September 17, 2020 in Articles & Newsletters | by Chris Pate


TNA Blog Second Quarter 2020

jcpenney3It is an election year in America in the 21st century. Given that Donald Trump is the incumbent, one might have predicted that things would get interesting. What would not have been predicted is that the election has nothing to do with why 2020 has already been one for the history books. Like virtually everything else in the lives of most Americans, politics took a temporary back seat as we grappled with the fallout from the coronavirus that causes COVID-19. When it comes to the virus news, if March was ‘bad’ and April was ‘worse,’ by July there are no accurate descriptors left, so we’re left with something akin to ‘weird.’ Parents of school-aged children, for example, may or may not be sending their kids to school this Fall, depending on where they live.

Among the myriad absurdities is a July 27th article from KXAN Austin noting that the YMCA will be holding tutoring-focused childcare over the next few months, for families with working parents that need assistance while schools are closed. The locations for these $195-per week sessions: the very elementary schools in Austin that are currently shut down. Differing mask mandates, travel restrictions, and quarantine rules are equally confusing.


Despite government-mandated lockdowns across the country, as of this writing the S&P 500 Index is back to the all-time highs reached in late February. Of course, anyone who follows their investments knows that the year’s volatility ranks behind only 2008 when it comes to market crashes during the past half-century. Leave it to 2020 to give us the steepest four-week market drop ever, followed immediately by one of the best ten-week stretches in history. Credit markets are still weaker than at the start of the year, but corporate high-yield bond performance has mirrored that of equities with an extended rally following March’s precipitous fall. Valuations across the spectrum would seem to indicate that all is well in the world.

A more informative dichotomy of winners and losers can be observed when parsing the performance of the corporations that make up the S&P 500 Index. Many companies have not seen their business materially affected in 2020. A number of technology companies and others in niche industries (personal exercise equipment, camping/outdoors consumer goods, electronics/gaming) are actually benefiting from the environment. But for every unaffected company or outright success story, there are horror stories of businesses – which in some cases took decades to build – being violently shaken in the days and weeks following the initial lockdowns in March.

commercial-airline-traffic2Some consumer-focused enterprises, saddled with high levels of debt coming into 2020, were already reeling before the virus knocked them out: Neiman Marcus, 24 Hour Fitness, Hertz to name a few. They are now going through the bankruptcy process as creditors fight it out in court. More shocking was the speed at which thousands of restaurants, airlines, cruise ship operators, hotels and other previously-thriving companies saw their financials decimated in March and April. The events of September 11, 2001, gave us a blueprint for what can happen when airline travel suddenly seizes up for a brief period, but COVID-19’s effects throughout the consumer and travel industries have been orders of magnitude greater.

meme2So what happens now? Does the virus eventually go the way of SARS and H1N1, and will our masks be gathering dust in the drawers this time next year? Or is COVID-19 going to be on our minds for years as everyday life becomes permanently altered? Opinions abound and vary widely, so rather than place bets on unknowns we would prefer to 1) recognize that unknowns will exist for a while and 2) formulate strategy in a manner that allows flexibility if/when volatility returns to markets. While 2020 seems like an outlier year, stepping back and taking stock of the past 12 years gives one an appreciation of just how many major events there have been. In the midst of this, equities have steadily marched higher as the zero-interest-rate environment has been an effective deterrent (punishment) for savers.

msci2At the moment investors are caught between the proverbial rock and hard place. The ‘rock’ represents investing in healthy companies, but at a price which in most cases represents all-time high valuations. The ‘hard place’ option necessitates taking a chance on cheaper companies that may or may not survive the next calendar year if the COVID-19 drama fails to come to a timely and quiet conclusion. Meanwhile, interest rates, after having come tantalizingly close to a meaningful figure of over two percent in money markets by the beginning of 2020, have fallen back to zero. Obvious solutions do not exist right now.

A common theme discussed internally and with clients over the past few months is that, regardless of exactly what occurs over the next decade, it is unlikely that global equity performance will match that of the previous ten years. Markets can and will gyrate wildly over short periods and mean-revert over long ones. Stock valuations today are not attractive when viewed in a historical context. Then again fixed-income prospects are not promising given the zero-interest-rate environment, which acts to funnel investment dollars toward risk assets like equities.

shiller-pe-ratio2This is a time when careful consideration needs to be given to the definition of diversification. While the S&P 500 might look expensive in P/E (price over earnings) terms, small-cap stock valuations are more reasonable. And even as high-grade bond yields hover at all-time lows, certain alternative debt investments have yields that could almost be called attractive. Real estate and venture capital, two industries that we have focused resources on over the past few years, potentially offer return streams that are differentiated from equities. Recent volatility has uncovered some attractive opportunities, but digging is required in an environment like this. The margin of safety in markets right now is also lower than it has been in recent years, which makes our job both more difficult and more important.

We do not take it lightly.

Q2 2020 Letter - Final_Page_08_Image_0002
Chris Pate
Managing Director, True North Fort Worth



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