February 18 Town Hall Transcript
Hello everybody. This is Mike Hengehold and thank you for joining us today. With me today is Doug Johnson, as usual. Doug of course is one of the partners here at HCM, and he chairs our investment committee. So he's the answer man when it comes to the portfolios.
Just briefly, the administrative items to talk about: if you have a question there is a Q&A button at the bottom of your screen. If it's not there, if you go down on hover, it, it should appear. If you would like copies of the slides that we're going to go through, you can request those and we'll send those out to you. And finally, we should have a replay of the event, up on our website, with a little bit of luck by midday tomorrow.
The main theme of our discussion today is going to be recovery. We've been talking about pandemics and things now for a year. And finally, with the vaccines rolling out, we get to talk about recovery. We're going to do that, and we're going to talk about the signs that we see amongst the population and as well as in the markets. One of the surest signs that recovery is on its way is the fact that people want to travel again.
Apparently, cruises are a popular item among HCM clients because I've had, at least, if not more, half a dozen people ask me, in the last couple of weeks, if it's safe to travel again, and if booking a cruise is a good idea.
The first part of the question goes way beyond my pay grade, whether it's safe to travel again. But, I did do a little bit of homework on the subject and the simplest thing to do is to go to the CDC website, which I did. And I double check this again this morning. And the CDC is suggesting that people stay away from cruises, both ocean cruises and the popular European river cruises.
The reasons given are all the ones you would expect, primarily because cruise ships are floating Petri dishes. That's not exactly the quote from the CDC website, but it's not far off. Is it a good idea if you were getting ready to set sail today? Probably not. Looking into the future, let's talk about a couple of other items.
If the whole CDC thing doesn't bother you and you're not particularly concerned with the health issues on board, the first thing to do is make sure that you have two good types of insurance. The first is obviously medical insurance that has good travel components, that will take care of you wherever you are, and make sure that it covers COVID, because not all policies do. The second is a good travel policy. These are expensive. People oftentimes turn them down thinking, “it's just money I don't need to spend.” However, particularly in the cruise industry, the cruise companies have been stressed financially as a result of the shutdown and their huge capital costs they have to maintain whether they're sailing or not. So they have a lot of financial problems right now. You want to make sure that if something happens and either because of these virus variants, or you are simply uncomfortable sailing at the last minute, that you have a way out and you're not going to be penalized financially.
I read an article just recently about Viking cruises. Viking, of courses is a premier cruise line in Europe. They have both ocean cruises, and they of course became popular with their river cruises. They needed to raise capital and they had to go into the junk bond market to do so. The rates that that their bonds were selling at were, were approximately a 15% interest rate. So it tells you that's a high risk credit, and those risks are pervasive throughout the cruise industry.
Make sure you have good coverage there. In terms of when cruises are going to start, they're scheduled to begin again just in a couple of weeks. March 1st is when business opens up; however, a number of the cruise lines, especially the most popular ones names you would recognize, have elected to push that back weeks or even months. Some by the cruise line itself, and some are by individual ships. But the point is it is starting. When the cruises do start, it's expected that the ships will be about 50% occupied. They're using advanced bookings obviously to control that. And the expectation is that the population on board will grow to about 90% by the end of this year.
And by the beginning of 2022, we will have probably chronically overbooked cruise ships, assuming that we don't have additional health issues because people are going to be itching to get back out there.
So, what are some of the safety precautions? Well, many of them are the ones you would expect, they're going to be the same on boat as they are on land. Passengers will be required to complete health screening questionnaires before they go on board. And this is the one that took me a little bit by surprise: passengers will be required to take a PCR test immediately before boarding.
For passengers who were in Europe or, or if you travel with the cruise company ahead of time, and you're staying in a hotel the night before your cruise, you'll be tested in the hotel. Otherwise you'll be tested ship side and the results of these tests can take three or four hours to come back.
So it's going to be a confused delay period while these results are obtained, same thing when you're disembarking, you'll take the same type of test. You also have to be aware and respect the policies regarding quarantine for the countries that you'll be going to. That's an issue that everybody's going to have to pay attention to.
Obviously, the boats all are going to have (early on anyway) masking requirements in all of the public areas, hallways, etc. Restaurant tables will be pushed further apart so people can respect distancing all the regular things with hand sanitizing. Contac-less activities, to the extent that it's possible, will be done. And, for the first part of the year, at least, up through October, I believe, no US cruises are allowed to last more than seven days. So, those are some of the differences that we were able to dig up. Between what people would have been accustomed to in the good old days. Also, Congress passed a law called the Cruise Passenger Protection Act, it had a couple of requirements. These are not particularly disruptive, however, in fact, they're good changes on all ships. I had read in one place where it was boats with 250 passengers. Others seem to be all ships, but, you have to have a licensed physician on board who is trained in viruses, COVID, those sorts of things. Also, video cameras are going to be installed in all public areas so that the monitoring of people's mask wearing and so forth can be done effectively. So it's going to be a different environment, at least for the balance of this year, until everything gets figured out. there will obviously be a number of other, specifics that the industry will figure out as time goes on.
