important is the election outcome to the economy and markets? While there are only four basic election outcomes, there are several more potential scenarios involving substantive change to legislative and regulatory policy. Let me try to explain. Assuming the House is not in play, the first two potential outcomes are: The Republicans win the presidency and hold the Senate, or they win the presidency but lose the Senate. Conversely, the Democrats could win the presidency and the Senate, or just the former, but not the latter. Four potential outcomes. However, it is unclear what any new administration or Congress will then attempt to accomplish, particularly if we have split government. Beyond that, even if the Democrats sweep, it is unclear in what direction they will turn. Will they begin with more “moderate” initiatives or try to push a more “radical, progressive” agenda? The net of all this is that there is too much uncertainty to make significant investment bets which are dependent on a certain election outcome. It will be important to be ready to adapt and adjust portfolio strategies. Depending on which party garners the most political power, there may be significant winners and losers across multiple industries and sectors. Virtually every aspect of our economy is subject to political developments, but they are difficult to predict and subject to continual revision.

Enough about politics. What else matters?… The Fed has signaled that interest rates are likely to remain near zero for an extended period. With the federal debt and deficit seemingly out of control they have little choice. Zero interest rates create a powerful tailwind for stock price valuations. But this valuation tailwind does not blow uniformly. With the post-Covid shutdown-economy still struggling to recover, earnings growth has been lackluster across most of the corporate sector. At the same time, driven by innovation and changing demand trends, several companies have managed to exceed earnings expectations and achieve accelerating profit growth. For these select companies, the valuation tailwind is like a powerful hurricane. In essence, it’s a “growth-scarcity premium” and it is extremely powerful. Going forward, it is likely to propel valuation on successful growth stocks much higher than historical levels.

Nothing grows to the sky… It is important to be ever vigilant to valuation levels achieved by these growth-scarcity winners. Moreover, if there is any crack in the fundamentals these stocks can plummet very quickly. Part of our ongoing research and portfolio management process is to continually retest and challenge the fundamentals of each of these leading companies. The art in this process is determining how long to let these winners ride as valuation levels expand beyond historical norms. There is a risk-management aspect to this as well. For each portfolio strategy, we set limits as to how big individual stocks can get in terms of the percentage of the total portfolio. This is one way to manage the risk in this environment of zero interest rates, slow economic growth, political uncertainty, and a stock market that keeps making new highs.

I am also frequently getting asked questions related to fairness. The question seems complicated to many, but maybe it shouldn’t be. Reminds me of another story…

When I was a young boy, my sister and I routinely fought over who would get to eat the last piece of pie. My mom solved this dilemma by giving each of us the choice of being either the one to cut the piece in half or the first to choose which slice they wanted to eat. Both of us learned that the only logical decision was to cut the piece exactly in half, which we did with incredible precision.

How broadly could we apply that approach today? I’ll give that some thought for next month’s edition of Exencial Views. In the meantime, send me your thoughts. Together maybe we’ll discover the whole truth, and nothing but the truth…

Michael Kayes, CFA

Sausage Rolls

There is a heart-warming story in the June issue of National Geographic magazine titled – “The Last Voices of World War II.”  The article includes the touching story of Betty Webb, age 97, who joined the British Intelligence at age 18, working during the war at a highly-classified location called Bletchley Park, where a team of extraordinary British intelligence personnel broke the German and Japanese codes.  By joining the secret operations there, she knew she would never be able to tell anyone, even her family, what she did during the war.  Despite that vow of silence, Webb enjoyed the job. As she put it, “I wanted to do something more for the war effort than bake sausage rolls.”  In my view, it was that attitude and the incredible sacrifice and courage of the British people that held off the Nazi’s during the early years of the war.

As I read Betty Webb’s story and others like it, this question came to mind – What is the most significant job each of us can do to help our country overcome the challenges we face today?  In short, what would be a Bletchley-Park-worthy job we could take on?

In our battle against Covid, nurses and doctors rise to the occasion every day.  In a time of ongoing civil unrest, police officers and other public servants are stepping into harm’s way as well.  Workers in stores and restaurants throughout the country, who wear uncomfortable masks all day, to protect others, are also sacrificing for the greater good.

