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Why We Remain Defensive

“*Offense sells tickets. Defense wins championships.”*
Legendary football coach Paul “Bear” Bryant

I sometimes joke that I should have named my kids Fomo and Yolo. If you don’t have a tween or slang dictionary nearby, FOMO stands for fear of missing out and YOLO stands for you only live once.

For folks keeping an eye on the stock market, there has a been a lot of FOMO. We have seen a powerful rebound in stocks over the past several months off their March lows. While it’s certainly a relief to see portfolios recover, many of the clients we speak to are frankly baffled. How is it possible that there is a party on Wall Street while there is so much pain on Main Street? It’s been a part of every conversation we have had with clients and the topic of recent articles by many professional investors.

One possible explanation for the inconsistency has been that the stock market is forward looking and tends to anticipate economic rebounds before they actually occur. Today, millions of people have already gone back to work and New York, perhaps as a bellwether, has nearly eliminated covid deaths. The market may also be rising on the expectation an early COVID vaccine will be followed by a quick rebound to pre-pandemic levels. After all, unlike the Great Recession, this recession was not caused by an economic shock.

Another theory is that the stimulus unleashed on the economy, to date at least $3 trillion, is propping up both businesses and the stock market. There is certainly something to this. By avoiding mass layoffs and putting money into people’s pockets for spending, the stimulus has allowed us to avoid a true depression scenario. The possibility of even more stimulus from Washington in 2020 means that the band could play on for even longer.

While it’s hard to resist FOMO, we are doing our best. As we’ve said in previous letters, it seems like the cost of the coronavirus lockdown has not been fully reckoned yet.

One risk to the best-case Wall Street scenario is the timing and efficacy of a vaccine. According to the World Health Organization (WHO) there are currently 21 candidate vaccines in various states of clinical trial, which is great news. Dr. Anthony Fauci, the U.S. government’s top infectious disease expert, cautions however that a COVID-19 vaccine may only become available for widespread adoption, at best, towards the end of this year.

Regardless of when we see a vaccine, with cases of coronavirus still increasing in the US and many parts of the world, we will continue to be under some form of restriction, voluntary or involuntary, that will limit our behavior and spending patterns. It’s hard to say how much of a drag this will be on the economy but it won’t be insignificant.

For Wall Street to continue to be right on the fundamentals and justify this stock market, we would have to be able to return to 100% of our old economy rather quickly. For that to happen, industries hit hardest by the pandemic would have to experience an almost miraculous and accelerated rebound. Pre-COVID, the leisure, retail and travel industries employed millions of Americans and depended on spending not just by domestic customers but overseas visitors as well. Achieving a vaccine this year probably still means an unemployment hangover that lasts into 2021. It seems unlikely that we get back to a 100% economy without these industries (not to mention many others) getting their pre-Covid health back.

As we see it, the stock market today is supported by improving fundamentals, vaccine optimism and government cash. Nothing to sneeze at but as Fed Governor Lael Brainard said this week, “a thick fog of uncertainty still surrounds us, and downside risks predominate.” If it ends up that we are positioned for a recession that doesn’t fully materialize, we may have missed out on some gains but protected our foundation. However, we believe the potential risk associated with this current, ongoing and still unfolding threat supports Longwave’s current cautious positioning.

So we are choosing to sit tight and make the most of this summer lull. Human contact is critical to our physical and mental health too. Personally, we are enjoying opening up our social circle to family and select friends. Small BBQ’s and one-on-one play dates are back on the calendar. We hope that your focus continues to be not on Wall Street or Main Street but your street. After all…YOLO.

At Longwave, we have no doubt that the world will emerge from the Covid-19 pandemic astronger and better society. Today, there are green shoots pointing to recovery – ‘the curve’ has been flattened and we are now starting to relax social lockdowns. However, we share the feelings of many of you that there are consequences to the coronavirus pandemic that have not yet been factored in or dealt with.

While as a society we are already thinking about recovery, the health crisis of this pandemic must still be tackled. Beyond that, we will have to deal with the economic consequence of the global effort to contain the virus.

From a health perspective, the good news is Covid-19 does not appear to be nearly as severe as the Spanish Flu. Treatments are in the pipeline and care for the most severe cases has improved. Historically however, pandemics tend to last 18 months to 2 years and we simply do not know if the virus will rebound as soon as quarantine ends or flu season begins. To truly feel safe we will need to find a vaccine or achieve ‘population level immunity’ but we simply don’t know when those will occur.

Then there is the record-breaking economic cost of the pandemic. According to the Chicago School of Business, through April alone, 30 million jobs had been shed and spending in the US had fallen by 30%. Some of those jobs could quickly return but it’s also likely many people will continue to self-quarantine even once government restrictions are lifted. Already, some company closures are becoming permanent. Leisure, travel and entertainment industries could be impacted for months and maybe longer. The loss of income and revenue will mean that consumers, companies and governments will not be able to return to their previous levels of spending right away.

While your portfolio is a key aspect of your financial life, we all know we can’t control the stock market. As we’ve often discussed, the most important aspect of your financial health is living within your means. This pandemic taught us how to quarantine ourselves, but for perhaps the next 6 to 12 months, we should also think about a quarantine for our money. Here are some suggestions:Recall that after the 2008 recession, it took 6 years just to get back the jobs that were lost. That recession lasted 18 months – we are only in month three of this event. While no one knows what might happen next, based on that comparison, Longwave believes that the short term holds more downside risk than upside potential. We are therefore positioned more defensively by increasing the cash allocation in client portfolios. Also, we continue to over-allocate to underpriced assets, known as ‘value’ stocks, which have been shown to outperform overpriced assets over time.

If you are drawing retirement income from your portfolio, we suggest you take less if you can, to preserve assets for future investment and recovery.
If you are contemplating a large purchase, continue to focus on your accumulation goal and building your savings.
If you have a little more time on your hands, now may be a good time to start creating a household budget. Start by looking at your last 12 months of bank statements and use a spreadsheet to write down each month’s total spending. Compare what you are spending now each month to what you were spending in 2019. Set a monthly spending goal for yourself for the rest of the year and track your progress toward that goal on a weekly basis.
If you have not taken a pay cut, this could be a great opportunity to add to savings and investment accounts.
If you have lost wages, it’s more important than ever to be conscious of core versus discretionary spending.

As we contemplate being a bit more budget conscious, our time under quarantine will show us the way. Today people are making changes to their spending that would have seemed impossible a few months ago. We’ve discovered the joy of meal prep with the family as an alternative to eating out 3 or 4 times a week. Walks in the park have replaced more elaborate weekend entertainment. Volunteering has replaced late hours at work. The concept of stillness has begun to be appreciated and practiced in our society in a way that could not have been accomplished without this seismic disruption.

At Longwave, although we are cautious about the next 18 months, we are long-term optimists. We believe in human ingenuity, the power of capitalism and entrepreneurism to find ever more efficient ways of organizing the economy. In the last century, this resilience has propelled the US economy like no other and we expect to continue on this historical arc, once we’ve recovered our health and financial well-being as a nation.

Halftime Thoughts from Longwave

Why We Remain Defensive

Summer Thoughts from Longwave