Thanksgiving Turkeys And Risk Management - Week of November 23, 2020
Chart of the Week: Thanksgiving seems an appropriate time to consider the “Turkey problem” as it relates to risk management. Nassim Taleb introduced the world to the “Black Swan” concept and used this example to illustrate the issue. Imagine the life of a turkey where everyday a kind farmer feeds and tends to it until suddenly on the Wednesday before Thanksgiving the situation takes an irrevocable turn for the worse. The turkey has only observed a positive trend during its lifetime up until that fateful Wednesday and in fact is the fattest and happiest at a point that turns out to be the time of maximum risk. It recalls another favorite quote attributed to Mark Twain: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” This philosophy has been one reason we have argued for some balance between owning growth and the “stay at home” stocks, many of which are priced for something close to perfection, and the value side of the ledger, which in many cases is priced for a less robust future. Clearly the observed trend in growth and technology has been and seems likely to continue to be stellar but beware that “the same hand that feeds you can be the one that wrings your neck.” For those looking for places where the greatest investors of all time are currently finding opportunity, our analysis looks at Berkshire Hathaway’s portfolio in the third quarter with a special emphasis on details around the new investments in the pharmaceutical sector. In case you missed it, our detailed analysis of Berkshire Hathaway’s 3Q earnings is here. Wishing you and yours a Happy Thanksgiving on behalf of Stone Investment Partners. We also count modern science among our blessings which has invented vaccines to end the scourge of COVID-19 and allowed us to finally see the light at the end of what has been a dark tunnel.
Week in Preview
· Geopolitical: Negotiations between the European Union (E.U.) and U.K. regarding their future trade relationship have an approximate deadline of mid-week so the legislative process can be completed before year-end, but there are whispers that the talks could last until early December. Increased restrictions continue in many parts of the globe to combat the resurgence in COVID infections, and the impact on economic activity will be closely monitored but revisiting the economic collapse of wholesale lockdowns during Lockdown 2.0 remains unlikely. Global November PMI data for the large, developed economies is released this week with the general theme of slowing economic momentum with manufacturing staying above the growth-level of 50 in many cases. The PMI services component is being hit harder by the impact of rising infections. U.S. stock and bond markets are closed on Thursday and close early on Friday to celebrate the Thanksgiving holiday. Japan is closed Monday for Labor Thanksgiving Day.
· U.S.: In addition to being packed into three days, the U.S. economic calendar is busy. October new home sales should continue to highlight the strength of housing in this economy. Initial jobless claims will be watched closely after claims moved higher last week. October personal income and spending should continue to moderate with income expected to be flat as the fiscal support from the CARES Act has diminished. November manufacturing PMI is expected to decline to 53.0 from 53.4 while services fall to 55.0 from 56.9. The Atlanta and New York Fed’s estimate of 4Q GDP growth is currently 5.6% and 2.9%, respectively. Less Fedspeak this week but the speeches and the Fed meeting minutes will be scoured for any hints at plans for additional future asset purchases as the economy slows. The Fed is making plans to return the unused money, provided by the Cares Act to fund five emergency lending facilities, to the Treasury department at year-end when the programs are scheduled to terminate. While some focus on a possible rift between the Fed and Treasury, these funds could provide the political bridge for the next fiscal support program from Congress though any action on that front before the new year seems unlikely. Readings for our U.S. Reopening Monitor moved higher primarily on market measures as COVID cases rose at a high rate even with Lockdown 2.0 continuing in parts of the country. Underlying high frequency economic data showed retail sales, airline travel, and consumer sentiment improving while the mobility, dining and public transit measures softened.
· S&P 500 3Q Earnings: The 3Q earnings season has only 13 S&P 500 companies scheduled with the majority either technology or retailers. With 95% of companies reporting, 84% and 78% have beaten earnings and sales estimates, respectively. According to FactSet if 3Q ends with an 84% beat rate on earnings, it would tie the highest level recorded since they began tracking in 2008. 3Q blended earnings (combining actual results with estimates) improved to -6.3% from -7.1% year-over-year (Y/Y) last week and -20.5% to start the earnings season. This improvement last week was primarily driven by better earnings from consumer staples and consumer discretionary. Consensus earnings estimates for 2020 and 2021 increased last week. In case you missed it, our detailed analysis of Berkshire Hathaway 3Q earnings is here.
