The Island Investing Blog

  • What the Worst GDP Decline in History Means for Investors

    From an email sent out to IIM investors…

    Good evening, IIM investors.

    The economic recovery continues to send mixed signals in early August. Increased COVID-19 cases in many parts of the country have led to increased restrictions by local governments and businesses. Nonetheless, there are clear signs that the economy is getting back on track. The data suggest that the worst is behind us at a national level, and that jobs will slowly return as businesses find their footing.

    Recent GDP data for the second quarter showed the economy suffered its worst decline in history. On an annualized basis, the economy shrank by 32.9% – worse than any quarter during the Great Depression nearly a century ago.

    However, it’s important to keep a few facts in mind when seeing those headlines.

    First, we often annualize economic numbers in order to understand trends. Normalizing the data helps better compare measurements…by imagining what would have happened had these events been stretched out to a whole year.

    In this case, the magnitude of that GDP decline is not expected to last a full year – since the worst likely occurred during April and May. The actual quarterly decline was 9.5% – compared to the first quarter, and the same quarter a year ago. While that is still awfully ugly, it really shouldn’t be compared to the Great Depression, either – which lasted a decade and technically spanned two economic cycles.

    Second, those GDP numbers are backward-looking – since they are only released quarterly, and with a lag. Many stocks continued to perform well over that same time because those numbers were widely anticipated. In fact, the consensus forecast for a 34.5% decline in GDP was nearly right on point – and we already knew that a new economic cycle began in March, according to the National Bureau of Economic Research.

    Finally, those GDP numbers don’t take into account what we’ve learned since the economy first went into free-fall: that businesses can successfully reopen, and the economic numbers can improve. That’s highly dependent on COVID, of course, but if businesses can continue to run and expand their operations – even at partial capacity – then jobs can return and corporate profits can recover.

    There were clear signs of this in the jobs data during May and June when even weekly jobless claims were improving. As retail sector jobs return, there are also signs that business and industrial activity has picked up. Various manufacturing and non-manufacturing levels are now rising at pre-crisis rates – a positive sign for the rest of this year and into 2021.

    As expected, corporate profits are trending with the economy. It’s estimated that earnings fell between 35% to 40% during the second quarter (they are still being reported) and will likely decline in 2020 overall by a little more than 20%.

    However, estimates also suggest that corporate profits will return to pre-crisis levels by the end of 2021.

    While a two years of lost profit growth is not what anyone wants to see, let’s keep some perspective there, too. Namely, this is occurring after the worst quarterly economic decline in history – and it may be shorter than the four years of flat profits we saw after the 2008 financial crisis.

    Ultimately, it’s important to see through this interim period in order to benefit from the economic recovery. Financial markets are forward-looking…one reason that stocks have performed well over the past few months despite the on-going crisis.

    So, please consider this a reminder that it’s still important to maintain discipline and not over-react to backward-looking data in the coming months.

    Below are three charts that put recent economic trends in perspective.

    1. The economy has experienced its worst decline in history


    The Q2 GDP decline was the worst in history. The economy fell 32.9% at an annualized rate or 9.5% on a quarterly basis. Still, unlike in prior recessions and depressions, this is not expected to continue at this pace. There are already many signs that the economy is rebounding, even if the pace is uncertain due to the on-going COVID-19 crisis.

    2. However, the recovery is still continuing


    Other data show that activity has been returning since the economic bottom. The ISM manufacturing and non-manufacturing indices both show that business activity has returned to a healthier pace. While these numbers will depend on how local governments and businesses deal with COVID-19 outbreaks, the overall trends are positive.

    3. Profits are expected to take two years to recover


    In the end, what matters to investors is how the economic data affect corporate earnings. So far, earnings have trended with the economy. Profits are expected to recover in the second half of the year and into 2021. This trend is one reason that stocks have recovered in recent months.

    The bottom line? While the Q2 GDP report was the worst in history, that was widely expected. There are many signs that the economy has been recovering since then – and will continue to do so, through 2021.

    Please let me know if you have any questions. 

    Thank you and hang in there.

    – Cale

    Posted by: Cale Smith , Commentary
  • IIM International Portfolios: First Half of 2020

    Sturm und Drang

    Our hearts go out to those whose loved ones are being impacted by COVID-19; we empathize with those businesses that are trying to find a path forward during this difficult time.

    The Market

    As if this insidious virus wasn’t enough of a challenge, investors had to deal with early tropical storms, a Godzilla dust cloud, civil unrest and outbreaks of dengue fever in Florida and Ebola in Mongolia – not to mention the typical geopolitical gyrations. By mid-March the S&P was down 34% from its record close; but rebounded in the second quarter to just a negative 3.1%  for the whole first half of 2020 as some countries gained control over the spread of the virus and many (including some that didn’t have control) began to reopen businesses and even their borders to select foreigners. The MSCI ACWI ex USA index also bounced back, ending down 11% for the 1st half of 2020.