That's sort of an outline of what we were able to come up with. So now, Doug has a variety of observations and statistics and market observations about this sort of recovery concept and where we're going from here and potentially, whether or not we're getting ready to play game of musical chairs in the market.
Doug you're on.
Doug: Thank you. If you've been listening to these webinars or keeping up with our communications recently, we've touched on several themes that we believe will be additive to portfolios going forward. And one of these Mike mentioned earlier is this is this general idea of reflation.
We've talked a lot about how we get there. A big part of that is getting the COVID situation - I don't know about under control, because I'm not sure that it will ever be completely under control, but getting those trends to move in the right direction. So one of the main aspects of that is the idea of getting a vaccination out to the public that has high efficacy and is able to be replicated in large quantities.
So this is a chart that just came out recently, but shows from the beginning of all this, the total recorded cases in the blue line, and then the total doses of vaccinations administered, in the red line. So, for the first time, back in early February, we had the total number of doses of vaccinations eclipse the number of total cases recording. So, from a standpoint of, are we moving in the right direction, in terms of trying to control the best we can, the COVID situation. I think this is a significant milestone towards that. And, hopefully those numbers are only going to improve as we move forward.
Now, as we look at a variety of different measures, both going back 90 days, on the top section, and since the beginning on the bottom, we can see that testing has become, extremely robust. In the beginning of this was very hard to get a test. Now, you can get tested fairly quickly, by contacting your doctor. They even have rapid testing.
But what's striking about this now is you see the number of new cases, both over the last 90 days, and then since this started back in March. We've seen a significant reduction in new cases, almost a 50% reduction, over the past 35 to 40 days. And then if you compare that to what we've seen since the beginning of this, it almost looks like a freefall back to levels that we saw at the peak of that, second wave in the summertime. So that is a step in the right direction. Part of that could be a result of increased vaccinations. Some of it could be just coming out of the holiday swing, where travel has dissipated. but for whatever the reason, we're certainly moving in the right direction.
Looking at hospitalizations, the same trend is continuing. Right around that peak in early January, you've seen a significant drop off in hospitalizations, both over the past 90 days and since the beginning of the episode. Finally, the death count is starting to roll over. Usually deaths trail hospitalizations by I believe two or three weeks, so as this trend of hospitalizations continues to move down, we expect the death tolls to decrease as well. Getting this situation moving in the right direction is a big, big step in order to allow people to feel the need to get out in the economy, spend money, and do things that in the past and during lockdowns, maybe were not possible.
So, how does that relate to the returns and some of the asset classes that we've talked about? Well, here's a chart that goes back approximately six months, and if you've listened to or seen the communications that we've put out, three of the main themes that we've focused on in terms of asset class has been value specifically, small cap, and then international.
So, this shows the return of comparable ETFs back six months. As we pointed out, really the inflection point in this trade, if you want to call it that, is a reflation theme took place right around the time of the election. You had a split government initially seen as a good thing. The split government lasted about two months, and now we have full Democratic control of the government, but nonetheless, seen as very stimulus friendly. Right now I think we have a $1.9 trillion package that's on the table. They're working out the details of that, but as we look at the returns here, you have the Russell 2000 in orange, so that represents small cap, then below that you have the value factor ETF in purple, international ETF in blue, and then you have the market in green. Since that inflection point of the election, we've seen a lot of the themes that we've been touching on and that we've been positioning in portfolios, performing well and adding a tailwind to the strategy.
So, so far so good. Where do we go next? Now these charts here are a Rorschach test of economic data. Beause I think you can look at them and see different things. The first one is a measure of TSA checkpoint travel members. It's the seven-day average. And then the dotted gray line is a percent of the last year's measure. So if you look at the blue line, that is 2019 to 2020. So, think all the way back pre COVID. Numbers, very steady, up right around 2.4 million. That's, a significant number. So, we look at the red line. We see that drop off during COVID close to nothing. And then we've had a slow grind back and then a little bit of a plateau. Obviously, you've got a spike during Thanksgiving, and then Christmas, but now you're starting to see a little bit of an uptick as well. and you're starting to see the percentage of that number move up.
