Dennis C. Butler, President
of all guest columns written by Dennis C. Butler, CFA
ost of the time we go about our business not thinking very much about dangers lurking in nature, beyond those that can be controlled by normal sanitation, hygiene, and a decent respect for our fellow creatures. But in the space of less than three months an amoral and lethal natural force that knows no boundaries of any kind has swept across the globe rendering even the most normal human interactions potentially dangerous. At the time of this writing fully 30% of the world’s population is subject to lockdowns because of the Covid-19 pandemic, and some governments have forbidden their citizens to venture forth from their homes in groups larger than two, and then only for essential purposes.
Since businesses are people, commercial activity began to decline rapidly as individuals en masse avoided contact, put off vacations, and postponed dental appointments. As the extent of the infection became better understood, governments began to shut down non-essential activity, bringing about the economic equivalent of an induced coma designed to put business infrastructure into a stasis mode until the disease is brought under control. These drastic but necessary measures mean that economic statistics will soon look ghastly — already unemployment claims in the U.S. skyrocketed to over six million in the latest report, a record number. Some projections call for unemployment rates in the U.S. to reach as high as 30%, meaning fifty million people without work, very quickly. The global economy appears set to suffer its biggest setback since the Great Depression, with growth almost certainly turning negative for the year.
In the face of such dreadful prospects, countries are also taking steps to preserve their citizens’ well-being, providing support for employees, small business owners, and contractors who suddenly find themselves without incomes or hope of finding alternative jobs. Large businesses as well, such as the airlines, in dire straits due to the shutdowns, will also receive public support. Fortunately for sovereign borrowers, interest rates remain quite low, in some cases even negative, so the financial resources necessary to cover the enormous expenditure that is required (the U.S. has so far approved over two trillion dollars in assistance of various kinds), appears to be readily available. And even in usually fiscally conservative countries such as Germany, the health and economic emergency has motivated all political factions to join in supporting measures totaling about 20% of GDP (the American program comes to about 10% of our annual domestic product.
At the forefront of efforts to contain the worldwide economic fallout from the pandemic have been the world’s central banks. The banks in the U.S. and European Union moved aggressively to lower interest rates, and both have pledged unlimited support for their respective economies and financial infrastructure. But the banks have long stressed the limits of their power to reinvigorate economies. Although it has taken a monumental crisis to incentivize action, fiscal stimulus measures to promote recovery after the crisis passes may also be in store in the form of massive government spending on long-needed infrastructure projects. With interest rates being what they currently are, almost any investment in public goods can be profitable to societies in the long run. That such measures are being seriously discussed at this time proves that, in a crisis, we are truly all Keynesians.
The sheer magnitude and uncertainty of the current situation, the realization that this is a different kind of menace perhaps not readily amenable to the usual ameliorative efforts, convulsed the financial markets. Investors raced to the safety of sovereign bonds and fled riskier paper, such as “high yield,” or junk bonds. In the US, stocks fell by about a third in the space of a month. Similar routs occurred worldwide, and behind the scenes far from the public eye, financial strains began to appear, necessitating massive central bank intervention in money markets. The stresses have not, so far, been as severe as in 2008, but they serve as a stark reminder of how quickly confidence in the core systems of finance can erode in the face of fear and uncertainty.
After what has happened it is hard to believe that in mid-February the U.S. equity market averages peaked at all-time highs. The subsequent collapse was epic: the Dow Jones Industrial Average had its worst first quarter ever; in March the S&P 500 suffered its worst month since 2008; foreign markets fell over 20%. The Dow also suffered its sharpest single-day decline, off nearly 3000 points on March 16. This is the stuff of market lore that will be talked about for years. It is testimony to the viciousness of the panic that the S&P fell 34% between February 19 and March 23, the quickest selloff of that magnitude in history. Subsequently, however, the Dow Jones Industrial Average rose over 11% in one day, the best one-day rise since 1933; the S&P gained 9.4% in one trading session, its best daily gain since 2008. Such steep moves, though bewildering to the casual observer, are not unusual when markets are shaken by fear. Also typical of emotional market situations are those sudden shifts that defy the prevailing market sentiment. As Jillian Tett of the Financial Times reported in a well-timed piece on February 20 (in other words, at the market top), two-thirds of those responding to a survey had expected stocks to continue their climb to more new highs. Such bullishness exceeded that of early 2007 and corresponded to equity valuations that were at their highest level since the dotcom bubble. We have no doubt that at the bottom of this cycle (at a date to be determined in hindsight), expectations will be just as determinately negative as they were confidently positive at the top.
