“The four most dangerous words in investing are: this time it’s different.”
-Sir John Templeton
This week is the eightieth anniversary of the Battle of Britain. During these somber times, we find inspiration in those who overcame adversity in the past. Investing would be easy with the benefit of hindsight, right? Well yes literally, but what if we asked you, knowing what you know about history, to guess when the British stock market bottomed in the Second World War. What would be your guess? Probably after it became clear that the British were not going to be annihilated, right? Wrong. Would you believe us if we told you that the British stock market bottomed a month before the Battle of Britain even began? How hard would it have been to buy at that period of time? Pessimism ruled. That means that through the fire-bombing of London, V1 and V2 Rocket attacks, The Blitz, the U-Boat Blockade, The Fall of Singapore, and the failed cross-channel raid at Dieppe, the upward trend of the market went unbroken. As we face a comparably grim moment, and indeed the most significant exogenous shock to the market since World War II, it behooves us to remember both what commentators were saying would happen in the markets and to recall what actually happened. Better still, let’s remember how they diverged. The last ten times the market made a comparable drop to the March lows, it was followed by a ‘V’ Shaped economic recovery. We see no reason why this time will be different, even in the face of rising COVID-19 cases.
What we see is an unprecedented contrarian opportunity to buy stocks with the intent of owning them. We understand why the glum sentiment on much of the Street exists, but we find the data refutes it. We do not think stocks will make another bottom, and we believe the market has a good chance of making new highs this year.
While the current situation is undoubtedly terrible, we find much of the commentary from bears to be long on emotion and short on fact. They have to squint more and more to see their negative narrative; all the while markets go up. The data is often ‘less bad’ than initially anticipated. Pullbacks are often short and healthy, not panicked selling, and we haven’t hit the breakers in a while. Then a lot of the people spread fear that the morally profligate Fed, sooner or later, will destroy us all, in some way or another. They rarely offer alternative action on what the Fed should have done. The discourse across the financial world is very bearish and capital across the system is positioned so short that some fund managers could fall into their loafers. We think you should be skeptical of commentary like this, which may or may not be self-serving, and we’ll explain why. Markets are functioning and markets are free, that is something we should be grateful for.
Inspiration From Previous Dark Times
To give our readers some perspective, we’d like to take you back in time. To a time when the freedom of markets was threatened not by Jay Powell’s dovishness but by the jingoism of Adolf Hitler, Benito Mussolini, and the Empire of Japan. In June 1940, the Nazis had achieved the pinnacle of their success, soundly defeating the entire French military, resulting in that nation’s abrupt and ignominious surrender. The British Expeditionary Force narrowly escaped without most of its means of making war by using primarily civilian boats to evacuate from Dunkirk. The German forces were by every measure more modern, better trained, and better equipped. The ‘Blitzkrieg’ offensive brought France to its knees in six weeks. This dazzled Europeans whose last conflict had been an intractable, bloody stalemate, marked by agonizingly slow and expensive military progress. To those experiencing these events, there was extraordinarily little reason for optimism. Far less than we have in today’s markets. Few of the times’ pundits and analysts predicted a positive outcome for the Allies at this point. Optimism was the gaudy possession of a few leaders, by no means all, and the masses they led. It seemed that the future would be ruled by Fascism.
The freedom of markets was truly in danger.
