Beyond The Headlines

Train wreck or a train you can’t miss?

June 11, 2020 | Bogumil Baranowski
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To most of us, the March stock market sell-off might have felt like a train wreck, but today in early June the fast stock market rally may feel like a train you can’t miss. Which one is it then?

These were the thoughts I walked away with from a talk I gave at Intel to some five hundred attendees recently. No, I didn’t hop on a plane to see them in person, as I would have only a few months ago. Instead I joined them over Webex from the comfort of my makeshift home office. The event was hosted by a good friend, Yedu Jathavedan, who is a fellow investor and a true stock market enthusiast. I shared the virtual stage with Jake Taylor, another good friend and fellow investor as well as an author and a podcast host.

The last time I saw Yedu in person, we were outside Portland, Oregon having lunch with our significant others. My most memorable time spent recently with Jake was when he was fighting with a water hose under pressure that came loose on the boat during our sailing trip. Our Intel event was not quite that dramatic — but it was thought-provoking nonetheless!


It seems impossible to discuss the current market without reminiscing about March, April, and May. In March we saw one of the fastest market drops in history, which prompted a dramatic shift in investor sentiment — from peak optimism to peak pessimism. This dark moment for investors was followed by one of the fastest rallies driven by a sentiment shift from peak pessimism to a fresh peak of optimism. But that’s not the whole story, let’s look at some key points to gain a broader perspective.

1: The stock market tends to overreact. It usually responds early to expected drops in economic activity, and it often recovers ahead of actual improvement. If you see the stock market as a place where you can acquire ownership of a business, and you see businesses as streams of profits, then it becomes logical that when economic activity shrinks, profits tend to follow. Depending on the nature of the business, sometimes a small drop in sales can lead to a significant drop in profits. It’s referred to as operating leverage. There are certain costs that a company can’t cut quickly (rent, for instance), and profits get squeezed. Not all companies have the capacity to withstand a drop in profits (let alone actual losses) and in times of distress such as an economic recession, they risk going out of business if they can’t pay their bills. In addition, if they have borrowed significant sums of money over the years, the debt burden makes them even more vulnerable, and bankruptcy might be inevitable. It’s something we’ve seen with major retailers lately, but not only, even Hertz, the 102-year old car rental company, recently filed for bankruptcy with some $19 billion in debt.

2: The stock market and the economy are not the same thing. The economy encompasses the entire complex activity of all its participants – earning, spending, investing money, time, and resources, while the stock market represents ownership in a selected number of businesses that play roles in the economy. Another way to frame the distinction is activity (the economy) vs. ownership (the market). Many businesses are not represented in the stock market, mostly because they are too small to have public shareholders. Nevertheless, they may play a very meaningful role in our lives and in the economy. They employ tens of millions of workers, pay taxes, and provide goods and service we value. Think of your local grocery store, your favorite restaurant, your hair salon, et cetera. Small businesses represent about half of private sector employment.

At the same time, the U.S. stock market isn’t just American anymore. Many of the listed companies have presences around the world. When we look at the aggregate sales of the S&P 500, a little under half of their sales come from foreign countries. If you choose to own a representative slice of those 500 S&P-listed companies, you are directly exposed to their success and failure in 100+ countries. Some of them are mature and developed – European Union, Japan, Australia — while others are emerging. When you walk past a Coca-Cola fridge in a remote town in Southeast Asia or South America or Africa, spare a thought for the stream of profits making its way to you, the shareholder, half a globe away.

The peculiar nature of the stock market is the availability of the price of all listed companies every minute of every weekday while the market is open. In the U.S. that’s 9.30am to 4pm, Monday through Friday. Buyers and sellers make their investment choices from locations all over the world. If they like the prospects of a business, they buy, and when they get worried, they sell. As long-term patient value investors, we at Sicart follow Warren Buffett’s wisdom: “Be fearful when others are greedy and greedy when others are fearful.” We know exactly what we want to buy, and we zigzag our way through the markets. We tend to buy when others panic, and trim our holdings when we witness boundless unfounded optimism.

