Annandale Capital – Latest Newsletter

Most people are aware that the Confucian adage “may you live in interesting times” may actually serve more as a curse, to the more viciously intentional and ironic.  Considering Covid-19 most likely came from a wet market in Wuhan, China, or a virus laboratory nearby, a nod to Confucius today seems appropriate indeed.

Be careful asking for “interesting” in life.  We certainly have achieved that in the first three months of 2020.  From January until mid-February, the U.S. stock market continued to set record after record after record.  And in the two months since, we’ve entered a bear market and subsequently exited a bear market.

So far in 2020, the S&P 500 Index was down 32%+ at its nadir from the peak, and the Dow Jones Industrials were down 35%+ from their peak.  While this is a significant fall, and in record-setting time (way shorter than most bear markets), it’s not historically significant in terms of magnitude, which I will address momentarily. 

Before discussing markets and investments further though, I want to acknowledge all the pain and suffering we are encountering as a country during coronavirus pandemic, the shutdown of the American economy, and the Russian-Saudi Arabian economic war against the U.S. oil & gas industry; any patriotic Texan would find any one anathema, but all three?  It’s disastrous and a call to arms on so many levels.

But how do you fight a virus?  Or an economic war against a nuclear power and a supposed ally?  Order takeout?  Deliver meals on wheels?  Post supportive messages on twitter to medical professionals on the front lines?

One can’t help but feel a bit helpless in this extraordinary, historical time.  The enemy we are fighting has no clear eradicator, other than social distancing, shelter in place, and time.  There is no vaccine.  Yet.  The enemy is a mystery, until we get additional data and have time to study and find ways to ensure its defeat.

I would argue the best thing an American investor can do right now is stay safe, be as generous to his/her fellow Americans as is possible under adverse circumstances, and mourn the sick and dying.  The virus will affect many, in extreme ways.  Although I do not know anyone who has expired from coronavirus, I know several who have acquired this nasty bug personally.  I want to give an anonymous shout out to a dear friend overseas who was in the vulnerable age group, but being a fighter for the ages, threw off the virus and recovered.  No small feat!

We are in the midst of the longest national pause since the Great Depression.  This bug, which we will fully defeat within 24-36 months, has been compared intermittently to the Spanish Flu, the Great Depression & World War II.  The reality is there is no comparable.  The Spanish Flu is the closest, but in 1918 the global economy was far from interlinked on every level, much less any level, beyond limited ocean and land trade.  It’s completely enmeshed today. 

When China sneezes, Venezuela all but dies.  When Russia floods the market with oil hundreds of thousands of jobs in the U.S. disappear, maybe forever this time.  But while the global economy will suffer more this time around, the loss of life globally is likely to be far less than the 50 or so million that perished from the Spanish Flu.  We know a lot more about combating pandemics today than a hundred years ago, even lacking a vaccine, for now. 

A key will be whether the summer obviates the bug’s effects, whether it makes an awful return in the fall, and whether mitigation strategies will be as effective and well-followed if it does come back in the fall.  The second wave of the Spanish Flu in the fall/winter of 1918 was the really brutal epicenter of the death and suffering.  The second wave was worse than the first.  That is something for all vulnerable Americans to keep fully in mind when assessing where and how they spend their time in the fall and winter of 2020.

The Great Depression has been raised repeatedly in the barely over a month period of time since this began.  Talk about premature, chicken little talk.  While we may see job loss and economic contraction of that order of magnitude in the short term, the monetary and fiscal stimulus being thrown at all these problems is truly unprecedented.  The policymakers are getting so much right and are to be saluted. 

So, a tip of the hat to Federal Reserve Chairman Jerome Powell and Secretary of the Treasury Steve Mnuchin, they have struck like lightning, with the greatest money shock and awe show of any lifetime.  The better question is not whether this is a recession or the Great Depression Part II, but how long will it take us to get back on track?  And furthermore, how many jobs just don’t come back, spreading the economic pain and suffering and creating permanent financial loss?

World War II is the worst comparable of all.  Most people don’t recall that the New Deal didn’t end the Great Depression; the greatest manufacturing mobilization in history, World War II, ended the Great Depression.  In the war, millions of people got back to work, and then stayed at work as America boomed after routing the Axis Powers.  This time around we are shut in and shut down, the opposite of all the positive energy and activity of the domestic front, war manufacturing boom of the 1940s.  This time around, we have an enemy which is best confronted and fought by isolation and passivity, for a time at least.

But for how long?  Sheltering seems likely to continue through April, at a minimum.  And whether we prolong efforts to socially distance and for the most vulnerable to shelter in place for more extended periods of time will impact the need to repeat April at a later date, which would be even more devastating to the economy than what we are going through now. 

We can’t stop-start-stop-start-stop-start over and over again, and the country can’t take on more and more debt up to an unlimited amount.  Getting the deficit under control and stabilizing the ever-larger national debt will be painful and difficult enough already.  If the bug does rear its ugly head again in a material way with colder, dryer weather in the fall and winter, the social distancing and lack of congregating we are practicing now may serve the country well in not having to completely shut down again in six months, and in keeping the loss of life in the U.S. far below some of the grim estimates.

So, with all that ruminating, how long will this recession/retraction/correction last?  I have no idea.  And neither do any of the talking heads, know-it-alls, and self-assured experts on anything and everything you’re hearing daily on the television or radio.  If I hear one more time from a big bank or economist that we’ve already bottomed, or that the bottom for the S&P 500 Index will be 2000, or that we’re going to have a decline just as big as 2008, I may post on social media just how irresponsible and unknowable all these assertions are.  All I know to lean on are cold hard facts and data.