One voice of optimism was Winston Churchill, who had previously been considered political dead weight after planning the botched Dardanelles Campaign and his association with other high-profile bumbles. His optimism was met by many, including the more respected politicians of the day, with skepticism. He was traduced and lampooned by opposing politicians for failing to see reality. He was derided and pressured to seek peace with the Nazis. On June 18, 1940, he gave an address before the House of Commons defiantly against the bleakest of backdrops. The very building he spoke in would be destroyed only months later. While few could see the light at the end of the tunnel, the worst for Britain had not yet begun, Churchill uttered the following description of the situation; which deviated significantly from consensus expert opinion:
In casting up this dread balance-sheet, contemplating our dangers with a disillusioned eye, I see great reason for intense vigilance and exertion, but none whatever for panic or despair. During the first four years of the last war, the Allies experienced,…nothing but disaster and disappointment, and yet at the end, their morale was higher than that of the Germans who had moved from one aggressive triumph to another. During that war we repeatedly asked ourselves the question, “How are we going to win?” and no one was able ever to answer it with much precision, until at the end, quite suddenly, quite unexpectedly, our terrible foe collapsed before us. -Winston Churchill, June 18th, 1940
Winston Churchill is one of the great orators that democratic society has produced. The words he offered had an uncanny ability to decipher the optimism and energy of the masses in the face of pessimism from his colleagues and expert commentators. During the gravest threat ever faced by Western Civilization, his inspirational words fomented optimism in the face of seemingly impossible odds. An example of the prevailing pessimism can even be found in a former titan of finance Russell Leffingwell, one of JP Morgan’s (the person) main partners during the pre-war period that said, “The Allies cannot subjugate the Germans. There are too many of the devils, and they are too competent”—and at the time, there was little reason to doubt his logic. This opinion was widely held throughout the elite corridors of high society in America and Britain.
However, Churchill gave a series of defiant addresses laden with hope and a call to national duty and unity. It inspired optimism where it mattered for Britain in the struggle to come: in the hearts and minds of the citizens that would operate the factory lines and fly the Spitfires. Churchill’s optimism seemed to be out of the blue; he derived direct inspiration from the people and channeled it into his defiant speeches. However, as Winston Churchill projected hope and strength from the unmitigated, and many experts would have said unwarranted, optimism of the steadfast British people, this hope also began to be reflected in the British stock price. Curiously, it bottomed after a long and precipitous fall in June 1940, about a month before Britain’s harshest and most harrowing period of the war began.
It should be noted that around this low point, there was a backlash against the Royal Air Force, and it was widely cursed by members of the Royal Army who’d suffered humiliation at Dunkirk and sought a scapegoat. As bad as things were in the times to come, every day the RAF held back the onslaught, it was outperforming the expectations of all who observed. The outcome was undoubtedly awful; half of London’s population slept underground as bombs fell from above, but it was less bad than what had been initially anticipated. The Nazi conquest of Britain was as yet incomplete. In this time of fear and widely held doomsaying, we must acknowledge the uncanny historical ability of markets to make sense of available information in ways that are at odds with the emotional fog of the present, in ways that obscure clarity to even the most astute contemporary observers.
So what does this have to do with stocks? Well, when commentators today harp about the market’s insouciance in the face of rising coronavirus cases, you can remind yourself that the British stock market went up when German bombs were leveling whole city blocks in London. This is not anomalous. Similarly, shortly after the Battle of Midway (which in retrospect was the major turning point in the Pacific War), the US bear market of 1939-1942, caused primarily by geopolitical instability, abruptly ended. At the time, it was impossible to determine that Midway was as strategic a junction in the conflict as we see with the benefit of hindsight. Even the German Bourse, vestige of its democratic past, seemed to peak at the absolute height of their territorial expansion when no one yet realized what an awfully bad idea it is to pack light for a Russian winter. Even that wayward and belligerent nation’s own prominent investors sensed over-optimism and that perhaps their opponents were more resolute than their initial successes indicated. So, what is behind the prescience of Democracy’s Delphi? No one knows exactly, and no one is saying the stock market is flawless in its predictions or always right. The facts seem to indicate that the aggregation of many opinions into an average is generally more accurate than any one of them alone.
How To Pick Stocks: Know Thyself, Nothing In Excess, Surety Brings Ruin
So then, how do you pick the best stocks? It’s easy! Just find the companies that are going to outperform their peers and remain profitable in the future in the face of risks you cannot possibly anticipate! The ease with which we provide our response is intended to be a comically simple answer to one of the most challenging and debated questions in Christendom and beyond. To put it lightly, there is widespread disagreement on how to best pick stocks.
We get it. Everyone wants to be right. Many investors may have pipe-dreams of a contrarian masterpiece like John Paulson’s great call during the GFC or some variation of something they saw in Michael Lewis’s The Big Short. We get it, it’s cool to call the market going down when everyone thinks it’s going up but there’s something even cooler; like someone calling the bottom on March 24th and going headlong into some names that consensus deemed little better than future bankruptcies with great success. Ah-hem! FS Insight Team clears throat.
