Q2 Letter - 2020
HomeGoods has always been one of my favorite shopping spots. Not just to shop, but pre-COVID my wife and I would often go after dinner to simply peruse. If you’ve never been in one, the place is like Shangri-la. There is a massive selection and variety of products that you didn’t know you needed, the shelf velocity is so high that it’s like walking into a different store every visit, and of course it’s one of those stores where you can afford anything.
Needless to say, we were rather bummed to have our nightly stomping ground shutdown during the start of the COVID pandemic. We knew that the day it reopened, pandemic or not, we would be there. Tuesday night my wife ran to me, “my friend’s friend said the HomeGoods in Fremont is open.” Enough said, we were there by Wednesday. I was surprised that it was even open, since the County had announced just last week that we’d be pausing any reopening plans, but I was completely blown away by the amount of people inside. I could have sworn it was Christmas Eve.
No one is feeling any financial hardship
Despite the 3,600 businesses that have filed for Chapter 11 bankruptcy and 40 million who lost their jobs, the CARES Act has made the individual consumer filthy cash rich. It is allowing people to put off paying expenses, like mortgage and rent, while simultaneously backfilling any lost income with a bonus $600/week in federal unemployment benefits. In fact, a study out of the University of Chicago found that more than 3 out of every 5 people receiving unemployment benefits today are earning more money than did on the job. This flood of cash has empowered consumers to make home improvements, pay down credit card debt at the fastest pace ever, and splurge at places like HomeGoods. It is no wonder the stock market rebounded the way it did – despite entering the worst economic recession since the Great Depression of 1929, no one is feeling any financial hardship… for now.
The most recent reports show that 1 out of 6 mortgages are either delinquent or in forbearance, and 1 out of 3 renters did not make their monthly payment as of July 1st. Let’s not forget, forbearance only lasts between 90 to 180 days before unpaid amounts are due in full. The small business PPP loans expired last week, and the additional $600/week unemployment benefit will likely end for most claimants come July 31st. The economic data is also turning incrementally worse. States are backpedaling on their reopening plans, large corporations continue announcing planned layoffs, and it may only be a matter of time before the daily death count begins to increase following the exponential rise in new cases.
Our inability to stamp out COVID in May has fueled a resurgence of the first wave and all but guaranteed a second wave come fall. We think this will prolong the economic pain but drive Congress to pass a second fiscal stimulus package in early August. In turn, this will force the Federal Reserve’s hand in providing more monetary stimulus (aka print more money) to fund the fiscal stimulus. This is the bull market thesis in its entirety.
Monetary stimulus ➤ Excess in asset prices ➤ Fragility in the financial markets
If stock prices have diverged from the real economy, then what are they tracking?
Over the past quarter, excessive monetary stimulus has created excess inflation in asset prices. Unfortunately excess doesn’t just exist in the cosmos, it must be absorbed by the financial markets in one of three ways – the excess can be removed as prices drop, it can remain temporarily while company profits grow into those prices, or it can evaporate along with the purchasing power of the nation’s currency. None of these outcomes are especially good for investors, and history provides us with extreme examples of when a monetary program goes AWOL (the Roman debasement in 64 AD, German hyperinflation post-WW1, Japan’s lost decade in the 90’s, modern day Zimbabwe).
This is a rather existential problem that the Fed is creating, but one that we need not lose sleep over at this moment. Lucky for us, central banks across the world are engaging in monetary stimulus in response to COVID which helps level the playing field, and the US Dollar remains the preferred international reserve currency. As a result, we’ve had the luxury of running massive stimulus programs since 2008 with no real blowback (unlike Zimbabwe or Venezuela). But what would happen if the rest of the world recovered from COVID before we did, and we were the only ones left relying on stimulus? What would happen if our geopolitical influence in APAC waned, and the 15 countries in RCEP (the world’s largest trade pact formed in 2020 that notably does not include the US) began accepting the Chinese Yuan as an alternative currency? What would happen if the stimulus stopped?
The combination of a deteriorating economy and total reliance on stimulus, means that the Federal Reserve is singlehandedly trying to thread a needle between a total collapse in the high yield bond market and hyperinflation. With such polarized outcomes, we see market volatility rising in the second half of 2020. +/-1000pt DOW days will not be uncommon. Several of our valuation gauges are also indicating that stocks have reached their upside limit for the time being. Any further gains from this point on will have to be supported by additional stimulus.
If the Titanic is your only option, then do not forget your lifeboat – hedge appropriately
We do believe in the Fed backstop narrative. The additional stimulus, that we expect will come in August, will most certainly be a boost for asset prices, but this will only create further excess and fragility in the markets. Having blind faith that the few voting members of the Federal Reserve Committee will be able to make the right decisions at the right times is not a responsible investing strategy. Again, the consequences of missing the eye of the needle can be catastrophic.
In our strategies we are picking our winners and hedging the rest. We’ve added positions like Alibaba as a strategic play on the faster recovery of the APAC region, and gold as a hedge against the Fed’s reputation of being unsinkable. We’ve also maintained our short positions, while adding to high growth names that carry real equity growth potential.
As I stated in the previous letter, companies are likely to come out the other end with even more leverage than they had going in. Although this is contrary to a typical recession cycle where deleveraging is a critical phase, we’re seeing it play out today as infrastructure critical industries take on large government bailouts, small businesses take on PPP loans, and companies that should have gone Chapter 11 are still managing to tap the debt capital markets. As everything turns to debt, investors will fight over any company that still provides real equity value. The sought-after portfolio of tomorrow will look a lot different than the ones that got us to today, so we’re keeping a night’s watch to implement changes in our own strategies when the market presents us with favorable opportunities.
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Information presented reflects the personal opinions, viewpoints and analyses of the employees of Mirador Capital Partners, LP, an SEC-registered Investment Adviser. The views reflected in the commentary are subject to change at any time without notice. Nothing herein constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Mirador Capital Partners, LP manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Visit us at miradorcp.com for more information.