And that brings me to the central topic of this first edition of Exencial Views – the Greater Good. What does that really mean today?  With the pandemic on everyone’s mind most people are just tying to stay safe.  Self-preservation is our primary focus and understandably so.  In this period of isolation have we lost sight of the greater good?

For almost every current issue, economic or social, there are numerous viewpoints, but too few public discussions about the greater good.  With four months to go before the November election, we remain politically polarized, with each side fighting, first and foremost, to keep the other side from wining.

Yet, off-camera, out of the spotlight, there is a growing sense of solidarity.  People are balancing the need for social distancing with the equally important need to feel connected.  Serving or sacrificing for the greater good cannot be accomplished in isolation.  Politicians and the mainstream media seem fixated on keeping us polarized and angry.  Despite this, individuals and communities can and are reconnecting and together are finding ways to do more for the war effort than bake sausage rolls.

The path from solidarity to positive change is a process.  To begin with, every issue, whether economic or social, must be analyzed comprehensively.  All sides of the debate must be heard, researched, and evaluated.  Intended and unintended consequences of every potential course of action must be thoroughly discussed and measured.  Mutual respect must always be adhered to by all.  It’s really not that difficult. It just takes a little practice, and a sense of servant leadership.

We have an attitude challenge in our country today.  On one hand, there are those that believe the best days of our country are behind us.  They magnify our nation’s faults without appreciating all that we have accomplished.  They are fearful and mistrustful of institutions and their fellow man and contend that capitalism is inherently unjust, if not evil.   

On the other hand, others are excited about the future. They believe that innovation and entrepreneurialism can eventually solve every problem. Specifically, that science will produce a vaccine and we will end the pandemic. They prefer to oversee their own destiny and understand that there is no such thing as a level playing field.  Despite this they are confident that all obstacles can be overcome through hard work and determination.

Negativity can exist, perhaps even thrive in isolation.  Optimism can only thrive in community.  It is our free will to choose either attitude, as individuals and as a country.  Is there a position of compromise and relative safety somewhere in between?  Interesting question, and perhaps there is, but as the battle rages, neutrality becomes increasingly elusive.

Michael Kayes, CFA

Seneca the Elder

I’ve been wrestling with this difficult decision for the past few weeks. Do I write about the incident involving the death of George Floyd or do I concentrate on other issues? As it states in the right-hand corner, this is my 166th newsletter. The inspiration for each newsletter has always come from current events. What happens in our country impacts the psyche of investors, which in turn impacts the prices of stocks and bonds.

Currently, however, there seems to be a disconnect between current events and stock prices, as multiple people have recently pointed out. What is going on? Let me try to shed some light on what may be happening…

Violent and destructive civil unrest on top of the Covid-19 economic shutdown is certainly cause for alarm. It is possible that there will be a spike in Covid cases in the near future. Worse over, the toll on businesses destroyed in the rioting will not help the economic recovery. It’s hard to find a silver lining in the protests seen in numerous major cities.  Moreover, we have a serious racial problem in this country and there are no easy solutions.

Corporate earnings are likely to be very weak over the next 2-3 quarters. Whether earnings recover in 2021, and at what rate, remains unclear. In the meantime, our nation’s debt continues to grow unabated, which is likely to be problematic down the road.

From all indications, it would seem that we are facing a Cold War with China. The fact that the world’s two largest economies can’t get along is not going to help the global economic recovery.

Given all these unsettling developments, why has the stock market recovered nearly all of the March decline? What could be driving it?

There are three primary reasons for the impressive stock market recovery over the past two months. First, the massive amounts of liquidity pumped into the economy by the government has softened the economic blow from the Covid-19 shutdown. As mentioned previously, all this debt will cause problems in the future, but in the short run, it has helped cushion the blow. Second, interest rates remain extraordinarily low, which supports stock price valuations, all else being equal.

“We are more often frightened than hurt; and suffer more often in imagination that in reality.” — Seneca. 