    Our International Folios

    Despite all the Sturm and Drang, Frigate our ADR (American Depository Receipt) Folio focus on capital appreciation only fell 7.3% (all returns are estimated and Folio returns are net of fees) versus the S&P 500 ADR index which fell 14.7%. In general, Frigate’s benefitted from a higher cash position early in the year and its exposure to healthcare stocks; in addition, new purchases Adidas and L’Oreal did very well. Financials, in particular those exposed to emerging markets such as Brazilian Banco Bradesco and HSBC holdings (also known as Hong Kong Shanghai Banking Corp), were obvious detractors for the six months as was energy solution provider TechnipFMC. 

    Treasure Harbor, our ADR Folio focusing on yield, fell approximately 14.5% versus  a negative 18.74% for its benchmark (15% SPDR Emerging Markets Dividend ETF, 85% SPDR S&P International Dividend ETF) for the first six months of 2020, as many typically defensive companies conserved cash by cutting their dividend. In addition to the aforementioned HSBC, energy stock Pembina Pipeline and Royal Dutch Shell were drags on performance. On the other hand, Deutsche Telekom and Spanish utility provider Iberdrola were positive contributors, as was spirits producer Diageo, which was purchased this year.

    Our international small/mid cap Folio, Yellowtail, was down 10.5% for the first half of this year versus a negative 13% return for the Vanguard FTSE All-World ex-US Small Cap ETF (VSS).  Strong detractors were as expected: Swiss travel retailer Dufry, British staffing company Hays and French caterer Elior.  Logitech, the Swiss provider of computer and mobile accessories purchased in the first quarter, did very well the first half, as did Japanese packaged-food company Nichirei Corp and French provider of diagnostics BioMerieux.

    Other IIM Investments

    In addition to our proprietary Folio, we have invested many of our clients’ funds into Exchange Traded Funds that address other areas of the markets. Adding large-cap growth has been especially effective as both our selected domestic and international growth ETFs outperformed their value peers over the first half.  Our selected domestic and international small-cap ETFs, however, underperformed their large-cap peers.   An unpleasant surprise was the performance of our low-volatility ETF; usually offering protection in down markets, it was down 13.53%. This is likely due to the ETF’s overweight in utilities and real estate which were at risk for provisioning for bad debts and bad loans.  On the other hand, the gold ETF we bought for client’s accounts did very well.

    At the request of some clients during this period, we invested in some relatively conservative, fixed-income ETFs that were on the spectrum of ultra-short to medium- term durations. These behaved as expected with flat to middle single digit returns. 


    The strong rebound in the markets while the virus is still spreading in some countries is a bit worrisome. The valuations of the US market, especially, seem high considering our relative lack of progress in containing the virus and the risks this may have for businesses and individuals. Although valuations in other equity markets appear more attractive, international companies’ earnings aren’t fully immune to what is happening in the US.  As we caution that past performance is not a guarantee of future results for any of our propriety portfolios or other investments made for our clients, we do suggest investors consider diversification consistent with their risk tolerance, investment outlook and financial goals.

    Office Update

    As some of you may know, I have moved to Raleigh, North Carolina. I am still managing the International Folios and working with Cale on the portfolios of our wealth management clients.  My phone number will remain the same, as will my email address, so please don’t hesitate to reach out with questions.  

    We wish for you all a safe summer and thank you for investing with Islamorada Investment Management.

    – Lauretta “Retz” Ann Reeves, CFA AWMA

    Disclaimer: This post nor any of the material linked to herein in any way constitutes investment advice. Historical performance data above represents performance results as reported by the portfolio identified. Performance results are for illustration purposes only. Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and timing of initial investment. Investing may cause capital loss. The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.

    Posted by: Retz Reeves , Commentary, For Investors
  • Seven Insights for the Second Half of 2020

    From an email sent to IIM investors on July 2, 2020:

    After collapsing by 22 million in March and April, 4.8 million workers returned to work in June, according to this morning’s jobs report – significantly more than the 3 million to 4 million consensus prediction among surveyed economists. This is the second consecutive month of improved job numbers – and the recovery not only continued through June, it accelerated. The unemployment rate, adjusted for misclassification errors, has now retraced half its pandemic-related increase.

    Today’s jobs data likely reflects the early recovery that began in May and extended into early June as some businesses reopened and consumers ventured back out to shops, salons, and restaurants.

    Since then, however, an unanticipated and significant rise in COVID-19 cases in major population centers in the south and west has caused many governors to rethink planned reopenings or to backtrack altogether, renewing closures and stay-at-home orders. This suggests that the June unemployment data may already be stale.

    So it seems like a good time to reflect on what we have learned this year so far, and what may lie ahead.

    During the first half of 2020, investors experienced a global pandemic, an economic shutdown, the end of an eleven-year bull market, and now the early stages of an economic reboot. The U.S. stock market has experienced large swings in both directions, rising 20% in the second quarter after falling 20% in the first. Interest rates have also remained low, especially as the Fed continues to provide stimulus.

    The irony is that as we begin the second half, the S&P 500 is only a few percentage points from where it started the year. While this recovery happened unusually swiftly – and we’re certainly not out of the woods yet – it is further evidence that staying invested and maintaining a long-term focus are good core principles to abide by when investing.