3: In March, the stock market felt like a train wreck heading for further disaster. The stock market drop was triggered by the looming economic recession driven by nationwide shutdowns. With constrained ability to earn and spend money, individuals and businesses were expected to come under a lot of pressure, and so they did. The March drop was an attempt to gauge the extent of the economic damage to come. Now, in early June, we are looking at over 40 million jobless claims, and the biggest plummet in corporate profits since the 2008 recession, 13.9% in the first quarter, with the second quarter likely to be worse. We saw a slowdown on Covid-19 cases, and some states have started to gradually reopen their local economies.

4: Based on the macro fundamentals and the actual earnings trends of U.S. companies, we are far from being out of the woods. We’d like to see the second quarter results, and we understand that there is a very real risk of a second wave of the pandemic later this year. With a second wave, we shouldn’t be too surprised to see further lockdowns. China and South Korea have already selectively restored restrictions in response to repeat spikes in Covid-19 cases. The level of uncertainty in March was so high that legendary investor Warren Buffett, with his 90th birthday around the corner and a dozen market crashes under his belt, decided to not make any purchases in March, and as a matter of fact he made a number of sales. He exited his airline holdings and trimmed his bank ownership. He chose to wait on the sidelines with an ample cash holding ready to be deployed down the road.

5: In late March/early April, investors shifted from peak pessimism to off-the-charts optimism. U.S. stock indices recorded a swift recovery with the tech index Nasdaq reaching a new an all-time high. It almost looks as if nothing had happened. The economy and the labor market have a long way to recovery. Easing lockdowns may offer some relief. It’s hard for us to imagine such an abrupt stock market recovery, and shift in investor sentiment without the unprecedented multi-trillion dollar fiscal and monetary stimulus – more government spending, lower interest rates, and the Federal Reserve’s massive intervention in the markets. This intervention has gone as far as buying high yield bonds, otherwise aptly called junk bonds.

6: A major price vs. value gap. If you see the stock price as what you pay, and value as what you get, today, we are looking at one of the biggest price vs. value gaps. The value of a business comes from its ability to generate sustainable and hopefully growing profits. The profits dropped dramatically for many companies recently. Their new normal level is possibly lower than what we are used to. Despite this backdrop, the stock prices rose back close to the levels recorded early this year, when profits were growing and reaching historic highs. It’s difficult to miss the growing disconnect here, and thus it becomes clear that the stock market as a whole is far from a bargain. In a current moment, the stock market price feels to us like a hugely oversized shoe with a small foot representing the value. The foot has a long way to grow into its shoe or the price level. It’s not impossible for the profits (and the value) to catch up with an excessively high price. If history teaches us anything though, this experience may be a very bumpy ride, and sets us up well for a high likelihood of a sideways market at best. It doesn’t mean though that there won’t be investment opportunities ahead, there will be many, but they will take an extra effort, and caution to find.


One of the questions that came up after my recent Intel talk was about our investment principles. The audience wanted to know if they had changed since the March turmoil. As we’ve written in earlier articles discussing investing in times of a pandemic, our principles remain unchanged. We are looking for quality businesses that we can buy at attractive prices and hold for at least for 3-5 years, if not forever. We want to get the most, and pay the least, while avoiding the risk of a permanent loss of capital.

We are reminded here of Benjamin Graham’s wise words, the father of value investing: “Though business conditions may change, corporations and securities may change, and financial institutions and regulations may change, human nature remains the same. Thus, the important and difficult part of sound investment, which hinges upon the investor’s own temperament and attitude, is not much affected by the passing years.”

Train wreck or a train we can’t miss? Where others see rising prices and want to jump in at any cost, we see a growing disconnect between stock prices and the value or the fundamentals. Where are we headed next, then? We have a long wish list of investment ideas and we bought a number of stocks in March and early April. We even made minor additions in May, and even now in June. We are far from building full positions in our new holdings, though; we’ve slowed or even paused our purchases. After sales of certain long-term holdings, we still hold a sizeable cash position ready to deploy, and a gold holding which we see as a hedge against uncertainty, and a potential source of cash when needed. Our stock holdings have done a lot of heavy lifting in the last few months making what we consider to be a respectable contribution to the performance.

We may all have more questions than answers when it comes to the second half of the year, but what we at Sicart know for certain is what kind of businesses we’d like to own, what kind of price we are willing to pay, and most of all, what’s really at stake here – the financial well-being of our clients and their families today, and for generations to come. In these uncertain times, we stand by our investment principles, and we intend to act decisively, but as always with a high degree of caution.


Bogumil Baranowski

Published:  6/11/2020




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