To say 2020 is an abnormal year would be the understatement of a lifetime. We started the year having seen a record Bull Market stretch into its 12th year. Then a new and deadly virus dubbed COVID-19 that attacks the human respiratory system took over the world and created a stock market crash. This ended the longest bull market in history and brought a self-induced economic depression in the U.S. with multiple government imposed shutdowns to try and slow the pandemic.
I am saddened for all the families and individuals who suffered losses amongst this tragic pandemic. Now, in less than a year, not one but two vaccines received FDA approval. The vaccines are the light at the end of this dark tunnel. Furthermore, we had a Presidential Election with the result contested by the incumbent President. We had Central Banks around the world lower interest rates and commit to long term quantitative easing effectively printing large sums of currency. And to think, the year is not even over yet.
Fiscal Stimulus and Monetary Stimulus:
Congress needs to continue to provide support to the American people as we are not out of this dark tunnel yet. During this COVID-19 pandemic, the government is picking winners and losers for the business world. Some industries such as the Airline Industry received free money in the form of billions of dollars of grants, billions in loans, and other support. Most importantly, many large businesses were allowed to stay open during this pandemic.
Meanwhile, small businesses took the brunt of these shut downs. Many small businesses were forced to shut down over and over. The PPP loans were only for two months of payroll and the new stimulus bill is not enough. We are going on nearly a year of this pandemic. I do not understand why a barber who is cutting hair outdoors with masks on is shut down repeatedly. Meanwhile, a large big box store that is 100% indoor shopping and can have hundreds of people inside is allowed to stay open.
Furthermore, Congress has taken three vacations since the end of the initial stimulus in June 30th and going on their fourth vacation soon. All the while, they continue to be paid full salaries and benefits while millions of small businesses and individuals suffer due to the government imposed shutdowns. The shutdowns were attempts to curb the pandemic which makes sense. The country just needs to help all the small businesses and individuals who had to sacrifice during this pandemic.
Congress, state and local governments should have their salaries cut based on all the months they kept businesses shut while government aid had run out and they haggled away on a game of political brinkmanship. They should feel the pain that individuals and small business owners have experienced and continue to experience. I do not think many of these elected leaders who continue to be paid full compensation feel the pain that the average American is feeling. The total number of unemployed workers has yet to fall below the highest point in the Great Recession of 2007-2008.
Now they pass a $900 billion stimulus bill and it is not enough. This represents only 5% of 2019 annual GDP. That is approximately only half a month of fiscal support. Yes, there is economic activity and yes there is monetary stimulus. However, more will likely need to be done in 2021 because the vaccines will not magically create enough jobs for all the millions still unemployed and the many small businesses on the brink of permanent closure.
 |
| We see the light at the end of the tunnel with the COVID-19 vaccines. |
We see the light at the end of the tunnel with the COVID-19 vaccines. Congress, state, and local governments need to continue to provide aid to businesses and individuals in the months to come. The current stimulus bill is likely not enough to sustain many of these small businesses from shutting their doors for good.
State of the COVID-19 Virus:
In one of the most remarkable developments in human history, two vaccines have been approved for a novel and deadly virus in approximately 9 months. The previous record speed for an approved vaccine was 4 years from start of development to the FDA approval finish line. That previous record belongs to the development of the Mumps vaccine from 1963 to 1967. Keep in mind, the vast majority of promising vaccine candidates never make it to the finish line.
The approved vaccines from Pfizer and Moderna utilize a new technology called mRNA. It utilizes strands of RNA to help train the body to fend off COVID-19 and is grown in a lab. The mRNA vaccines provide instructions to a human body to produce antigens which prompts T-cells to respond to fight the virus. In comparison, traditional vaccines are a weakened form of the virus it is combating. These traditional vaccines are produced by incubating them in chicken eggs. The mRNA vaccines have thus far shown a nearly 100% prevention of severe symptoms for COVID19.
We do not know if there are long term side effects for the two approved COVID-19 vaccines since the vaccine trials lasted less than a year prior to FDA approval. All previous approved vaccines have taken years to study for long term side effects prior to FDA approval. Still, this is one of the greatest achievements in science we have ever seen.
The COVID-19 virus has mutated like all viruses mutate. Although a few COVID-19 strains have developed in the world, a new COVID-19 strain found in the United Kingdom is causing concern because it could be more contagious than the original COVID-19 strain. It appears doctors and researchers are confident mRNA technology can be used to easily adapt to the new strains that arise from COVID-19. It is great news if that is the case. It is very bad news for the world economy if it takes a lot of time to adapt the vaccines to new strains of COVID-19. Based on what we know thus far, it is more likely these new strains will not be a problem for the vaccines. We shall see.
