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Y H & C Investments Monthly Review: May 2020- Edition 142

Economic & Financial Markets Outlook-As the U.S. Economy Starts to Reopen, How Quickly Will Employment Recover?(Y H & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research possible investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)

In April, the Dow Jones  Industrial Average gained 13.69%, the S&P 500 rose  15.26%, and the NASDAQ grew by 18.78 %.  With the United States economy going on six weeks of being locked down with a stay at home order, May unlocks the first shackles off it’s citizens as 15 states will open their businesses in a restricted way tomorrow.  As we get deeper into May, the rest of the states will follow in a phased opening.  The repercussions of the stay at home order have been broad and deep, and estimates are that over 30 million workers (over 20% of the total labor force) will be out of work by the end of the month.  Not good, not good at all.  The job losses are especially significant in the service sectors of the economy, considered the backbone of employment.  Industries like restaurants, bars, hotels, housing, casinos, health care, and real estate are under massive dislocation.  Throw in the grim situation in energy, and you can see why so many economists are really worried about how deep and long this situation will last.

The massive injection of government capital to create band aid programs for providing bridge capital to these distressed areas is quickly being distributed.  The Treasury Department has created these band aids with the sole purpose of helping businesses get to the other side of the lock down.  How effective it will be in  preventing permanent  job losses remains to be seen.   The Federal Reserve has also stepped in to provide support, meaning buying, of many different parts of the bond market, including municipal bonds, commercial paper, and even corporate bonds.  These measures offer liquidity to financial institutions needing an outlet for their securities in an effort to stem potential liquidity issues.  Further down the road, the trillions of dollars being spent creates a budget deficit issue that only adds to our nation’s fiscal debt.

For investors, the question of an economic rebound rests in part on how much success the country has in seeing national and statewide infections and mortalities recede.  At the same time, testing capabilities need to ramp up and the ability to monitor and analyze potential sources of outbreaks are part of the plan to handle the virus.  How good the execution is and whether the public trusts these measures will determine the public’s confidence in reopening the economy.  Usually, small successes leads to confidence which can lead to greater success.  Start with minimal openings, make sure very few people contract the virus, and gradually move into more businesses and public areas opening.  The question of how quickly businesses bounce back is state specific and dependent on governor decisions.  The different approaches are based on the severity of restrictions, with most Democratic governors opting for a longer stay at home period.  Republicans governors are more eager to open their economies.  With economic pain being felt in local and state municipalities, job losses, budget cuts, and salary cuts are all on the table all over the country.  The lockdowns will be lifted sooner or later, if only out of self preservation.  It is difficult to see how the U.S. economy recovers in a V- shaped or W- shaped trajectory.  Pessimists see a U-shape with no upswing, more like an L shape.  It is probably more realistic to expect a long, slow, gradual recovery.  The caveat here is history has proven it pays to bet on the U.S. economy and entrepreneurial spirit.  We know one person who is betting on it, and his initials are DT.

Global Economic & Financial Markets Outlook-! (All country index data provided by countryeconomy.com, March 31, 2020.)

The Corona Virus pandemic continues to infect global equity markets.  With most major economies shut down or dramatically impeded, equity investors face never before seen challenges in evaluating the future prospects of a wide range of industries.  With consumer related sectors and energy usage dramatically impacted by the shut down, job losses, and the closure of international borders to travel, the important issue of public health continues to take priority from the ever cautious and always cover your posterior politicians.  Let’s take a look at some of the country results to get a better indication of where markets have been, and maybe where they are headed.