Third, and less quantifiable, but still powerful, is the worst-case-fear-mentality that has our country in a stranglehold. For some time now, there has been a steady stream of predictions that our economy and country is about to face some historic calamity. From global warming, to debt default, to a second civil war, to a financial collapse from some unknown reason.  A sense of doom and gloom seems pervasive.  Cynicism has replaced optimism, and distrust has replaced a sense of community and shared experience. Despite all this trepidation, there are multiple reasons for optimism. To begin with, our country has tremendous natural resources, the world’s most productive farms and the finest universities.  Moreover, our entrepreneurial spirit combined with access to capital makes us the most innovative country in the world.

The stock market, in its collective wisdom, understands two important things. First, worst case fears, almost by definition, never come true. Second, people are adaptive, resilient, and creative. Most problems we face are eventually solved. Change is constant, and progress, while never steady or predictable, continues.

Over the next several years, my sense is we will solve many of today’s problems. We will find solutions for global warming and we will discover a vaccine for Covid-19.  Beyond that, there is always hope that we will eventually find leaders who can unite our country, and encourage us to embrace the critically-important core values of integrity, community and individual responsibility while we recommit to a determined work ethic that built this great country in the first place.   

“Unhappy is the man, though he rule the world, who doesn’t consider himself supremely blessed. In order to consider himself supremely blessed he must deeply understand that things could be much worse but aren’t! To not do that is to always be less happy than he could be.” – Seneca the Elder

Michael Kayes, CFA

Downhill

For the first time in my life I love to shop for groceries.  Face mask on, running shoes tightly tied, I swerve between the aisles and away from other shoppers, grabbing items off the shelf as fast as possible.  It’s free-form, almost chaotic, and reminds me of my youth, downhill ski racing with my friends.  More on that later, but first back to the grocery store.  From the deli, to the meat counter, to the opposite end for ice cream, swerving to avoid collisions or close encounters with other people.  Eventually heading to self-check-out, I insert my credit card into the chip reader and am soon gone without interacting with a single person.  It’s all rather strange.  I don’t really feel safe, more like I have managed to escape.  At the same time, I feel no sense of community.

The Covid-19 national crisis is impacting our country in profound ways.  Our health, our economy, and our sense of community have all suffered.  I had been hopeful that this national crisis would unite us, but I fear that our political and ideological polarization may survive long after the virus threat is gone.   

It does appear that social distancing, self-quarantines, and business closings have slowed the spread of the virus.  It will eventually run its course while therapies and eventual vaccines will be discovered.  Meanwhile, our economy is starting to reopen, and it will recover over time, although not smoothly.  However, it may take more effort, or perhaps creativity, to rekindle a sense of community, especially since technology makes it convenient to remain isolated.  More people may prefer the safety and convenience of working from home well past the threat of the Coronavirus.  In some lines of business, productivity may actually increase from more people working remotely.  But what does it do to relationships and team building within an organization? 

Some people prefer solitude and isolation.  While there is nothing wrong with that, isolation can be debilitating for others.  At some point, we must reconnect with our neighbors, with our community and we have to do this before it is 100% safe to do so.  My sense is the debate about when it is safe enough will continue throughout the remainder of the year.  In my view, what endears us so much to our health care workers is that they are doing their jobs even at personal peril.  Can the rest of us find a way to serve others, to build community, to be good neighbors, when health risks, though minimized, still exist?  Can we as a nation, step up to this noble challenge?   

In practical matters, the vast majority of our country wants to go back to work and they want to experience some level of personal interaction and community.  Most people are not wired to remain in isolation.  Local, state, and federal government officials are in some cases impeding this process, but in other cases they are offering sensible solutions.  It’s a difficult responsibility, and we should be supportive of their efforts while holding them accountable for policy mistakes. 

Going forward, from an economic perspective, there are countless potential scenarios related to Covid-19: restarting the economy, government debt and out-of-control spending, zero interest rates, upcoming presidential election, and stock price valuations, to name only some of the key issues.  It’s nearly impossible to predict what will happen in the next year with any degree of certainty.  Given this heightened uncertainty, we are utilizing several prudent investment strategies: 

  1. We are maintaining a relatively high level of cash across all our equity portfolios (approximately 15%).
  2. We are continuing to hold a position in gold (GLD) as a hedge against inflation and economic uncertainty.
  3. Our stock selection is focused on companies with these characteristics:  low debt, strong cash flow, industry-leading positions, high return on invested capital (ROIC), and stable revenue growth.
  4. We are using the extraordinary market volatility to take profits after short-term rallies and adding to names after short-term corrections.  Patience and discipline are paramount.

