In our view, the main attribute of the second quarter was noise. The economic noise introduced by COVID-19 and the responses to it by individuals, businesses, and governments made it extremely difficult to determine what the underlying trends were. We expect this noisy environment to persist for at least another quarter or two assuming that COVID countermeasures diminish over time. If there is a resurgence of the virus and additional countermeasures are taken by governments the period of noise will be extended.
This inability to discern the underlying trend makes things difficult for businesses. In many cases demand for goods plummeted a year ago then soared this year—but what will it be next year? Should management expand their capacity or is the soaring demand temporary, and any expansion a waste of money? The service sector was hit even harder as many service providers were forced to close their doors due to lockdowns and are now working hard to get their operations back to a pre-COVID level of efficiency. Big swings in demand make planning difficult. Exacerbating the difficulty for businesses is the continuing chaos in supply chains, particularly those that are international. Not only are suppliers subject to local restrictions and shutdowns but port closures are occurring seemingly at random throwing shipping routes into chaos and driving shipping rates and transit times up. This increases both cost and uncertainty. Should the business owner invest time, effort, and money into diversifying or localizing his sources, or ride it out as best he may? These are the questions each business is asking currently, and good answers are hard to come by. Their answers will likely affect both employees and customers over the longer term.
The noise in the economy is reflected in the stock and bond markets. Interest rates have fallen over the quarter with the 10-year treasury yield on 29 June at 1.48% (down .2% since our last letter and down .4% since 2 Jan 2020). Contrast that with inflation, which was up 4.99% year over year as of 31 May as measured by the Consumer Price Index. There is a reason inflation remains a top concern for many investors! The Federal Reserve’s stated position is that higher inflation will be temporary and if that doesn’t prove to be the case they have the tools to bring it back in line with their 2% goal. So far the bond market believes that message as indicated by the low yields on treasury bonds. The Federal Reserve continues to buy roughly $120 billion worth of bonds monthly to support the economy. After their June meeting they gave just the slightest hint that they might start thinking about reducing those purchases some time in the future. Fiscal policy remains exceptionally loose as well with the government continuing most COVID-era emergency programs including rent forbearance, unemployment bonuses, student lending forbearance, etc. Some programs have been curtailed, specifically the unemployment bonuses which have been discontinued in a number of states, while some have been extended. The details vary from state to state.
So it’s tough to tell what demand looks like in the longer run, what supply looks like in the longer run, and how long government support will really last. Call it noise, call it fog, call it uncertainty.
In that context we continue to pay close attention to companies, not only the ones we own but also the ones we might like to own. Last quarter we highlighted that the economically sensitive companies we own had done quite well for us in the first quarter. This quarter they pulled back somewhat. Of particular note is the housing market where exceptional demand and limited supply drove prices dramatically higher very quickly. Prospective buyers are now getting sticker shock and rethinking their plans, suggesting there will be a shakeout in the industry in the near future. How exactly that will play out is, of course, unclear.
Also worth noting during the quarter was the FDA approval of a drug that treats Alzheimer’s disease, Aduhelm, developed by Biogen Incorporated (BIIB, Financial). We happen to own some shares of that company. While the approval was certainly good news and drove the stock price higher there is considerable controversy over both the effectiveness of the new drug and its pricing. We expect volatility in the stock price of Biogen to continue in the near future as market participants learn more about the drug, its effectiveness, demand for it, etc. We continue to hold a bit of gold, which hasn’t done much this quarter, and a bit of cash. We continue to look for good opportunities for investment and will take advantage of them when we find them.
As always, if you’ve got questions or comments feel free to write or give us a call. We’d love to hear from you.
With our best wishes for your continued success and good health.
The comments made in this letter are opinions and are not intended to be investment advice or a forecast of future events.
Refer to the SMA All-Cap Value Fact Sheet for the Top 20 Holdings and performance data as of the most recent quarter-end.