Chairman’s Letter Q2 2020

A summary of our economic situation at the rise of the pandemic.




July 1, 2020

Well that feels better! Portfolios have shown a sharp snap-back as quickly as they plummeted in the early days of the Pandemic.  While we are thankful that the reports attached are much improved from the first quarter, we want to assure you that our eye is still very much on the risks and rewards that are always prevalent when investing. 

The investing landscape is still fraught with what I would describe as the most diverse mixture of exceptional and highly variable factors that need to be considered to forecast the future. And yet, Mr. Market has recovered most of its losses despite the general consensus that the market has rarely been worse in economic history than right now. 

What gives?

The good news that is clearly lifting investor spirits is that governments have thrown a lifeline to everyone and that has mitigated, to some extent, the devastating impact of shutting down economic activity. As J.J. points out in the accompanying Big Picture, economic activity is snapping back sharply from exceptionally bad readings. The quandary remains; how long will it take to recoup the losses of this devastating period? Looking at past deep recessions would lead one to expect that it could take 2-3 years of further stimulus from governments and rebuilding from businesses and consumers to regain all that was lost. Presently, equity markets seem to be agreeing with fairly optimistic timelines. Further setbacks in reopening the economy because of continued outbreaks of the virus could dent that optimism and progress.  

Further good news is that some businesses in your portfolios are experiencing minimal negative impacts from the virus and some are outright winners. These “Kings of Capital Markets” (Amazon, Apple, Facebook, Google, and Microsoft) have roared back and soared to record highs. Lifting not just your portfolios, but for the most part being the sole stocks lifting markets, period. A few other ‘rocket ships’ are helping boost the market as well, but it’s the Kings that count. 

The following matrix tells the inside story behind the headlines of booming markets. What they show is that investors are not valuing all stocks in the same manner. Clearly big is beautiful and is valued very highly. Small is out of favour and looks relatively cheap but, it is still out of favour. Not everything is up, and indeed most are down and by quite a bit. 

The headlines are telling one story, but the inside story tells a more conservative and potentially a more constructive view toward better returns ahead. Markets may be high, but the disparity of valuations is huge. 

JP Morgan is a top 10 company but because it is exposed to hurting businesses and consumer loans (along with all banks) it remains down 36% from its highs (in line with most bank declines). Most economically sensitive companies are still struggling and giving warning signs that while it’s getting better, it’s still bad. Although the economists are hopeful and brokers are chirping happy days, the people who run businesses and those of us who buy their products and services are a bit more circumspect. 

Clearly, investors are discounting some type of trouble with quantifying when and to what extent the recovery will lead to better prospects for earnings. Many question the extent of the rally we have witnessed but as with all things, a little investigation like the matrix above shows that not everything is up and in fact a lot of good companies continue to be depressed.  We remain hopeful that the optimists are correct but rest with a conservative stance knowing the businesses we own are prudently financed, sensibly managing their businesses, and are focused on building long-term shareholder value. While we own the Kings of Capital Markets, we also own some outstanding companies that are still depressed for now, and we have cash ready to deploy should the optimists prove early in their prediction of a rosy future.

As always it is our privilege to be a trusted advisor to you and your families. We wish you continued good health and look forward to seeing you all soon under less constraining circumstances. If you would like to speak to me or any of the fine team at Davis Rea, we are here for you.