Lockhart Capital Management Market update – 22 May 2020

We are currently living and investing through the most uncertain and strangest of times.

The hugely-experienced and well-regarded Jim Stack at InvesTech Research in the US, states that “the past couple months are unlike anything we’ve seen in our historical experience… or archival data”.

Simply put, there has never been a time in modern history when the economic outlook was so opaque and with such wildly differing potential outcomes.  The following chart shows the variability between economic forecasts during the last fifty years, and needs little additional commentary:

Source: @SoberLook, Financial Times

This is not helped by the fact two-thirds of companies are now not providing “forward guidance” of their earnings, although one can hardly blame them.

In the UK, gilt yields out to five years have gone negative, which is yet another “first”, and has seen the UK Treasury auctioning off negatively yielding debt. The market senses the possibility of UK interest rates being taken down below zero, and that the Bank of England is literally monetizing UK debt.  We were told just a few weeks ago that both were supposedly off the table…

For their part, the US Treasury has begun auctioning 20-year debt, for the first time since 1986, which is also what we would be doing if we thought that inflation was coming further down the pipe! Demand for this was, strangely, quite strong, although the Federal Reserve is hoovering up most Treasuries it can find, in the secondary market, so perhaps the thinking is that they can be sold on at a better price, to a “greater fool”.

So, there has been a vast increase in the global money supply, with banks encouraged to lend (not tend to their capital ratios) and – importantly – with fiscal joining monetary largesse this time, as opposed to the (attempted) austerity of the post 2008 period.  Also different is that now deficits will be more explicitly monetized.

Therefore, and despite the fact that measures so far by governments and central banks have been more relief than stimulus, it is right to expect some mix of asset price gains (over time) as well as the return of inflation.  We think the bias will be strongly towards the latter, although both may be present to some extent, and inflation does not preclude at least strong nominal gains in asset prices, stocks in particular.

Gold has already started to respond to this, making all-time highs against the mighty Swiss franc. Even some of the recent better performance from stock markets may be partially due to prices sniffing out future currency debasement.  The – arguably – greatest investor of recent generations, Stan Druckenmiller, says that Capitalism is under real pressure (as is American exceptionalism and meritocracy), being “as challenged as I have ever seen it my lifetime”. Previous readers will note that we have been increasing our exposure to gold in the Lockhart portfolios for some time now.

A surprising development has been the impact on markets of a tidal wave of day-traders in the US. This has been driven by two factors.  Many of the (hundreds of?) thousands of sports gamblers that were twiddling their thumbs while the NBA remained shut, have appeared on E*TRADE and the like.  This has coincided with the move towards commission-free stock trading that we have mentioned before, which had attracted do-it-yourself investors, and especially now given how many people are stuck at home…

CNBC stated that the coronavirus-inspired market volatility appeared to bring a slew of new accounts to online brokers in the first quarter – Charles Schwab reported “monumental (record) volumes”.  People earning between $35,000 and $75,000 apparently traded stocks about 90% more than the week prior to receiving their stimulus check.  This when household debt is back at record highs, although debt-servicing costs remain extremely low, for now, and the overall savings rate is increasing.

Technology has facilitated this shift, and Millennials seem to have taken to the Robin Hood app (March trading was up 300% from last March, and they say over half its customers are first time traders), via their smartphones.  Additionally, you can now buy fractions of a share, allowing easy small investment in businesses with large share prices – some of the key Technology names price at over a thousand dollar a share.

To cut a long story short, the trading dynamics of the financial markets are consequently changing again, with implications yet to be fully understood, and risks and opportunities now coming in slightly different colours.  The level and valuation of the overall market itself, not just certain sectors and stocks, is being impacted, perhaps to the chagrin of the 68% of institutional investors who are still bearish.

All 50 States in the US have now re-opened to some degree, but we do not see consumers and the economy getting back to normal any time soon. A Reuters poll found that only 40% of Americans would go to theme parks, concerts or sporting events even if a working vaccine were found.  Meanwhile, we have seen, in April, the sharpest ever increase in delinquencies in US home loans, and that includes the 2006-9 period. Additionally, fifteen million credit cards and three million auto-loans have gone into “hardship programmes”.

This highlights the entirely different outcome compared to the H3N2 pandemic of 1969, when over a million died in the US, but life was carrying on as normal (admittedly there may be some causality in that).  That virus was brought back by soldiers returning from the Vietnam war (via Hong Kong) and was in all fifty States within three months.

So, the big difference here is that, as Matt Taibbi of Rolling Stone magazine puts it: “Millions have lost their jobs and businesses by government fiat”.  Steven Davis of the University of Chicago has concluded that 42% of pandemic related job losses, the majority of which are in theory “temporary”, will actually prove to be permanent.  If we look at how many have been furloughed in the UK (see following chart), one must wonder just how many of these jobs will stay open beyond the period of government support, and hence how high unemployment really may be, both in the UK and the US.

Source: Daily Telegraph

The wider problem then is that the people losing their jobs are also those with the least savings, on average.  Federal Reserve Chairman Jerome Powell has said that of those households earning no more than $40,000 a year, some 40% of those who had a job in February lost it in March.  75% of those who did lose jobs, were not college educated.  There is a socio-political reckoning to come.

The World Economic Forum states that 500 million people are at risk of falling into poverty, as a result of this crisis, and the World Bank says that 60 million people could be pushed into extreme poverty.  The results of the policy medicine may well prove to be far worse than the disease.

Having witnessed the sharpest equity market sell off through to mid-March we then saw one of the quickest recoveries since the late 40’s whilst all the news around us was dire. Financial markets are forward looking however we now think that it sensible to lean a little against this wind, and indeed we are doing so, at the margin, as we are in the process of reducing exposure to “core assets” (equities and bonds) in the Lockhart portfolios by 2%, in favour of Alternative investments.

In terms of economic policy, fiscal and monetary, we are at a point that we always felt we would reach, it is just that we have got here a lot faster than one might have thought!  COVID-19 has effectively accelerated and exacerbated this process, but the investment thesis remains the same and hence it is reasonably straight-forward to adapt the portfolios accordingly.

The same speeding up is likely true for many pre-existing trends, with fairly obvious examples such as internet retailing, home-streaming, etc.  For us, one take-away is that the “winners”, be it sectors or specific businesses, are likely to be even-more dominant in the future.

Government support may continue to help some “zombie” companies survive, and with an unhelpful associated misallocation of capital and reduction in productivity.  Nevertheless, it is possible that we may yet get some of the “creative destruction” that was due a decade ago but staved-off for an indeterminant period by low interest rates and quantitative easing.

Overall, we feel it is critical to remain adaptive, nimble and liquid.  There are likely to be significant risks but also big opportunities, which no one has even thought about yet, as the world shifts.  Habits and behaviours may change, but investor psychology and the laws of supply and demand less so.


Andrew Wilson, Chief Investment Officer, 22 May 2020


The content of this newsletter is for information only. It does not represent personal advice or a personal recommendation, and should not be interpreted as such. Please do not act upon any part of it without first having consulted an Independent Financial Adviser.