IPO Mania:
The initial public offering market has been busy with a large number of new companies going public. The $78 billion of total dollars raised thus far in 2020 is the third highest ever. 2014 was $85 billion and 2000 was $97 billion. Most years, total dollars raised from IPOs are less than $50 billion. No one foresaw this amount of cash would be raised back in March when the pandemic started and the Stock Market took a huge dip. There has been a lot of enthusiasm for these new stocks, especially from new retail investors.
Most of the companies that went IPO this year have never made a dime of net profit in their life. It does not look like they will be able to earn profits anytime soon. They are valued as a high multiple of sales or some far worst metric. It harkens back to the eyeball tests of the internet bubble. The percent of IPOs with negative earnings have hit approximately 80% which is the same level as 2000.
Many of these IPO companies have garnered a lot of media attention and their stock prices have gained significantly in a very short time. These situations often do not end well. They are being pushed higher in large part by retail investors, especially the new investor crowd. On one hand I am thrilled people who have never invested in stocks before are now buying stocks during this pandemic. The advent of mobile platforms for buying and selling stocks made this very easy. However on the other hand, many new retail investors in this group have never seen a prolonged downturn in stock prices. They buy every dip in prices. The February-March drop in the Market was too short lived and not deep enough for them to see real pain.
Another form of public capital fundraising are the Special Purpose Acquisition Vehicles (“SPACs”) which have exploded in popularity this year. SPACs are blank check funds that will invest in a single company or asset. SPACs have reached mania enthusiasm as well.
Adding fuel to the mania is the Federal Reserve pledging to keep interest rates low for the foreseeable future which makes debt investments yield low returns. These factors have driven stocks and other asset class prices to stratospheric levels and the air is running thin.
It is not just IPOs. Many “hot stocks” that have been publicly traded and Cryptocurrencies have reached bubble-mania conditions. These situations have historically not ended well for speculators of those bubbles.
Pandemic COVID Stocks vs. Recovery Stocks:
There were massive COVID-19 winners earlier this year. Online retailers, cloud services, in-home entertainment services, and delivery companies were all winners. Some of these pandemic stocks will take a big hit either because of gross overvaluation or their business will drop off post pandemic. Others should continue to perform well due to a macro secular shift that has been playing out for years. The COVID-19 pandemic merely accelerated these trends. Examples include the continued growth of online shopping and the digitization of the economy, which should continue to benefit post pandemic.
There were massive COVID-19 winners earlier this year. Online retailers, cloud services, in-home entertainment services, and delivery companies were all winners. Some of these pandemic stocks will take a big hit either because of gross overvaluation or their business will drop off post pandemic. Others should continue to perform well due to a macro secular shift that has been playing out for years. The COVID-19 pandemic merely accelerated these trends. Examples include the continued growth of online shopping and the digitization of the economy, which should continue to benefit post pandemic.
An interesting case is the Healthcare Sector. A global pandemic should help lift all healthcare stocks right? Well, it did not initially help for some healthcare companies. In fact, many suffered a decline early on. Such as medical supplies and instrument companies that cater to elective surgeries. Hospitals took a big hit because the cost of treating COVID was exorbitant. Federal and State government support eventually came but not before a big dip. Pharmaceutical companies that focus on vaccine development or COVID-19 treatments did well. Device makers that produce ventilators, tubes, and anything COVID-19 related did well. For some of these companies, this scenario will not last forever as it appears COVID-19 will eventually be defeated.
The speed of vaccine development and the brand new technology of mRNA will change the trajectory for biotechnology. There is more interest now than ever by investors, companies, and governments to fund research. If the mRNA vaccines have the efficacy and minimal long term side effects, this opens up a whole new field for treating viruses. This might mean way better efficacy for future flu viruses and other viruses. We are entering a new age of drug discovery.
This does not mean companies in the vaccine space will all be profitable. Most likely, most biotech companies will continue to be cash flow negative. Pharmaceutical companies are receiving enhanced support to develop new drugs. However, both pharmaceutical and biotech industries will face pressure for lowering drug prices from governments and the general public.
Meanwhile some cyclical industries such as non-home entertainment and travel will experience pent up demand when vaccines become more widely administered. I caution to be careful here as well because many of these companies have taken on an exorbitant amount of debt during the pandemic just to burn it. They had operations shut down so the cash raised was simply to keep the lights on and avoid bankruptcy. This is pure equity destruction because that debt is not going away without repayment or a bankruptcy filing. Of course, there will be winners here as well as COVID restrictions eventually ease in the next few years.
