The Island Investing Blog

  • 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

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    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

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    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

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    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

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    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

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    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

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    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

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    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.


    Cale

    Posted by: Cale Smith , Commentary, For Investors
  • Letter to Investors: Tarpon Folio – June 2020

    Dear Tarpon Investors,

    Several quick notes before updating you on Tarpon:

    1. The topics I was hoping to cover in this year’s Annual Investor Meeting will be delivered via a series of emails later this summer.

    2. Goldman Sachs is buying FOLIO. Stay tuned for what, if anything, that may mean for us.

    3. Here are some recent resources we have published related to COVID and the last few months in the market…

    Emails:

    Historic Unemployment and the Months Ahead (originally sent out May 13)

    An Economy in Recession (April 30)

    Negative Oil Prices?!?! (April 22)

    Coronavirus Versus the Fed (March 19)

    Thoughts on Thursday’s Market Drop (March 13)

    Thoughts on the Coronavirus (March 4)

    Downloadable checklists:

    COVID Relief Checklist for Individuals

    COVID Relief Checklist for Small Business Owners

    Now, on to Tarpon.

    Below is the intro to this quarter’s letter, followed by a link to download the full PDF.


    Thoughts on the Year-to-Date:

    To those of you who have not looked at your account performance for a few months:

    Congratulations. Good call.

    The spring of 2020 was brutal for the energy sector in particular. An oil price war started during the arrival of the coronavirus pandemic was exacerbated by a technical anomaly in a popular oil trading product. On April 20th, those events culminated in the price of WTI oil hitting negative $38 a barrel.

    Energy stocks got crushed. Tarpon was not spared.

    The good news, however, is this:

    Through last Friday, the Tarpon Folio, on an unaudited basis, is now up 0.63% on the year, compared to the S&P 500, which is down 0.3%.

    We’ve had a significant rally off the lows of late March. I am particularly pleased with the changes made to Tarpon during the spring chaos. We appear to be through the worst of it, finally, and have a long runway in front of us – though it’s going to take time.

    To download and read the rest of the letter…

    Click Here For The Full PDF

    Please let me know if you have any questions.

    Yours in Quarantine,

    – Cale

    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: Cale Smith , For Investors
  • Historic Unemployment and the Months Ahead

    From an email sent May 13, 2020:

    Good morning, IIM investors.

    Given the nature of this COVID crisis, recent unemployment numbers are particularly important to understand. Below is some context for how we’re thinking about them. 

    It’s also the time of year that RIA firms like ours are required to send out updated versions of our Form ADV and privacy policy. You’ll find the former here and latter here. There were no material changes to either document this year, but please let us know if you have any questions.

    On this recent spike in unemployment…

    Last Friday’s jobs report contained eye-popping, historic numbers and is further evidence that the economy is in recession. However, that sudden rise in unemployment due to the nationwide lockdown is not only well understood, it is the defining characteristic of this economic crisis. Non-essential businesses have closed, demand has temporarily dried up, and many individuals have been laid off or furloughed as a result, creating financial hardship across the economy. What matters now for long-term investors is when and how the economy begins to reopen in the coming months.

    The specific numbers in the Friday jobs report show that changes in the labor market were extremely abrupt in April. While it’s important to maintain perspective around these numbers – as they are backward-looking – it’s useful to understand their scale and context, too.

    Specifically, the data show that the unemployment rate jumped to 14.7% in April. It had risen to 4.4% in March from a 50-year-low of 3.5% in February. 
    To put this in perspective, unemployment reached a high of 10% during the last recession, before steadily falling over the next decade.

     The so-called under-employment rate, which better accounts for those who have dropped out of the labor force, jumped to 22.8%.

    As recently as February, 192,000 new jobs were being created per month on average. In April alone, 20.5 million jobs were lost. When combined with March, payrolls have shrunk by 21.4 million, consistent with recent weekly jobless claims numbers. Compare this to the global financial crisis when 9 million jobs were destroyed during the entire period from 2008 to 2010. So these recent job losses nearly offset the 22.7 million net jobs that were created during the most recent economic expansion.