Uncertainty creates risks but also presents opportunities.  We are doing our best to mitigate the former while exploiting the later.

Back to the downhill…  The most fun I ever had ski racing was when we would hide in the woods at the top of the mountain, wait until the ski-lift operators turned off the lights, then race to the bottom navigating only by moonlight. Racing in near darkness seemed foolhardy to some, but we knew the mountain and we knew our limitations.  Was it 100% safe?  Not hardly, but nothing worthwhile ever is.

Michael Kayes, CFA

A Really Good Thing

After the jaw-dropping 35% decline in the markets from February 19th to March 23rd, the stock market rebounded over 22%, including one of the best weeks in recent memory.  Could this be the start of the much-hoped-for V-bottom recovery?  Is the Coronavirus-induced bear market over?  Moreover, how bad is the economic fallout going to be from the social distancing and business shutdowns?  Let’s tackle these one at a time.

First, it is highly unlikely given the lingering uncertainty about the Coronavirus and the economic shutdown to expect a V-bottom recovery.  It seems more appropriate for the recovery to come in the shape of a W-bottom, with multiple retests of the lows in between powerful, short-term rallies, like what we have just witnessed. Extreme volatility is here to stay, at least in the near term, driven by positive and negative news related to COVID-19.

Social distancing may be working…  Second, while there are increasing signs that the rate of growth of infections is slowing, it is too soon to declare victory.  As the world listens to Dr. Fauci and other health experts, we can share a glimmer of hope, but we must remain vigilant in terms of following their guidelines to mitigate the spreading of the virus. 

But at what cost?…  Herein lies the most difficult question, and one with no clear answer at the current time.  The pressure to reopen at least part of the economy is growing by the day.  So is public frustration with politicians who see the opportunity to take over more control of everyday life, whether driven by good intentions or an insatiable thirst for power.  Let me be clear.  In crisis, we all expect and want the government to step up to the plate and do what it can to overcome the challenge at hand.  However, we also expect government not to go too far and let us get back to a normal life once the challenge has been defeated.  It’s a difficult balance and unfortunately, imbalances have consequences.         

The process of trying to get the balance right, is likely going to take the rest of this year, if not longer.  There will be periods when government initiatives have largely positive results and other periods when the opposite occurs.  It’s just going to be a volatile process.  Then, lest we forget, there is an election in seven months, which could upset the apple cart as well. 

How to invest in uncertain times?…  Underlying valuations for most companies will be much more stable than their stock prices, which will be battered by positive and negative developments related to the pandemic, as well as government initiatives.  Patience and valuation discipline will be critical to take advantage of this extreme volatility. 

Earnings season has arrived…  Generally speaking, earnings expectations are very low, and we expect conservative guidance for the remainder of the year.  It will be interesting to see how the market will react to lower earnings and any reductions in guidance going forward.  Everyone understands the economic shutdown is going to be a stiff headwind for corporate profitability, so it is not out of the realm of possibility to see some positive earnings surprises.  We are not expecting positive surprises to be widespread, but if a few bellwethers surprise on the upside the market could rally sharply.

Businesses are retooling…  Businesses large and small are retooling.  Non-health care manufacturing companies are finding ways to produce personal protection equipment that is currently in great demand.  Companies are rethinking their supply chains hoping to become less dependent on China.  Restaurants are trying to survive by offering delivery and curb side pickup.  My point here is that America is responding to the pandemic in multiple ways.  Before COVID-19 arrived on the scene, America may have been complacent.  Why wouldn’t we be?  Life here for most of us was pretty good.  Now we realize we are all in this together.  Well, maybe politicians haven’t realized that just yet, but they are followers, not leaders.  The real leaders are leading.  They are our doctors and nurses, small business owners, neighbors and volunteers, and individuals in all walks of life doing the best they can to stay healthy and help others in need at the same time.