What’s Next:
Many parts of the Market are grossly overvalued. However, I find that there are still quality companies with reasonable valuations available. They are reasonable because they are often ignored by the Market and are not talked about much by the media or by online retail forums. They are also reasonable because sometimes they have idiosyncratic or industry specific problems that can be solved.
Most of the time, the Market is rationally forward looking. It is when the Market overshoots on the upside and downside for price movement that often creates the most interesting investment opportunities. The Stock Market crashed in February and March even though COVID cases were just surging. Now Markets have surged and continue to surge even though there are more cases now than the past and millions are still unemployed.
There will also be some excitement when a new Presidential Administration is sworn this coming January. However, that excitement will eventually give way to some reality. On one hand, many public companies are benefiting from being able to stay open while many small companies were shut down. On the other hand, unemployment remains astonishingly high. It has yet to dip below the peak of the “Great Recession of 2008”.
Conclusion:
I am more convinced now than ever equities are the way to go for preserving and growing wealth in the long run. Stocks have beaten every other asset class in the past two hundred years over the long run. Even with stock valuations at elevated levels, they are much better positioned than ultra-low interest rate returns for bonds. Government treasury bonds and corporate bonds have such low interest rate returns that they do not pay for their risk. There are two main risks to investing. One is a loss of your initial investment due to idiosyncratic or industry risk. Two is inflation. All this government money printing around the world runs the real risk of inflation. Inflation is not great for many stocks, but it is certainly worst for bonds. There are many stocks that do well in an inflationary environment if you know where to look.
I am more convinced now than ever equities are the way to go for preserving and growing wealth in the long run. Stocks have beaten every other asset class in the past two hundred years over the long run. Even with stock valuations at elevated levels, they are much better positioned than ultra-low interest rate returns for bonds. Government treasury bonds and corporate bonds have such low interest rate returns that they do not pay for their risk. There are two main risks to investing. One is a loss of your initial investment due to idiosyncratic or industry risk. Two is inflation. All this government money printing around the world runs the real risk of inflation. Inflation is not great for many stocks, but it is certainly worst for bonds. There are many stocks that do well in an inflationary environment if you know where to look.
My investment strategy has helped us play defense in big downturns such as the one earlier this year. My strategy has also helped us play offense when stock prices were depressed. What the future holds is never certain. What we offer at Talguard is a long term investment strategy that seeks to preserve and grow wealth over time.
My goal is to survive the one year that no one else does. This is that year. We preserved and grew our capital in this pandemic year.
We now turn the page to 2021. If history rhymes like it does most of the time, expect more volatility ahead. The recovery will be bumpy. All this money printing by Central Banks will have ramifications. As the old saying goes, “the piper has to be paid”. On the flip side, there is pent up energy and demand to get out there and re-engage and explore the world for many people.
There is no doubt about it, COVID-19 has been a tragedy for many families and it has created scars in the collective conscience of humans. Approved vaccines are little comfort for those who lost loved ones. The only solace is that there is a light at the end of the tunnel for those still living. We just have to make sure we reach that light.
That is why Congress needs to continue to provide Fiscal Stimulus support for the economy. The recently passed stimulus bill is only one step in a series of steps needed to help sustain small businesses and individuals in the year to come. This is to ensure small businesses and families make it through this difficult pandemic without having to file for bankruptcy. The country owes it to them since many were forced to shut down multiple times through no fault of their own.
Until next time, I hope you and your family stay safe and happy.
Happy Holidays.
Best,
Dan H. Chen
President
Talguard Investments LLC
Disclaimer Statement:
This document and information herein represents the views of Talguard Investments LLC and is not to be considered investment advice. The information herein should not be considered a recommendation to purchase or sell any particular security or financial instrument. There can be no assurance that any securities discussed herein will remain in the Talguard Value Fund LP.
This document does not constitute an offer to sell or a solicitation to buy membership interests in the Talguard Value Fund LP. Past performance is not necessarily indicative of future results. All information provided herein is for informational purposes only.
Investment in the Fund will involve significant risks due to, among other things, the nature of the Fund’s Investments (as defined herein). Investment in the Fund is suitable only for sophisticated investors and requires the financial ability and willingness to accept the high risks in an investment in the Fund. No assurance can be given that the Fund’s investment objectives will be achieved or that investors will receive a return of their capital.
In making an investment decision, prospective investors must rely on their own examination of the Fund and the terms of this offering, including the merits and risks involved. Prospective investors should not construe the contents of this letter as legal, tax, investment or accounting advice. Prospective investors are urged to consult with their own advisors with respect to legal, tax, regulatory, financial and accounting consequences of their investment in the Fund.
©2020 Talguard Investments LLC, all rights reserved.