I have heard much discussion about the time it could take to create, test and produce a treatment and a vaccine to combat this disease. Some believe it will take eighteen to twenty-four months. Given that, I hear multiple cries asking why it will take so long. I can’t tell you how long it will take, but each and every one of us should be thankful that we can envision that short of a time. Close to the entire population of individuals born before 1957 contracted measles, a childhood disease that was a part of life for generations of children until a vaccine became available in 1963. The first year we were required to report measles to US health authorities was 1912. On average 6,000 children died and 48,000 children were hospitalized per year. It took 50 years to create a vaccine! So, I have hope that the end of this scourge is near, and that the attention given by our scientists and health professionals will surprise us and find a solution faster than we can imagine.
Having hope does not change the need to address our portfolios under the current worldwide slowdown caused by the stay-at-home and social distancing orders. Over the years we have talked in detail about the fundamentals of managing your portfolio. This includes the need to address risk at all times and offset risky assets with risk-free assets, or as close to risk-free as we can understand. This balance is determined by quantifying the current level of interest rates with our estimates of current values for the businesses we own. These values are based on discounting future earnings to the present. In addition we modify our outlook based on the present psychology of market participants. Given that our ability now to forecast earnings, dividends, revenues, profit margins and financial strength in the short run is extremely limited, we have to extend our time frame and make estimates based on the time period beyond the current crisis. This fact alone requires us to pay particular attention to psychology of market participants world-wide.
It is helpful to search history for similar periods of stress and see how others successfully navigated crises. I want to share a few words from Bernard Baruch and Philip Fisher, two of the most influential investors of generations past.
Bernard Baruch wrote these words in his autobiography My Own Story, published in 1957:
First the stock market does not determine the health of our economy. Largely because of the 1929 crash, the impression got built up that the stock market itself is the cause of economic booms and busts. Actually, the Stock Exchange is simply a marketplace where buyers and sellers of securities meet. All the market does is register the judgments of those sellers and buyers on what business is like and what it will be like in the future.
The stock market, in short, is the thermometer and not the fever. If the country is suffering from the effects of inflation or from a weakening of the government’s credit, the effect will show up in the stock market. But the causes of the trouble will not lie in the stock market itself.
This distinction between the thermometer and the fever, I repeat, is a crucial one. We face one kind of problem if the thermometer is not working properly, but quite a different problem if the difficulty is that the stock market is recording – all too accurately – the ills of our economic world.
Today the thermometer is reading accurately the current economic shutdown and the questions surrounding the timing and future world after the crisis subsides. There are a few things we have to consider that are still unanswered:
- Will people change how they live, work, and consume?
- Will people willingly give up personal freedom to government dictates?
- Will the use of technology replace social interaction with others?
- Will the government abandon fiscal responsibility and simply create money?
- Will printing money cause a surge in inflation?
For each business we own, and for those businesses we would like to own in the future, we have to determine:
- What will earnings, if any, be in the short term?
- Can they continue to pay a dividend?
- Will they remain a viable business in the future?
- Can we estimate the present value of the company?
These are just a few of the questions that need to be addressed given the uncertainty of the future of our country and others around the world. This leads me to the words of Philip Fisher, found in his classic book Common Stocks and Uncommon Profits, published in 1958:
... If an arrival of a full blown war scare starts knocking down the price, he should ignore the scare psychology of the moment and definitely begin buying. This is a time when having surplus cash for investment becomes least, not most, desirable. However, here a problem presents itself. How fast should he buy? How far down will the stock go? As long as the downward influence is a war scare and not war, there is no way of knowing. If actual hostilities break out, the price would undoubtedly go still lower, perhaps a lot lower. Therefore, the thing to do is to buy but buy slowly and at a scale-down on just a threat of war. If war occurs, then increase the tempo of buying significantly. Just be sure to buy into companies either with products of services the demand for which will continue in wartime, or which can convert their facilities to wartime operations. The great majority of companies can so qualify under today’s conditions of total war and manufacturing flexibility.
If you have questions, special requests, or just want to talk, please give us a call.
Until next time,
Kendall J. Anderson, CFA