· Europe: Eurozone COVID cases accelerated again but remain below peak levels. Restrictions across much of the globe have impacted dining with a-55.8% decline from the global baseline. Italy and Spain continued the decline in the weekly infection pace, but Germany and France accelerated again though below peak levels. Eurozone November PMI readings for manufacturing and services declined to 53.6 and 41.3 from 54.8 and 46.9, respectively. The U.K. pace of infections continued its decline and may have turned the corner. U.K. November manufacturing PMI fell to 55.2 from 53.7 while services plunged to 45.8 from 51.4. Please see our U.S. Reopening Monitor for international COVID charts.
The increase in cases and restrictions are weighing on dining across the globe.
· Asia: October China industrial profits are on tap with the September reading at 10.1% Y/Y. Japan COVID cases rose sharply with the weekly pace of infections hitting another all-time high. Japan November manufacturing PMI retreated to 48.3 from 48.7 and the services PMI fell to 46.7 from 47.7.
· Central Banks: The central banks of Pakistan, Ghana, Nigeria, Sri Lanka, Mauritius, South Korea, Sweden, Kenya, Angola and Colombia are scheduled to meet with Sri Lanka expected to cut their policy rate by 0.25%.
Week in Review
· Stocks pulled back by -0.8% for the S&P 500 with only four of eleven sectors higher for the week. Energy (5.0%), materials (1.1%) and industrials (1.1%) outperformed the S&P 500, while utilities (-3.9%), healthcare (-3.0%) and real estate (-1.6%) were the biggest laggards. WTI (5.0%) and Brent (5.1%) oil were higher with MLPs (7.6%) and the energy sector (5.0%) outperforming.
· Large cap value as measured by the Russell 1000 Value outperformed at 0.1%. Banks outperformed as well with the Invesco KBW Bank ETF (KBWB) higher by 1.0%. High dividend strategies outperformed the S&P 500 with the iShares Select Dividend ETF (DVY) rising 0.5%. Momentum outperformed with the iShares MSCI Momentum ETF (MTUM) remaining almost unchanged for the week. Small-cap stocks outperformed relative to the S&P 500 with the Russell 2000 higher by 2.4% and small-cap value stocks outperforming at 2.7%. The 10-year and 30-year U.S. Treasury yields were lower at 0.82% and 1.52%, respectively.
· High yield credit spreads narrowed reflecting increased risk appetite. AAA municipal bond yields as a percentage of Treasuries fell, causing municipal bonds to outperform. The negative revenue impacts of the economic lockdown on local governments and talk of state bankruptcy have driven municipal bond valuations to low levels relative to Treasuries. Between the strong 3Q economic rebound and Federal support so far, states declaring bankruptcy remains an unlikely outcome. Additional support for the states is likely to come in any future stimulus bills, but one of the sticking points to a new deal is the size and distribution of Federal government aid.
· The U.S. dollar was weaker against both developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in U.S. dollar terms (1.9%) and on a hedged-currency basis (1.3%). MSCI Japan outperformed the S&P 500 returns in U.S. dollar terms (2.2%) and on a hedged-currency basis (1.5%). Emerging market stocks outperformed the S&P 500 with a non-hedged return of 1.8% for MSCI EM.
· The 10-2 yield curve narrowed to +66 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield declined slightly to +15 basis points. The yield curve has historically provided an accurate forecast of future recessions when the difference in these measures turns negative, also known as inversion. Yield curves are one of the major indicators that we monitor to judge recession risk, but these inversions typically happen more than a year in advance of an economic recession. External shocks like the current coronavirus-induced recession might not be accompanied by inversion. Stocks have historically had significant advances post-inversion.
Our detailed analysis of Berkshire Hathaway's investment portfolio from the 3Q 13-F filing is here. The PDF version of Stone's Weekly Market Guide is linked here. The Guide to the U.S. Reopening Monitor is linked here. The weekly update to the U.S. Reopening Monitor is linked here.
I appeared on a number of shows last week:
- Watch a fun discussion on CNBC Worldwide Exchange here
- Listen to the Money Life Show here
- Read a quote from CNBC.com here