The Valley Below and the Hillsides Beyond

This report comes at the end of an extraordinary quarter. The S&P 500 index fell by 20%, its worst quarter since the 4th quarter of 2008 in the depths of the financial crisis. Interest rates on safe government bonds rest near their all-time historical lows. The outlook as we entered the year was optimistic. Stocks rose in 2019 despite stagnant earnings in anticipation of global economic growth in 2020. Instead, historic policy steps taken to minimize the health effects of the Covid-19 virus have stunted economies all over the world. Pessimism rules.

The world’s major economies are likely to post the weakest GDP numbers since the 1930s. Although the adjustment of the stock market to these new distressed conditions has been swift and, at times, chaotic, this price decline is consistent with such a dramatic change in the outlook. Investors cannot know precisely when the negative economic effects of Covid-19 will end.

What we do know, however, is that current stock prices are discounting a very sober outcome versus the sunnier scenario inferred by January prices. To us this represents a buying opportunity even if the market heads downward from here. Stocks as represented by the S&P 500 now trade at around 13 times an estimate of their forecast 2020 earnings vs. more than 18 at the beginning of the year. Certainly, estimates of earnings can fall, but today’s prices offer investors a more reasonable tradeoff between risk and return than prevailed in January.

Investors looking for a guide to how deep the valley of economic damage is will not find useful landmarks in the earnings and labor numbers. More clarity is likely to be found among the reports and projections of epidemiologists and scientists than those of economists and analysts. Since this began as a health crisis, it will likely end as the crisis abates.

Consensus among public health professionals appears to be that the virus may be with us for the next 18 months or so. During this period, the economic effects should be truncated as hospitalizations peak, perhaps in the next month or so and as testing becomes more widespread and available. So, while optimists and pessimists may argue over when the nadir of this episode will be reached, it is agreed that this valley has a floor.

When market participants begin to sense the end of this economic decline, history suggests they will quickly begin to look to the sunlit hillsides that show the path out. When that happens, it is likely stocks will climb in anticipation.

When the story is told about the investors who successfully managed this downturn, they will have a lot in common with those who thrived during the crash of 1987, the “tech wreck”, 9/11 and the financial crisis. They entered the downturn with an appropriate mix of stocks and safer assets like bonds. They patiently began to buy stocks during the downturn, not when the “bottom” was reached but when the fundamental values were compelling. As each crisis ended, they had had invested quality stocks at attractive prices and enjoyed the returns as conditions improved.

We are aware of how important good communication is, especially at times like these. We will continue to reach out to you and do not hesitate to call us to discuss any concerns or questions you may have. We never forget the privilege you have granted us by allowing us to serve as your advisor.

The Altavista Investment Team – Spring 2020


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