Everything we do to stay healthy and every creative way we find to help others matters in this battle.  The much-needed unification of our country is starting.  We have a long way to go, but this is a really good thing.       

 Michael Kayes, CFA

Not Nearly Enough

Since I have written nearly three-hundred newsletters over the past twenty-five years, I’m finding it necessary to do a search before I begin the next edition. As the saying goes, I want to make sure I’m not being redundant over and over again.  When the theme of this edition began to germinate, I thought it would be apropos to talk about Dwight Eisenhower and Andrew Higgins, but even my failing memory suspected I had done that before.  In fact, I had not once but twice.  First in May of 2012 and again in March of 2017.  So, we won’t go there again.    

Nevertheless, there is another amazing story from June of 1944 that we might want to remember.  In just six days after the historic D-Day landings, the U.S. military engineers constructed five operational airfields.  Within two weeks there were eleven.  The logistical accomplishments made by the Allies following the invasion of Normandy were unprecedented and haven’t been approached since.  It took leadership, planning, and faith in the cause.  Are we capable of that today as we face what may be the defining challenge of our generation?      

It seems that our country has finally taken the Coronavirus threat seriously.  Schools are closing, sports activities are being postponed or cancelled, and businesses are encouraging their employees to work from home.  All these initiatives are focused on slowing the contagion and they all make sense.  We all know the economy is going to take a hit, possibly a recession is at hand.  It remains unknown how long and deep it will be.

The attitude of our country matters a lot at times like these.  Are we focused more on what we should have done, or what mistakes were made, or how to score political points?  Or are we focused on what we can accomplish working together?  Can the private sector and the public sector unite for the greater good?  Can we harness our collective creativity, ingenuity, and determination that has been the hallmark of our country since its founding? I may be going out on an idealistic limb here, but I believe all this will happen.  I see and feel the attitude of our country changing as we come to grips with this nationwide health issue.  Despite our political differences, we are coming together as a nation.  It’s early in the process, but it is happening, and good things will come from it.

The faith of our country also matters a lot at times like these.  Do we have faith in our leaders and institutions?  Do we have faith in each other, and do we have faith that a higher power is ultimately in control?  When we are impacted by events out of our control, it is natural to fall back to our foundation and our core beliefs.  These are certainly going to be tested in the weeks and months ahead.  My hope is that we will find renewed faith, and I believe it too will happen.

Novelist James Lane Allen said, “Adversity does not build character, it reveals it.”  Could it not do both?  Can we, as a nation, face our failings, admit our weaknesses and commit to doing better and being better?  Isn’t that the challenge before us right now?

This past week, the stock market had one of its wildest rides since the 1987 crash.  The market fell 10% on Thursday and rebounded nearly 10% on Friday.  I have not witnessed this kind of volatility in my 35+ year career. 

Heavy weight boxing champion Mike Tyson once said, “Everyone has a plan until they get hit in the mouth.”  Well, America has been hit in the mouth, and now we are responding.  We are going to unite with business and government both playing an important role.  We will get through this, stronger, more united, more faithful.

In the meantime, extraordinary market volatility is likely to remain until we more fully understand the extent of the contagion and the degree of severity for those infected.  I believe we will know significantly more over the next couple months.  For right now, we are being patient, looking for opportunities to upgrade the quality of our holdings in all of our portfolio strategies, and to improve the overall upside potential once the eventual recovery arrives.

During one of the most difficult market days recently, a good friend texted me asking how I was doing.  My short answer was, “I live for moments like this.”  Given the continuous news of people getting sick, a small percentage dying, and all the economic and financial carnage, how can this be?  Let me try to explain.

When the game is on the line, the greatest players demand the ball.  They want to shoot the clutch fourth quarter free throws.  They live for these moments to demonstrate poise, and the self-confidence they have built through all the hard work, dedication, and commitment to be the best they can be.  That’s the essence of competitive greatness, as defined by John Wooden.  I make no boast about my abilities in clutch situations, but I am supremely confident in our team at Willingdon.  We remain laser-focused on three critical responsibilities:

  1. Developing appropriate asset allocation specific to each client
  2. Maintaining prudent risk management across each portfolio strategy
  3. Relying on disciplined fundamental analysis on every individual security

Through our time-tested approach, we can remove the emotions from our decision-making process.  In the current environment, that is no easy task, but one we embrace every day.  Fourth-quarter free throws…  We live for moments like this.

