Winter 2021: It Was A Bad Time

By Christopher R. English, President of Lumen Capital Management, LLC            

Perhaps nobody captured the mood of 2020 better than the singer/songwriter Taylor Swift. Suffice it to say, using Ms. Swift’s own words, 2020 was a “bad, bad time.” Let’s dive into the details and look at what happened.

The Stock Market Reality

The world was knocked off its axis by the novel COVID-19. As if that wasn’t bad enough, as the extent of the impact of the virus began to be appreciated back in the spring, both the markets and the economy contracted at an unprecedented rate. Between February 19th and March 23rd, the S&P 500 declined by nearly 35%. (1) Thankfully, we then experienced a rapid market recovery as government stimulus, credit aid by the Federal Reserve, and remediation strategies began to take hold in the following months. Back in March 2020, I wrote that value was being created in the markets. While I thought the news cycle would continue to be grim, I also thought this was a good time to buy attractive assets that had been priced down to unreasonable levels. That proved to be the correct strategy as markets rebounded in the coming months and erased much of their earlier losses. The major averages ended the year all in the green.

Yet while the major averages ended higher, the same cannot be said of all stocks. There’s been no other time in my investment career (now spanning 35 years) where I’ve seen such a distinction between stock winners and losers. Early on in the pandemic, investors gravitated toward equities that benefited from people isolating in their homes, such as technology, certain consumer stocks, and healthcare. Everything else, not so much. The pandemic destroyed the economy in a similar way that a woodland fire devours a forest. Animals that needed their previous habitat to survive disappear, but eventually, species that can adapt to this new environment colonize it and change the landscape. Life returns, although perhaps in a different form or by different species than were there before, and the cycle renews itself. 

For example, the Chernobyl nuclear disaster created a wide area around the former reactor that was uninhabitable to humans, but, surprisingly, wildlife has thrived. If you were in a business that relied on many forms of discretionary spending, then you were hit by a Chernobyl-like event last year. Restaurants have struggled to survive. Many movie theaters probably won’t. Cruise ships and airlines are on life support. The impact down the supply chain when this happens ripples through the economy as well. When a theme park shuts down, it not only impacts the employees but also the businesses that generate revenue by being near the park or supplying resources the park needs.   

Winners And Losers

This same trend has been reflected in U.S. equities, although not in major U.S. indices, which all finished the year with nearly double-digit returns and, in some cases, substantially higher returns. However, many companies are still trading below their 2019 highs. This doesn’t necessarily show up when you look at financial headlines because major market indices like the S&P 500 are weighted by their market capitalization. (2) Currently, the market cap weighting of the top 10 stocks in that index approaches 30%. In order of size, the top five companies are Apple, Microsoft, Amazon, Facebook, and Alphabet (Google). (3)  These five companies make up 22% of that index’s market capitalization. (4) Another way of looking at this is that these same top five stocks carry as much weight in the index as the bottom 370 companies. While each has strong fundamental strengths in their businesses, each was also at the right place and right time regarding the virus. While these specific companies have helped propel these indices higher, they have also masked much of the rest of the market’s hard times. Many companies with traditional business lines, so-called value stocks, were up about 4% on average for the year. 

There are many growth and value-oriented companies that have struggled because they’ve been in the wrong parts of the market due to the virus, not because there is anything fundamentally wrong longer term with their underlying businesses. Unfortunately, some businesses won’t recover. For example, we already had too much retail before the virus hit. But the paring down of stores is an acceleration of a trend that was already in place. Department stores were in trouble long before the virus hit. Many other industries are just trying to survive until things get better. I often said last year that I believe we’re going to see substantial economic recovery in 2021. Here’s why I still think that: the combination of vaccines, better treatments for those already infected, more testing, human adaptation, and a more coordinated response by the Federal Government, plus pent-up demand should be an explosive element to growth at some point later in the year.  

Pent-Up Demand

Right now the focus is rightly on devoting many resources to those currently experiencing hardship, and there’s a valid argument about whether we’re doing enough to help these folks. But on the other side, pent-up demand is not discussed enough. You also don’t read much about the build-up in savings from Americans that still have jobs, have been receiving benefit checks such as Social Security, or who received money under the CARES Act. Much of this has gone into savings because many of the things we spend money on, from sporting events to vacations and dinners out, went away. What happens as things start to open up and there’s all this cash burning a hole in people’s pockets? Well, I think it might look like the years after World War II. The country went on a war economy back in 1941 with the government funding a massive increase in infrastructure and defense spending. People finally had jobs after the Great Depression but didn’t have many ways to spend their new wages because of rationing related to the war. But the war ended and the soldiers came home and began spending all that back pay. The economy had a few rough years initially as we transferred back to a civilian economy, but all that saved cash eventually found a home in investment and consumer spending. Between 1946 and 1966, the U.S. economy grew at about a 3.5% clip. We had some years back then with over 6% GDP growth. Similarly, there’s now at least a year of pent-up spending that is going to be addressed in a relatively short period of time, economically speaking.  

