Markets Stumble As Powell Warns On Asset Prices

 

The month of May is known for the Triple Crown horse races. The most important contest is the Kentucky Derby, held in Louisville, KY at Churchill Downs. It usually draws well over 100,000 spectators. The next jewel in the series is the Preakness, which takes place just outside of Baltimore, MD. Finally, the longest and most difficult test is the Belmont Stakes, which is held outside of New York. The Derby is a one mile and a quarter in length, the Preakness a mile and one eight, while the Belmont is a mile and a half. The extra quarter of a mile in the last race has separated many would-be triple crown winners from those who only manage to win the first two of the races. There have not been that many horses which could win all three of the races in succession. Only thirteen champions have managed the accomplishment, in well over one hundred years of racing. In many years, there are three different horses which win each of the triple crown races. It goes to show you that the initial quote about racing is very much applicable. With this in mind, let us turn to the investment world and see why this matters in our universe, too.

In his famous interview many years ago, Charlie Munger compared investing to the parimutuel betting world at a racetrack. Essentially, his message was that like wagering on horses at a racetrack, identifying quality horses can be done, but in almost all wagering cases, the odds of the horse winning reflect the superior animal. The same holds true in the capital markets.

With digitization and algorithmic trading, machine learning, and plenty of other technological innovation, there continues to be a great deal of capital which jumps on trends and companies which reflect those temporary situations. Yes, we know Amazon is well positioned, thanks, and you are going to pay dearly for that. It is reflected in the price. Over the last few months, a massive amount of capital has been allocated towards enterprises which are believed to benefit from the corona virus. Conversely, those that are seen as suffering the brunt from the economic devastation are sold.

Let’s look at some specific examples. On the winning side, the dominant providers of internet based commerce cannot be bought fast enough, and no price matters. Amazon, Shopify, Wix.com, Wayfair, and the always solid Microsoft are most notable. Count the oil sector, travel, airlines, financials, and commercial real estate entities as those which will suffer. Look at JP Morgan, Goldman Sachs, Southwest Airlines, United Airlines, Simon Property Group, Expedia, Bookings.com, and the pain in Exxon, Chevron, and Shell, and you will see my point. However, if one pays attention to both economic events and history, we know the one constant is change. So, yes, Amazon and Shopify have had great runs over the last few years and months, but investors are only concerned about the future. Could the next three or five years be vastly different than the last five?

No one has a crystal ball, but it certainly seems reasonable to think the energy market cannot stay in the current situation. If one is paying attention to the number of wells being shut down in the major production areas across both the United States and globally, the process of reducing supply is well underway. Anecdotally, with Las Vegas just starting to open it’s economy, there are more cars on the road daily, and I would imagine the same holds true in every state that is opening. Summer is starting, and that means more driving, or gas usage. Air travel is seeing a slight pickup off the bottom as well, although international travel is still non existent. China has seen volumes go up over the last few weeks, so that is also encouraging. However, if we are investing for the long term, meaning longer than two or three hours, days, weeks, or months, the gradual improvement in energy usage should bring prices back into equilibrium.

I have seen estimates of oil prices recovering by the end of the year (call it $50 oil, but take that with a grain of salt). On the travel and leisure side, New York, Las Vegas, Hawaii, Southern California and Florida are the major markets to pay attention to. Florida is probably furthest along in opening as most of major counties are open or planning to in the next few weeks. Vegas casinos and hotels will open at the end of the month. In the case of California, it looks like the end of June should see some freedom, while New York and Hawaii are signaling the end of the June at the very earliest, and probably a lot longer . The banks remain cheap, but try running any kind of economy without financial institutions for lending, borrowing, payments, or custody. In sum, I always enjoy the challenge of picking the winning stock (horse), and the current prices offer interesting ‘odds’.

In the markets last week, Fed Chairman Jay Powell warned of the severity of the current situation. Powell may become the key player in the congressional discussions regarding another stimulus package over the next few weeks. You see, the very states which are most adamant about not opening their economies are the most broke - New York, Illinois, New Jersey, California, Nevada, and Hawaii. The western states have turned to the Federal Government to borrow a trillion dollars to fill their budget holes. This week Nevada Governor Steve Sisolak announced the state is in a financial emergency. California’s Governor Gavin Newsom is only facing a fifty billion dollar deficit, in addition to nearly a trillion in unfunded pension liabilities. The other states are as bad or worse off.

If you are manager of a bond fund, and an underwriter like JP Morgan or Goldman Sachs comes to you with a prospectus of a debt offering of, say, five to ten billion dollars that is backed by a state’s tax revenues (70% of which are sales or income tax related), I suspect you aren’t interested in buying unless the interest rate rewards you for the much higher risk you take by owning those bonds. In fact, why bother as your client’s hard earned capital is at stake? Of course, this is why Mr. Powell becomes important.

The Fed can now buy municipal debt, and if nobody else wants it, well Jay is always a team player, right? Keep in mind that the discussions between Speaker Pelosi and Majority Leader McConnell will revolve around issues like insurance liability protection for businesses, additional financial help for all citizens (including small businesses), and help for the individual states. One last thought, I don’t know,  maybe President Trump could use his experience as a deal maker in requesting concessions from Mrs. Pelosi, maybe something about opening up the economy or help with sanctuary cities, the border, or aid for the energy industry. Mr. Trump, after all, has to sign any agreement. Anyway, May is almost over, and the Triple Crown won’t be run this year, but maybe Del Mar will go off as planned in late July. If so, I’m looking forward to finding a good horse with nice odds. Are you in?