    Staying disciplined is difficult. As recently as March, it was unclear whether COVID-19 could be adequately contained. As the country shut down, it was uncertain whether individuals and businesses would survive without paychecks and customer activity. As credit spreads widened, there was a fear that bankruptcies and defaults would ripple across the financial system, leading to a 2008-style crisis. Finally, it was unclear when and how the economy could reopen, and if it did, whether consumers and businesses would feel confident enough to spend.

    Fortunately, we’ve learned a great deal since then. While we are still in the early stages – with many more negative data points to come – there are clear signs we are bouncing back. Jobless claims and unemployment are still very high, but have begun to come down steadily. Consumer spending has picked up as cities have reopened, although overall confidence is still low. Industrial activity has thawed as factories fire up again across the country. Credit markets have stabilized despite some large restructurings. Many parts of the stock market have fully recovered.

    None of this is to say that the economic recovery will be easy. This is especially true in parts of the country that have seen a resurgence of COVID-19 cases – and in industries that are deeply impacted by social distancing including restaurants, travel, retail and more. And while there are signs that customers are returning to those businesses, COVID case spikes and limited capacity mean that the jobs that have been lost are increasingly at risk of becoming permanent.

    Despite this, there have been companies that have not only survived the crisis, but have thrived. Not only has telecommuting and video conferencing become the norm for office workers, but the shift to online retail has accelerated. That is one reason that some sectors of the stock market have not only recovered from pre-crisis levels, but have achieved new highs.

    It’s important to set proper expectations about the recovery going forward. Many economic forecasts, including those of the Fed, expect a strong rebound in the second half of the year, but not enough to stem negative growth for 2020 overall. In fact, most economists and business leaders expect conditions to be uncertain until the end of 2021, at the earliest. While this partly depends on public health developments, including the possibility of a vaccine or other treatments, it also speaks to the severity of the economic crisis.

    So, as is always the case, long-term investors should continue to be disciplined and patient. That has been the best way to weather this particular storm to date – and has been the best way throughout history, too. With so much widespread uncertainty around the world heading into the second half of the year…the pandemic, November elections in the U.S., and trade disputes, to start…staying disciplined and unemotional will remain the best way to invest in the second half of 2020, as well.

    Below are seven key insights and trends we will be following in the second half of the year.

    1. The COVID-19 crisis continues to create economic uncertainty


    When it comes down to it, this crisis is rooted in public health. Although many early hot spots for the coronavirus have managed to control the pandemic, other states are now seeing an acceleration in new confirmed cases. Financial markets have been volatile as these patterns call into question the ability of the economy to reopen smoothly.

    2. Still, there are early signs of an economic recovery


    Although the economic data is still generally negative – which will also be the case for Q2 GDP when it is released – there are also signs that a bounce-back is on the way. Many new data points have shown that unemployment is stabilizing and that consumers are beginning to open their wallets again. While it will take time to reach pre-crisis levels of growth, these are positive early signs of a recovery.

    3. Unemployment is beginning to stabilize


    The job market has also shown very early signs of stabilizing after reaching record levels. Not only did the unemployment rate skyrocket to levels not seen since the Great Depression, but weekly jobless claims show that nearly 20 million Americans are still out of work. The good news is that more recent data suggest that furloughed employees are being recalled and unemployment is slowly improving.

    4. Consumer spending has picked up as well


    One of the key considerations for the recovery is whether consumers will feel financially secure and comfortable enough to spend. After all, the national savings rate jumped to 33% while the country was on lockdown.

    Fortunately, there are initial signs that consumers are feeling more confident. Retail sales have bounced from their recent lows, especially for online digital retailers. This will be important as the recovery continues since consumer spending is the foundation of the economy.

    5. The Fed and Congress will keep stimulating the economy


    Although government support is a controversial topic for many, actions by the Federal Reserve and emergency legislation by Congress helped keep businesses and personal finances throughout the country on life support. Fed stimulus in particular helped to keep the financial system functioning smoothly, especially during that period when credit markets were particularly unstable.

    It’s unclear what long-term consequences this historic level of government stimulus will bring. The Fed has projected that it will keep interest rates at zero percent through 2022. Only time will tell if they will shift their policy stance once the economy successfully comes out the other side.

    6. Corporate earnings may take years to recover


    The economic impact of the shutdown to the stock market is primarily through corporate earnings. Not only are earnings incredibly uncertain, but many companies stopped providing guidance. This creates challenges for understanding the outlook for profitability and market valuations.

    Overall, estimates suggest that 2020 and possibly 2021 will be “lost years” for corporate earnings growth. However, this is well understood by investors at this stage. Rather than looking backwards at the impact of the COVID-19 crisis on corporate performance, investors should look forward at how profits will react once spending starts up again.

    7. Stocks tend to rise with economic growth over the long run


    Ultimately, the last six months have been further proof that investors should focus on the long run. And I expect that lesson will be as true going forward as it has been historically.

    Please let me know if you have any questions. And Happy 4th of July.


    Posted by: Cale Smith , Commentary, For Investors