    It should be noted that there are some blips in the data due to the way it is defined and calculated. The labor force participation rate, which measures the percentage of the population engaged in the labor force – i.e. those that are either working or actively looking for work – plummeted. This is the result of being physically unable to pursue work, and for some, expecting to be recalled back to their jobs. So this number should quickly recover, as individuals begin to look for work again. A similar blip is present in the wage growth data, just due to the nature of recent layoffs.

    With that in mind, it’s important to focus on the bigger picture. First, many workers are still only temporarily unemployed – either officially furloughed or expected to return to work once businesses reopen. These workers are currently counted as unemployed, and their jobs are considered lost, in the data above. In theory, though, many of these workers are in a position to return to work quickly, which would reverse some of the April numbers. With only a couple months having passed, both worker skills and capital equipment can still be competitive.

    Whether this happens will depend entirely on the manner and timing in which the economy is reopened. With each passing week, the likelihood that temporary layoffs become permanent increases. Additionally, if the economy is reopened in haste, the risk to public health could bring further shutdowns and other economic consequences down the road. That is obviously a fine line that both the government and business owners and operators are going to have to walk here.

    While there are reasons for optimism, it’s unfortunately also the case that some jobs may be either permanently lost or slow to return – especially in industries such as restaurants, hospitality, and travel…all of which those of you here in the Keys know all too well.

    There will no doubt be scars from this crisis that change both consumer and business behaviors. And while it’s no consolation at the moment to hear this, that sorta thing is, historically speaking, always true of recessions and economic crises. The economy, as a dynamic system, will evolve by re-allocating resources and creating jobs in other areas.

    Second, and more importantly for long-term investors, the stock market’s immediate reaction to those brutal Friday numbers was a positive one, actually. And that’s because investors and economists had been expecting exactly these types of numbers or worse over the past couple of weeks. Not only are the root causes clearly understood, but data such as weekly jobless claims and last Thursday’s ADP payrolls report provided hints of what was to come on Friday.

    Which is one reason the stock market has risen by over 30% since late March, when focus shifted toward reopening the economy. Markets, again, are forward-looking…even as we are still adjusting to being stuck at home. It has always been the case that trying to time the bottom of a market is a difficult – if not impossible – exercise. Trying to do so in the middle of a rapidly changing, global public health and economic crisis is no exception.

    Luckily, for long-term investors who are focused on achieving financial goals over years and decades, it’s not only unnecessary to try to time the market perfectly – but it’s likely be counter-productive. While the jobs data above is historic in nature and may come to define this period, it is also more likely than not, statistically speaking, that the situation will improve in the coming months. And we continue to believe that investors should focus not just on the immediate future, but on how the economy will evolve over the coming quarters and years.

    Below are three charts that help to put recent jobs reports into perspective:

     
    1. Unemployment jumped to levels not seen since the Great Depression

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    Unemployment spiked to historic levels in April. The unemployment rate of 14.7% eclipses the peak of 10% experienced during the height of the prior global financial crisis.

    Many of these workers may be only temporarily unemployed. If this is the case, then there could be a recovery in these numbers as the economy slowly reopens.

    2. Over 20 million jobs were lost in April

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    20.5 million jobs were lost in April, nearly matching the 22.7 million jobs created since 2010. Prior to this crisis, the economy had been creating an average of 192,000 jobs per month.

    3. There are short-term blips in the job market data

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    One blip in the numbers is the labor force participation rate. Due to the way this number is defined, it most likely didn’t include temporarily laid-off workers and those who were physically unable to search for work in April. It’s reasonable to expect this number to rebound in the coming months.

    The bottom line?

    As historic and ugly as recent jobs numbers have been, they are not unexpected by the market, either. We continue to be adamant that it’s more important to focus on the light at the end of the tunnel, especially for those planning toward long-term financial goals.

    Please let me know if you have any questions.

    Thank you.

    – Cale
    ______________

    Cale Smith
    Managing Partner
    Islamorada Investment Management

    Posted by: Cale Smith , Commentary, For Investors