So again, some may look at this and say, wow, we're we haven't recovered. We're still not close. I think that's one way to approach, but I think the other thing is. There's still a lot of slack that that can be added. There's still a large gap from a optimal capacity, so to speak, and as we relate this to COVID and the idea that vaccinations will continue in case counts will continue to move lower. We will start to see travel pickup. You will start to see things like people go out to restaurants and you hopefully will see things like people staying in hotels again. All the things that before were taken for granted, as an engine of the economy, so to speak, now will have the ability to fill that gap, and begin to fuel growth.
Here is a similar chart. This is sourced from an app called Open Table, which you can go on and make dinner reservations. This breaks it out by state. Now this is clustered all over the place, and I think part of that is that different states have different rules in terms of dining, both indoor and outdoor. So, you're getting a big divergence in patterns here. But nonetheless, you're still quite a ways away from where you were when all this started. Restaurant industry, travel industry, there's still a lot of slack there.
And then lastly, we mentioned hotel occupancy. So again, the blue line represents 2000 to 2020. 2019, which was the previous worst year, since the great depression for hotel occupancy rate, and then you have 2020, which obviously was the COVID year and you can see the large dip, and then that red line right there, is 2021. So we're still well below capacity in those areas, and we think as things begin to open up, that trends will continue to move higher and we can see that as a multiplier effect in the economy, so to speak, to bring some of these cyclical sectors back into focus.
Now, one concern that's taken place with all this possible stimulus is the idea of inflation coming back with a vengeance. On the next slide, we'll touch on the rate aspect of it, but, in order to have inflation, you need to have too many dollars chasing too few goods. So, you need a lot of money in the system, but you also need something called velocity of money. So how many times is a dollar changing hands, so to speak. Now, this chart goes all the way back to 1960 and what it shows is the velocity is the blue line and it peaked right around 1995, 1996, 1997. And then since that point has slowly worked its way down, almost crashing at the beginning of the COVID situation. Meanwhile, M1, the money stock, has grown almost exponentially. It’s absolutely exploded during the COVID crisis, as the fed has just flushed the system with liquidity. So, when we look at this massive gap, there is a huge amount of money sloshing around in the system. Yet, for whatever reason, we haven't been able to get the velocity of money to increase. So, when you look at that large gap there, if that M2 can finally figure out a way to catch fire, we could really see the beginning of some inflationary pressures, throughout the economy. And many argue that you're already seeing them in certain places, asset prices, real estate prices, food prices, things like that. But the CPI, the inflation rate has stayed low for a significant amount of time.
As we see stimulus plans with money going directly into consumer's hands, maybe that's the start of seeing an M2 or a velocity number increase, and we start to see some significant inflationary pressures.
Mike: Can you just take it back for a second? So, the red line shows the money that's slopping around in the system. And we're about to add $2 trillion to that, not necessarily going into banks, but we're about to put more money into the system. And the blue line basically says, “Nobody really wants it.” Is that somewhat fair?
Doug: I think you could term it that way. I think another way to think about it is, as money has tried to find homes, literally and figuratively. You think about when you purchase a house, so the money goes in and then it just stays there. That is a dead end in terms of velocity, and in the same way that money goes into a portfolio, and unless you're actively doing things, they're taking it out and then spitting it into the economy. It stops, so to speak. So, I think that a lot of the money that we've seen going in the system has found its way into things like real estate and equities, and we've seen asset prices go up, but I think as the economy begins to open back up and we see goods and services become available again, I think we can start to see that flow of money going into places other than just assets. They can actually go into to goods and services to where I buy something from the small business owner down the street, he takes that money and buy something from somebody else, and so on and so forth.
Mike: Yeah, and we talk about inflation - the CPI basket of goods, some would argue is a little outdated, in terms of the things they measure, is interesting. I S I saw a statistic, just earlier this afternoon.
I'm going to get this somewhat wrong, but the point will be clear that. Lumber and building a house. It now costs a thousand dollars for a thousand board-feet of lumber for a house. And that's the most expensive it's ever been in history. Yeah. And anybody who's bought a two by four recently that used to buy them for $2 and now buy some for $8 can see that there's plenty of inflation in the system. It just doesn't happen to be in the things that are being measured here. And to some extent, we import deflation for around the globe through inexpensive labor from other countries, and that's had a massive impact on us for a lot of this chart that you see running down.