Since the Financial Crisis twelve years ago, investors have been spoiled by long periods of calm markets, rising stock prices, and falling interest rates (or rising bond prices), so the recent market action should serve as an important reminder that disturbing declines and sudden reversals of attitude are nothing new — we have all been here before. As difficult as it may be at these times, it is critical that investors keep matters in perspective. While down significantly from their highs, U.S. stocks are still above the lows reached relatively recently at the end of 2018 — such has been the strength of the advance over the past year — and valuations are nowhere near as compressed as they were in the early 1930s, or during any of the major downturns since. While it is tempting to think that with the selloff, stocks are attractive — and in some individual cases they are — on average they are not especially compelling. After markets have stabilized somewhat, as they did toward quarter’s end, it is also tempting to pronounce the market crisis over. In late 1929, after the October crash that year, stocks began to recover toward previous highs, leading some to conclude that the turning point had been reached, and that sentiment would return to its prior bullishness. Immediately thereafter began a sickening decline that took the averages down to total losses of about 85% by mid-1932.
At this point no serious observer, including ourselves, expects a 1930s-style calamity; the massive fiscal and monetary programs now underway should mitigate against a contraction of that magnitude. Nevertheless, it is wise to be mindful and respectful of what markets are capable of doing. Used with care they can be the source of great benefit, but like the corona virus, they are impersonal, amoral, and apolitical, and certainly not your friend. It is also very important not to let them do your thinking for you. At the extremes, people are inclined to make the worst decisions — to buy when markets are bullish and sell when bears are prowling, out of fear of missing out on more gains, or of losing more after declines. All things being equal, the appropriate response is to do just the opposite. When skies are blue, the road ahead clear, all around the world is in bloom and markets are rocketing higher, that is the time to sell if you wish to do so; buy when no one sees hope for the future and prices are heading down. It is best, however, for investors to ignore the markets entirely and buy businesses that they want to own (such businesses are seldom sold), when the numbers are attractive. Acting rationally, you will have fewer regrets; the market will go on its merry way regardless of what you do, and securities will invariably rise in price after you have sold them and continue to fall after your purchases. “Shoulda, woulda, coulda” is an occupational hazard in investing.
A final word from our perspective: people do recover from the corona virus. It will not wipe out the human race. Markets will recover in due course, as they always have. Whether a pandemic or a bear market, in the midst of a crisis it feels like things will never get better. But it is unwise to let the current darkness cloud your judgement, as many in our grandparents’ generation did after the Great Crash, when, by shunning equity investments out of fear, they failed to participate in the stunning growth in wealth that followed. At such times it’s wise to recall an overlooked aspect of the 1930s experience: after that devastating 85% loss, U.S. stock prices multiplied by about five times in the middle years of that decade. Not all is lost.
No one, including us, knows what the financial markets will do going forward, but that is not a subject for productive inquiry in any case. It is far better to concentrate on acting rationally in a manner that current circumstances require, and in accordance with basic principles, the chief of which is one of attitude: we own businesses and do not trade stocks. We believe this gives our efforts an advantage in the face of panic — stock prices may fluctuate wildly, but good businesses endure.
If the present market instability continues it is likely that we will have new opportunities to deploy our capital, in both the equity and fixed-income spheres. Mistakes will be made, especially in an environment as unusual as the one we are now living through. But buying assets from distressed sellers, at sharply lower prices, and offering higher expected returns, has worked well for us in the aggregate in the past. We believe the future will be no different in this regard.. ________________________________
Dennis C. Butler, CFA, is president of Centre Street Cambridge Corporation, investment counsel. He has been a practitioner in the investment field for over 33 years and has been published in Barron’s. He holds an MBA from Wharton and a BA in History from Brown University. His quarterly newsletter can be found at www.businessforum.com/cscc.html.
“Current low valuations reward the long-term view”, an article by Dennis Butler, appears in the May 7, 2009 issue of the Financial Times (page 28). “Intelligent Individual Investor”, an article by Dennis Butler, appears in the December 2, 2008 issue of NYSSA News, a magazine published by the New Yorks Society of Security Analsysts, Inc. “Benjamin Graham in Perspective”, an article by Dennis Butler, appears in the Summer 2006 issue of Financial History, a magazine published by the Museum of American Finance in New York City. To correspond with him directly and /or to obtain a reprint of his featured articles, “Gold Coffin?” in Barron’s (March 23, 1998, Volume LXXVIII, No. 12, page 62) or “What Speculation?” in Barron’s (September 15, 1997, Volume LXXVII, No. 37, page 58), he may be contacted at:
Dennis C. Butler
Centre Street Cambridge Corporation
Post Office Box 390085
Cambridge, Massachusetts 02139
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Revised: April 10, 2020 TAF
© Copyright 2020 Dennis C. Butler, All Rights Reserved