Think about the family last year that canceled a trip to Disney World and still has the financial wherewithal to go. Well, Disney World is still there. Florida didn’t go away. If your favorite restaurant has survived on takeout, then at some point it’s going to start welcoming patrons back. Or if, unfortunately, it became a casualty of the virus, it’s likely that somebody new will take over the old space. There’s always a new entrepreneur willing to take a chance on a restaurant sitting in a prime location. That restaurant then starts hiring back the servers, cooks, bartenders, busboys, etc. Those employees don’t care where they work in the business as long as they’re getting paid. The point is that restaurants will adapt. Those that can’t will die, but something new will likely take their place. There will still be profits in feeding people. Many other businesses are also adapting.    

Many of these old economy companies are represented by stocks that have continued to pay their dividends, which overflows into the exchange-traded fund (ETF) space where we participate. It is highly probable that many of these securities, as well as the ETFs that hold them, are still undervalued and have the potential for above-average total returns as the economy recovers this year. I invest money using investment strategies that utilize ETFs. I believe you own ETFs for three purposes: capital appreciation, dividends, and expected future dividend increases. 2020 put much of this potential on hold, but assuming the virus becomes a manageable event, then it is highly probable these growth characteristics could resume next year. 

Some Perspective

Nothing I’ve written today is meant to minimize the economic hardship many have experienced from the pandemic, and nobody should discount the human cost in lives. Over 22 million Americans are currently infected, and over 375,000 have now officially died from COVID-19. (5) That’s like having a city nearly the size of Cleveland wiped out.* While there is now a vaccine, the virus is currently on a path to kill perhaps a half million of us. Nothing in the modern world has prepared us for this experience. There is no playbook on how to invest or navigate a global pandemic. I have cautioned you in the past and will say again that while I believe we’ve turned a corner, the news will continue to be grim for the next few months. But assuming we’re on the winning track versus COVID-19, I believe prospects continue to be economically brighter for 2021.  

Finally, after the events of the past few weeks, I even more firmly believe there is more that unites our country than divides us. A review of the election results has shown me that the center held better than most imagine. I especially believe that after watching good people of both parties push back against President Trump’s efforts to overturn the results of the election. As to the reprehensible acts seen on January 6th, I will state that it is likely that 300 million of us were horrified by what we were watching. I hope that if there’s any good that comes from that day, it will be the realization that democracy has shown itself to be a resilient thing and one worth saving. On that, I believe both the right and the left will agree.

Times are tough, but we are resilient, and with each other’s help, we will get through it! I am here for you. Call my office at 312.953.8825 or email us at lumencapital@hotmail.com. 

About Chris

Christopher R. English is the President and founder of Lumen Capital Management, LLC-a Registered Investment Advisor regulated by the State of Illinois. A copy of our ADV Part II is available upon request. We manage portfolios for investors, developing customized portfolios that reflect a client’s unique risk/reward parameters. We also manage a private partnership currently closed to outside investors. Mr. English has over three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 312.953.8825 or emailing him at lumencapital@hotmail.com.

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(1) https://www.cnbc.com/2020/04/16/larry-fink-coronavirus-low-last-month-may-have-been-the-market-bottom.html

(2) Currently, long indices related to the S&P 500 in both clients and personal accounts

(3) Apple, Microsoft, Amazon, Facebook, and Alphabet {Google} and the Walt Disney Company are component parts of indices owned by clients and in personal accounts.

(4) Guide to the Markets, 12.31.2020.  JP Morgan and Co.

(5) https://www.cgtn.com/special/Global-COVID-19-cases-top-19-7-million-U-S-cases-exceed-5-million.html

*An update on mortality under Covid-19 and population comparisons.  As of today, 02.01.21, the US has now seen over 26 million cases of Covid-19 with over  441,000 deaths.  That is now the equivalent of losing all of Oakland, CA.  If the current trajectory of deaths is maintained over the next month we are on pace to lose city population equivalents in the following order:  Miami, FL {462,000}, Raleigh, NC {474,000}, Kansas City, MO {495,000}, Atlanta, GA {506,000} and Sacramento, CA {513,000}.  Census data on city populations comes from Wikipedia.