Doug: And I saw that as well. We are seeing pockets of inflation, certainly in areas of the market. It just may not be in the place that is measured by the fed and CPI. So one place you are starting to see it in the marketplace is with rates. So, you've got this going back five years. You have the purple line on the very bottom, which is the two year treasury, which basically is the rate that the fed controls, and then you have the orange line, which is the 10 year treasury rate, which the fed does not directly control. And then you have the blue line below, which is the spread between the 10 and the two year, also called the yield curve. And then the green line is a forward inflation expectation rate that's derived from the market. Since the beginning of the COVID crisis, you start to see rates and inflation expectations slowly moving up, and then over the past few weeks significantly, you now have the 10-year treasury at almost 1.3%. and then, while the, while the two-year rate has stayed fairly low and you have inflation expectations starting to move up.
So, we've talked a little bit about fixed income and adjusting, fixed income allocations, and trying to add some, some positions in there that, that are not as rate sensitive, to take some of the interest rate risk out of the fixed income side of the portfolio, and I think you also run the risk of inflation runs too hot, and rates move too fast, it could upset the market a little bit, in terms of how things are evaluated. Specifically, on the growth side, I think that the growth in tech assets, would certainly be more sensitive to an interest rate moving higher. If we start to see those things catch fire it wouldn't be unusual to see rates continue to move higher, and in some instances almost put the Fed’s feature the fire, in terms of trying to raise rates to quell that if they need to.
So we've had a lot of questions and comments about the speculation, and risk-taking in the market right now. I want to go through a few slides that confirm that. Here you have a Panic-Euphoria model from City Group. It’s hard to see, because it almost goes off the chart here, but that red line with the question marks shows that the euphoria level is almost historic. Going back to at least 1987, the one on the right you have a net percentage of investors who are taking higher than normal risk levels, and that's touched to a record high, going back to 2001.
Here are charts showing that penny stock volume has exploded higher over the past year. In addition to total options volume, which has moved up significantly while S&P 500 volume has stayed in pretty much normal range after some increased volume at the end of 2019.
And then, you see the word “mania” on here, but this chart is self-explanatory. This is small trader call, buying, volumes. So, call options are basically just leveraged bets on positions to increase in value. When we think of small trader they're buying and lots that are below a certain number, maybe five or 10, contracts. But you can see that, since the pandemic started, you've had this absolute explosion in speculation, through options. I'm sure everybody followed the GameStop situation. This was a portion of that. But the option activity there is absolutely unprecedented. And then finally this chart does a good job of showing the sign of the times.
So this is the Goldman Sachs‘ non-profitable technology impact. It's just a basket of US-listed companies that they say are in the innovation industries that are optimized for liquidity and weighted with nothing greater than a 4.6-5% waiting. So you can see this goes all the way back to 2014, pretty innocuous., up to right at the end of 2020, and it just absolutely explodes higher, almost an absurd rate. Seeing this, it almost looks like a penny stock chart, to be honest. So these are companies that are, they're currently making absolutely no money, but are selling the idea of innovation and things that are concepts that are significantly out into the future.
Now, not all of these are going to fail. Some of them will turn into significant businesses, but any line that goes parabolic like that, in an industry where the companies aren't making any profit, there's certainly signs of a little bit of a froth there, And we've talked a lot about technical indicators that we've seen, that show the market in a little bit of an overbought posture over a short-term timeframe. A few weeks ago we took the opportunity to take some profits because of that, and quite frankly, that hasn't necessarily been worked off yet, and we're still waiting for that to take place. There is a fair amount of speculation in the marketplace right now.
And those charts bear that out, so to speak.
Mike: So Doug, with the speculation and words like “mania,” I look at this, and I'm old enough to say, “Can anybody say the dot-com bubble?” Looking at that thing run off the chart, should people be running for the hills if there's manias and bubbles?
Doug: No, I don't think so, because the amount of support you're getting from the Fed and from the stimulus right now, has put a little bit of a, I don't want to say a floor under the market, but the bare market situation, the type of trading that we saw after the tech bubble burst, it's hard to envision a drawdown like that with that level of support. Some of the names that have been running significantly over the past year are still decent companies: you have your Facebooks, your Amazons, these companies generate a ton of cash. So during the tech bubble, almost all those companies were wildly overvalued. Most of them didn't make anything, whereas here, it's a better mix. The other thing I would say is that not every part of the market is suffering from this type of speculation. A lot of the value sectors: energy financials, industrial materials, some of the cyclical stuff that is more economically sensitive, you're not seeing that level of speculation there. Those assets have shown some good growth recently, but they're probably still fairly valued to slightly overvalued. So it's always hard to time things like that as well. A saying that we've used before: every 20% bear market started as a 5% correction, but not every 5% correction turns into a bear market, and that's important to remember. You get to a point where there's signposts that say, okay, things are really starting to turn from correction to problems, but to front run that is a tough proposition.