One last thought, in case you’re wondering, I did do a search to see how many times I used a quote or theme from John Wooden.  Only four times in the past ten years.  Not nearly enough… 

 Michael Kayes, CFA

Unity, Liberty, Charity

A very dear friend reminded me of a wise quote from John Wesley – “In essentials unity, in non-essentials liberty, in all things charity.”

These impactful, yet challenging words, bring me to the topic of this edition of Willingdon Views – “Stakeholder Capitalism.”  Let me try to explain…

The notion of “Stakeholder Capitalism” is that corporations should consider the interests of groups beyond shareholders, including society as a whole.  Naturally, social goals like climate change, as well as race, religion, and sexual orientation have worked their way into the discussion.  CEOs of some of the largest companies in the world, like Larry Fink at BlackRock, are promoting Stakeholder Capitalism. 

In essentials unity…  I can’t think of anyone who dislikes unity.  But who gets to determine or define the essentials?  Should CEOs drive that?  How about politicians?  Or, should the people decide?  And if so, how would that process work?

People make choices every day about what to purchase, what to invest in, and how to spend their time and energy.  By doing these things they are making a statement as to what is essential to them.  In other words what they value.  These essentials change for numerous reasons, but over time, collectively, a determination of value is made about most things.  From a business perspective, over time, companies that provide valuable products and services succeed and those that do not eventually fail.  This “survival of the fittest” is one of the laws of free-market capitalism. 

As noted economist Milton Friedman espoused, the primary purpose of a corporation is to maximize shareholder value. As Friedman goes on to explain, to maximize shareholder value over the long run, companies will quite naturally have to take into account the interests of various groups, even society as a whole. In this sense, stakeholder capitalism is really nothing new.

Still, it warrants further discussion as to what are the essentials, in our economy and in our country. (I’m guessing loyal readers knew I was going in this direction all along…)

We are an economy and a country of numerous and often competing essentials. To one person, combating climate change might be an essential, but to a West Virginia coal miner, not so much. The same can be said for other controversial issues. My point is this – while all these issues are important, at least to some people, they aren’t essential in the spirit of John Wesley. What is essential is to find unity with people we disagree with. What is essential is to love the unlovable. What is essential is to be respectful and kind and caring even when we prefer not to.

Capitalism can only achieve the maximum benefit to all if it is built upon the foundation of these unifying essentials.  Perhaps our focus should be on promoting “Unifying Capitalism”…  This might seem like a radical refocus and perhaps it is.  Moreover, like morality, it cannot be effectively legislated.  However, it can happen gradually, over the long run, driven by charismatic leaders who as the saying goes, know the way, show the way, and go the way.  The challenge before us continues to be finding unifying individuals who are willing to lead. 

In non-essentials liberty… In my view this statement comes across as a warning. In today’s climate, especially at many universities, are we trying to diminish the liberty of dissent? If we believe and practice the unifying essentials, would we naturally uphold liberty regarding non-essentials? I think this is a discussion worth having.

In all things charity… Being charitable goes way beyond donating our time and money. It includes looking out for the welfare of others and sacrificing for the common good. And like liberty, it should be a natural by-product of a society built upon unifying essentials.

Another dear friend recently sent me a long email outlining how wrong I was about an issue we had been discussing.  He was dead right.  Not only do I respect his honesty, I told him I need him to continue to let me have it when he thinks I am wrong.  To me it was a unifying email.  I have a hunch that emails in general cause more disunity than they do unity.  What can we do to change that? 

There are all kinds of challenges on the horizon, from the Coronavirus, to what is sure to be a nasty and polarized presidential election.  Meanwhile, our federal deficit continues to expand unabated.  Fear and anxiety remain elevated while confidence in the future is declining. 

That is why values and leadership matter, perhaps more today than ever.

“In essentials unity, in non-essentials liberty, in all things charity.”

Michael Kayes, CFA