We think it is always easier and more likely that you will make money on the way up. Owning stocks over the long term has pretty much always been a good deal, and some prominent tech stocks are beginning to have risk-adjusted returns that rival some of the safest assets available. We have great ways to pick stocks for all different risk appetites. We’d gently say to you that going long when consensus is overly bearish is an easier and better deal than trying to time and short the market.
Glass Half Full: Please Can I Have Some More?
The headline unemployment numbers we currently have, amongst other numbers, are enough to make even the brave blush. However, the Nasdaq is also making new highs. It’s a hard market to make sense of. Did you know that because of how wealth and unemployment are distributed in the United States that it is possible that after all is said and done that the Global Financial Crisis (GFC) may result in a more significant loss of income than the coronavirus crisis? We bet that was not your first thought. This seems like it is impossible. How can this be with such a high unemployment rate? The majority of job losses have been suffered by workers who have low incomes, many being minimum wage. Higher paying jobs have not been lost in great numbers so far as they were in the GFC, which resulted in an outsized loss of income due to their higher than average salaries. Notably, the government stimulus to individuals in many cases results in many of these workers actually having more income than before. Consumer confidence has stayed at a way more elevated level than it sank to in previous bear markets, and this solidifies our analysis. It remains much higher than the reading of 20 that was registered in the dog days of the GFC. It might be easy to forget after so long that the entire reason we pay attention to the unemployment number is its proxy effect on income. We have been telling our members that employment numbers would dramatically overstate the loss of income experienced by the economy. We also pointed out to our clients that even if all ‘social distancing casualty’ companies were to permanently shut their doors that the US economy would still operate at 93% of its pre-crisis capacity. This is an example of how we translate state-of-the-art data analysis into actionable insights for our investors. We adapt, and we pivot to markets and relevant developments in real-time.
These insights, along with the immense amount of capital on the sidelines, largely informed our decision to recommend some of the best-performing stocks since the market bottomed. We provide our rationale and thoughts regularly to our subscribers. While we primarily aim our insights toward giving our investors stock picks, we believe our diverse analysis is useful for anyone who can benefit from sound investment advice, from day-traders to brand new investors. Whatever your trading strategy, we can help.
How We Pick Stocks
Bottom-up investing is looking for stocks based on their idiosyncratic fundamentals and financials, essentially picking stocks of financially sound and stronger companies that will outperform their peers and deliver to shareholders. Top-down investing, particularly crucial in times of uncertainty, is working downward from macroeconomic data and determining how those conditions will affect stock prices. At FS Insight, we combine the unique and beneficial aspects of both these kinds of analysis, and others like our premier technical analysis, to provide versatile and actionable investment advice to our clients, including single stock names derived from combining diverse types of intersecting analytical criteria. We provide detailed macro-guidance (it seems lately our job has been more akin to Virology than equity analysis at times). However, we think this ability to pivot on data and to react and inform investors on what appears to be causing price movements gives our clients a better edge in investing than any other service. Check us out, some of our more prominent clients will verify our approach. During the Internet Bubble, people made money by avoiding everything that had suffered the worst drop in value. In the Global Financial Crisis, running directly into the burning building and buying banks and financials gave you the highest return. If an analyst only does one of the analysis methods, they can easily get stuck in a logically defensible strategy that loses them money.
We also like to look to the recent past in less definitive and headline-grabbing ways than some of our competition. For example, we take a lot of stock in the experience of one group of companies that were recently hit by a virtual complete stop in demand; prognosticators and market talking heads vehemently proclaimed the imminent collapse of the Homebuilders in the early days of the Financial Crisis. How could they possibly deliver to shareholders with the collapse in demand? The homebuilders exceeded even the most bullish expectations, and by Q1 2010 they had the same operating income with 69% less revenue. We think that the same remarkable ingenuity demonstrated by the Royal Air Force in the face of the bleakest odds, the Homebuilders in the wake of the GFC, and many of the stocks at the ‘epicenter’ of this crisis is something that as it was historically, is currently being grossly underestimated. Human beings can do amazing things when faced with profound adversity or ruin. We identify the strongest of the hardest-hit companies to our investors as some of the best places to put your money to work. From March 24th to June 9th, our picks outperformed even the wider market’s impressive comeback significantly. We believe that upward movement will continue, perhaps jaggedly, into year-end and into 2021.