Here’s some data for you.  The bear market in the early 1970s saw a drop in the markets of just over 40%.  2000-2002, 45%.  2007-2009, 57%.  The Great Depression, over 80%.  Bear markets on average last a little less than 2 years.  This one has gone on for 20 days as I write this letter, and we’ve technically come out of it already, at least on some of the indices.  If we were to see a decline similar to the “average” bear market decline, we’d bottom somewhere around 2300, where we were last week.  Problem is, there is no such thing as an “average” bear market.  If the market responds more similarly to three of the more recent bear markets, 1973-1974, 2000-2002, and 2007-2009, we would likely fall to the 1,500-2,000 range on the S&P 500 Index.

Today we are at 2,600 up from 2,200 only last Monday.  That’s a significant loss from the all-time high in February of 3,393, but nowhere near the losses of some prior bear markets.  Below average at these levels.  Slightly above average at the levels of last week.  Oh, and in terms of data on earnings – forget about it.  We know what “P” is today, but we have no idea what “E” will look like over the next 12-18 months.  What’s important is what “E” will look like 18-36 months from now, when a semblance of normalcy is restored.  Will it be anywhere near the original expectation for “E” in 2020, around $175, or lower, or higher?  Tell me that information, and I can get a lot better at soothsaying and market predicting.  Not perfect, but better.

Now let’s talk about how long this is going to last.  And once again, I have no idea.  What I do know is, our odds of having higher stock prices in 5, 10 or 15 years from 2,600 today, or 2,200 a week ago, or 1,900 in a year (not a prediction, just an observation) just went significantly higher.  Close to 100% in 10 or 15 years.  Much better than 50% odds over 5 years.  Good odds all the way around.  So, have we already bottomed and the buying opportunity is over?

Quite frankly, I hope not.  We have deployed somewhere between 20-40% of spare cash for most clients with additional cash to invest.  We have additional buying power for our most conservative clients, but don’t want to disrupt their allocations or get aggressive unless we get much more attractive prices. 

The same for our more aggressive clients – no need to do anything other than re-balance back to agreed upon allocations outside more attractive prices for such clients.  But for clients with plenty of dry powder, we will slowly be gaining additional market exposure over the next 3-9 months.  Prices will determine both pace and sizing of additions.  Our last purchases were the day the market bottomed, for now, last Monday.  We were just starting to get aggressive.

If the average bear market, which is over 600 days, is any indication, there are more declines to come.  But whether they will go back down to 2200 on the S&P 500 Index, pierce it and go lower, or whether it will never get near that level again for years, I have no idea.  We’re going to all find out together, which will require patience, resilience and courage. 

We’d all forgotten a bit how awful bear markets are, hadn’t we?  They are psychologically, financially, and emotionally gut wrenching and exhausting.  But we all know the stock market always, eventually, makes new highs.  And the more stock you buy at lower prices, the better your percentage and absolute returns will be, in time.  So as Shakespeare told us, “once more unto the breach dear friends!” 

We’re in a weird form of war – war against the bug, war against a declining economy and stock market, as well as an oil war with Russia and Saudi Arabia.  The best way to win all of these is through wisdom, character and endurance.  And Job-like patience.  All we have to do is look to Job’s example to fully appreciate that no matter what our current circumstances, many in the world are far worse off than we.

I’d like to close by acknowledging a great American we lost to cancer this past week.  Dr. Tom Coburn was a man of great faith, courage and boldness.  He was jokingly referred to as “Senator No” or “Dr. No” during his career in the U.S. Congress, as he almost never met a spending bill, earmark, or pork barrel project which, if presented with the opportunity to vote upon, he didn’t gladly, and resoundingly, vote “no”.

Tom was a friend.  He also was one of the few citizen legislators, consistent with Washington and Jefferson’s vision, who served his country for a time and then returned home, to face the judgment and scrutiny of neighbors in his community.  Tom made a pledge to self-term limit, and only serve three terms in the U.S. House.  So he did.  After getting elected to the U.S. Senate four years later, he made a pledge to only serve two terms in the Senate.  So he did.

Tom thought career politicians, runaway spending, and the arrogance of Washington were all together an unpatriotic, toxic scourge on American society.  He was, and is, correct.  Some of the populist scorn for Washington that Tom so effortlessly tapped into explains why, despite all the obvious flaws of behavior and character, we have Donald J. Trump as our President.  The President gets it too. 

One of many wishes I have for our country today is for a lot more Tom Coburns, and fewer arrogant, power hungry, ineffective career politicians in Washington, Austin, and every other locale where politicians flock together, whether Democrats, Republicans, or Independents.  We need more Toms in our future, if we are to have a brighter one for our children and grandchildren.

The Annandale Team is hard at work every day, whether sequestered at home, in the office, or wherever we need to be.  Thank goodness for technology and our modern day financial systems, both at our level of endeavor and for much larger enterprises, such as the New York Stock Exchange or the Federal Reserve. 

We’ve had several clients and friends apologize to us for asking for our help during this time of national crisis, worried about the strains on our firm and the stress and demands on investment managers while markets are plummeting.  The sentiment is appreciated, but we are honored and eager to assist and communicate during this time. 

Eager, willing and able, whether we’ve already bottomed on the market or have a lot farther to fall before we’re done.  It’s a privilege to do this, and a privilege to work for you.  Thank you for providing the opportunity.  Here’s to our decisions and actions over the next 12 months, many of which will likely look foolish or flat out wrong during that time frame, instead looking great over a 3, 5, 10, 15 and/or 20 year time frame.  That is our aim and our pursuit.  You have our best efforts to put a bulls-eye on that aim.

With our very best regards and wishes.  Stay safe.


George Seay, CFA

Executive Chairman, Annandale Capital

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