In mature countries, the UK’s FTSE Index is down 21.70% for the year, but rose 6% in April.  A similar result exists in Germany, with the DAX down 18% for the year but ahead by 10.65% for the month.  Ditto for Greece, Portugal, Italy, and Spain (down 31.4%, 17.84%, 24.74%, and 27.51% for the year, ahead by 12.45%, 7.56%, 4.85%, and 3.94% in April).  Canada’s TSX only lost 9.32% so far in 2020, and had a strong month as well, rising 19.19%.  Turning to Asia, the losses weren’t quite as heavy but the pattern was similar.  The Shanghai Exchange is down a measly 6.23% for the year but rose 4.11% in April.  The Hong Kong Hang Seng retreated 12.58% so far, but rose 4.94% in the last month.  Japan’s Nikkei also is in the red for the year (-14.64%), but saw black in April, gaining 5.81%.  In India, we see the same thing, down 18.97% for the year but put up a strong number in April, rising 19.07%.

Looking ahead, central banks are following the Fed’s lead with a do whatever it takes attitude to provide enough liquidity for credit and equity market participants.  The first task is finding a way to effectively address the public health issues so economies can open.  Once businesses are open, the service sector can slowly begin to recover, and then travel and energy would follow suit.  Of course, as the global economy is in unfamiliar territory, it is probably best to be very patient and very observant.  Pay attention to everything is a prudent course of action.

The Art of Contrarian Thinking- The Epitome of A Contrary Investment Thesis! (YH & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research possible investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)

It is well known in the investment world that in order to generate better returns than the market, an investor must allocate capital in a way which is clearly different than the passive indexes (S&P 500, Dow, Nasdaq).  You may see a high profile money manager get interviewed and asked about what companies he recommends owning.  They will discuss their supposed unique idea of Amazon, Microsoft, or Facebook.  All are great companies and are growing quite quickly for such large enterprises (in the most recent quarter, Amazon grew revenues 26% and Microsoft’s cloud division grew nearly 60% year over year).  News flash, you don’t need to be a good business analyst to know these are already great businesses.  All have already gone up 10, 100, or 1000X already.  The horse is already on the track.  Instead of buying the names every investor knows and make up a large percentage of major indexes, looking for what is detested or ignored is what a genuine contrarian does.  The risk is your position turns out to have business problems where you wind up with a permanent loss of capital, or more probable, a no growth business.  Let me offer up one area of the market which I believe is the epitome of a contrarian view.   Yes, you know it, you hate it, the world hates it, the artist known as the energy sector.

Let’s start by saying we have been investors in the energy area for over twenty years.  The last ten years have been brutally bad.  Clearly it is as hated and unloved as any time in it’s history.  When a sector is this out of favor, the price is cheap.  Let me repeat that important idea, the price is cheap.  With investing, the price you pay is critically important.  It is always a key consideration in my investment process- what am I paying for the business versus what am I getting?  What else is important?  Within energy, oil and gas is the most hated area, while the alternative segment is adored.  The demand destruction by the pandemic has led to an oil glut because of idled airplanes and reduced automobile usage.  The Saudi-Russia tift has not helped either.  Why invest now?  Over the next twenty years, if you are going to travel in almost any way (car, plane, train, ship, RV, off road vehicle, motorcycle, helicopter, jet-ski, etc) you are going to probably use some form of oil.  Oil is also the source of important products like drugs, plastics, PPE masks and clothing, petrochemicals, and lubricants.  Basically, when the economy opens and every day activities like driving cars and airplane travel resumes, demand will improve.  Many energy companies will not survive the next 18-24 months, but those that do will become much larger entities.  There is a good chance they will snap up prime assets at attractive prices, or buy other competitors.  Also, reduced capital expenditures on current projects will limit future production.  It is often the case that when it is very hard to make the investment, almost to the point of physically making you ill, it probably is a good decision to invest.  Of course this depends on the business and it’s quality, and you have to turn over quite a few rocks to find what you are looking for  Still, energy is currently a situation to consider, although it has been quite a poor performer for a long time.  Thanks for reading the monthly newsletter.

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(Y H & C Investments may have positions in companies mentioned in this newsletter. It is the responsibility of each investor to research possible investments mentioned so they can decide on the appropriateness and suitability of the investments consistent with their risk tolerance, risk constraints, and return objectives)

 

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