While we’re on World War II, we’d also like to point out that bears are betting against the largest singular collection of private and public resources toward a single objective in human history. That is right, the accumulation of scientific and intellectual capital aimed toward curing or developing a therapy that reduces the Coronavirus’s impact definitely exceeds what was done in the Manhattan Project. We want to think of ourselves as in the business of betting on human ingenuity, not against it. We’re certainly not urging our clients, as many bearish commentators are, to assume there will be no vaccine. Vaccine news has been positive and we believe continued positive news in this area will be a strong positive binary event for markets.
Exogenous Versus Endogenous Economic Factors
The discussion of these types of investing lends itself to another key difference that we believe many investors are struggling with. Most of the time, by a long shot, the market is more affected by endogenous economic cycles rather than exogenous economic shocks. Most investors do most of their planning based on these more predictable events; these cycles are perennial, while each shock is unique. The difference can be illustrated quite easily. Regular endogenous economic cycles of boom and bust are driven by FOMO and the wealth management industry’s tendency to pile into ‘crowded’ trades (that we can help you avoid) until they cause a correction that is usually greatly amplified by investors being over-leveraged and unable to meet their commitments. The result is the thing that causes prices to go lower than any war, plague, or catastrophe so far; forced liquidation. Hyman Minsky’s famous Financial Instability Hypothesis is an economic model that explains booms and busts within the context of internal dynamics unique to capitalist economies, perhaps the quintessential description of the herd behavior and mania that bears love to focus on. Prices go down mostly because of the irresponsible accumulation of private debt in Minsky’s model and unbeknownst to many bears apparently, also as a prerequisite for their grim price targets and predictions coming true.
For the type of downward price movements to occur that ‘bubble-spotters’ and ‘perma-bears’ love to foretell, markets need to be over-leveraged, and a significant proportion of market participants need to meet the definition of a ‘Ponzi borrower’ thus resulting in forced liquidation that drives all correlations towards one. The Global Financial Crisis is a good fit for demonstrating what happens in Minsky’s model because of an endogenous shock. An astute analysis by Economist Paul McCulley described how Minsky’s theory was expressed perfectly by the subprime mortgage crisis; with the hedge borrower being represented by those holding traditional mortgages, the speculative borrower holding interest-only loans, and the panic borrowers holding loans with negative amortization features. This situation is clearly not what we are in today. Consumer confidence didn’t plummet, rent and mortgage forbearance is occurring widely, loans are flowing out of banks, and another part of Minsky’s hypothesis seems to be coming true as well; regulators seem to have done well in their role of improving the functioning and stability of markets. The government’s most significant effort to do so since FDR was in charge was tested by this crisis and, in many ways, passed with flying colors. The mandated recapitalization of the US banking system, for instance, seems to have paid for way more than it cost.
It May Not Seem Like It, But Endogenous Conditions Cause More Price Movement
Believe it or not, since World War II, aside from perhaps actions of OPEC in the ‘70s, there does not seem to be an exogenous shock that has affected markets so significantly as the Coronavirus. For example, the Cuban Missile Crisis caused roughly a 7% drop. The peculiar way markets price exogenous events is perplexing, and it certainly doesn’t comport with our typical understanding of what will be ‘bad’ for the economy and what will not. Otherwise, the prospect of nuclear apocalypse surely should have caused a more significant drop than the inexplicable 2010 ‘flash crash’ of about 9%, right? Nope.