Mike: So the Fed has some objectives, one obviously dealing with employment and other dealing with inflation. We have a long way to go with the unemployment rate as some of the charts you've shown us indicate where we've made a lot of progress from the bottom, but we've got a long way to go. And, with inflation, they've seemed to indicate that they're willing to let things run hot for a while in order to make sure we're on solid footing.
With that said, and words like “mania” and some of these extremes we've seen what would be, (and let me just say at the beginning, we absolutely regularly tell people we can't predict the future), but understanding what markets typically do, what would not surprise you in the way of market volatility going forward? And what do you think would allow us to keep our base case recovery scenario, even for these select equity groups that we've already talked about.
Doug: So, going back to the beginning of the presentation, the trends in COVID are an important aspect of that. That holds the key to everything else being able to function properly, and if you didn't get any indication from the fed that there was any tightening on the way, or if the stimulus package wasn't a complete bust, everything that we see now would lead us to believe that you're going to see some volatility over the next few months just because the path we’re on is probably not sustainable, at least in its current trajectory.
So the two ways that you get that to work itself off are through a price correction, which is exactly what it sounds like, where the prices correct and move lower by anywhere from five to 15%, or you see something called a price consolidation where the market just moves sideways, over the course of weeks or months, and doesn't necessarily have to fall off a cliff, but some of that excess is it's worked off, over time. So that normal volatility is healthy, and it's part of markets, and sometimes we forget that because we've been through a timeframe where we've had very little of it, even before COVID started 2019, same situation at the very beginning of the year.
We just had so many days where we didn't have big volatility moves, and then all of a sudden, a few happened out of nowhere, and it took everybody by surprise. So I think volatility can be a good thing, and in this over the next few weeks, if we see things settle down a little bit, it will probably present an opportunity, as long as we don't have any of those other things, in terms of COVID stimulus, fall apart.
So we're butting up against time here, but I wanted to get to one or two of these questions that came in. One was: as we see the speculation aspect of things, and if we wanted to make adjustments to portfolios, what would be the best way to add asset classes to that? Would it be things like gold, Bitcoin, cash, real estate, and what assets would look the best there?
In a situation like this, and this certainly isn't a recommendation to raise a large amount of cash, unless you're really uncomfortable with the situation, but cash and long-term treasuries are normally going to be your best hedge against equity volatility. A lot of times we think gold is, but gold is more tied to the concept of a real yields and real rates. So, even though we've had inflation pressures come up, you haven't really seen the price of gold go up substantially. In cryptocurrencies, you're in between the world of some functionality. some institutional adoption, and then also some speculation there. So, I wouldn't certainly expect those to be a safe haven in a time of a time of a sell off. I'd always recommend going to the normal cash and in longer-term quality bonds if you're looking for a safe place to run.
And then one more that we had come in, a question about where we are in terms of our positioning, with regards to both value, small cap, and international. We've touched on those themes a lot, and I've even described them to clients in almost section.
If we think about where we are in terms of our value positioning, I would say we're pretty comfortable with that. It's probably our largest overweight right now. When we look at small cap, we've added a small position in small cap. In an ideal world, we could add some more, but with the trajectory and pricing within small caps recently, we’d just like to see that settle down a little bit.
We think it's gotten a little bit ahead of itself, and any pull back would offer the opportunity to possibly increase the small cap allocations a little bit. And then finally, international has also performed well, and we've had a standing allocation to international.
It falls into the small cap camp where we'd like to see a little bit of a pullback, a better entry point, but we do think there are opportunities in places like emerging markets. Specifically, the economies where the vaccine is going to have a bigger impact because the health care infrastructure isn't quite as robust as in the US, and then if we have a dollar that continues weaken in the face of stimulus and inflation, that would certainly provide a headwind to those assets. Those are the themes that we've started to add. We're probably not fully where we want to be with them, with the expectation that, once we get the opportunity that we expect over the next few weeks or months, we'll certainly look to add to those areas, when we get the chance.
So I know, Mike, we've run over, so I'll go ahead and throw it back to, and we can wrap this up.
Mike: Alrighty. thank you, Doug, and thanks everybody for participating in our call today. Unless news breaks between now and then our next call will either be March 11th or March 18th. Those are both Thursdays. We always try and do these on a Thursday. We're just looking at some internal scheduling to pick the date. So you'll be notified of that well, in advance.
As always, if you have any questions, as I said at the outset, if you'd like slides, transcripts, things of that nature, let us know, and we will get those to you.
If anybody that needs our help, let us know we'll help any way that we can. There are no strings attached to that, And that does it. Thanks everybody. Thanks for joining us. Bye bye.