We believe the discipline and heterogeneity of our diverse analysis methods give us a key edge that provides our clients with actionable insights that they can understand. We must also remember that markets have tended to overestimate the economic damage caused by exogenous shocks in past decades. The refulgence of re-illuminated risks causes people to see the ‘glass half empty.’ For several reasons, we think this will prove to be the case again, despite the horrendous human and economic toll we see playing out before us. As in the Battle of Britain, every day that the worst possible outcome did not manifest itself seemed to be a bullish development. So, remember markets don’t need good news to go up, they just need ‘less bad’ news than they were initially expecting. Forecasts usually take the path from bad, to less bad, to outright good. The possibility of millions of American deaths was initially projected as a possibility, as bad as things are going, that still seems unlikely.
The mentality that seems to be pervasive on the street is one of bearishness and false contrarianism. We want to let you in on a little secret. It is not contrarian to be bearish when everyone else is. Also, people making moral arguments about those purchasing equities (denigrating Robin Hood traders and the like) seem to be missing how markets work. Be suspicious of those attacking new investors and not trying to help them. The whole point of the market is, people with different risk appetites and different analysis methods will buy things that others would not. The market is democratic with an added stake; you’re voting to get a healthy return on your money back. Many folks will always take that vote more seriously than the one they cast for political office.
Avoid Commentary That Is Nasty, Brutish and Short (On data)
Thomas Hobbes once described the human condition on Earth as nasty, brutish, and short. He was definitely a glass-half-empty guy! Despite all the challenges and risks we face in our current predicament, his description of the human condition would be better applied to a lot of market commentary from bearish hedge fund managers. Life in a modern capitalist society, especially for hedge fund managers, is pampered, ‘refined’ and long (unless you include burning man, then it is nasty too). However, their commentary is still nasty, brutish, and often short (positioned short rather than long). They are nasty in that they tacitly approve of the Fed and US government’s extraordinary and well-timed intervention, but shake their finger at it as if taking some kind of moral stand for the freedom of markets. They are brutish because they extrapolate wide-sweeping conclusions that are clearly distorted by biases, fear, and questionable analysis. Many crude comparisons with history, this crisis, and that crisis, are woven into fallacious arguments meant to appeal to fear and ego rather than reason. It seems like quite a lot of pontificating and opinions rather than giving investors macro-insights they can benefit from (which we thought this was all about). They are short in that they all appear to provide dire warnings to investors that the market, any day now, will be meeting the dire moral reckoning they foretell, at the very least will retest March lows, and that the world will probably abandon the dollar as a reserve currency too, for good measure.
We find both of these scenarios to be highly unlikely. We actually predict that after all is said and done that the US Government’s debt service will be lower than before, which is another bullish harbinger of things to come. So, if government debt is not having its typical adverse effect on private-sector spending and stimulus is plugging demand that had to be suspended to protect commerce, then why is everyone so testy? Many ascribe fear-mongering language that is usually reserved for the moral hazard that occurs in the regular, endogenous boom-bust cycles of markets, not a great national emergency more reminiscent of the Second World War than the 2008 Financial Crisis, at least in terms of its significant interruption in daily life and economic activity.
The nasty, brutish, and short nature of a world where hedge funders can’t rely on models that have mined, now useless, historical data to predict ups and downs of endogenously motivated economic cycles, is just too much for them. If they can’t rush in to exploit market anomalies using market power, algorithms, high-frequency trading, and other tools most investors couldn’t hope to have, then what kind of messed up, unfree world are we living in? According to many market bears, the forces of totalitarianism have apparently won: by giving the economy useful and timely aid and staving off a much worse economic disaster, which could have resulted in a much more ‘Hobbesian’ outcome had fiscal and monetary authorities not acted as effectively.
We Prefer Minsky Over Hobbes
Being faced with the worst brings out the best. Hobbes’s grim description of the human condition is the basis of his political advocacy for an absolutist monarchy. Think about when he wrote it. Life has gotten continually better, albeit in a jagged but always upward fashion. We think the stock market will continue to reflect this truth. One of the government’s critical roles has always been to facilitate and protect commerce, and for all that is currently wrong with our government, it has at least done that very well on the monetary and fiscal front. The foot-dragging on assistance in the GFC caused some of the worst down days of that crisis; amazingly there was little delay or partisanship in the fiscal response this time. This and taxes are what markets primarily care about when it comes to the government, so don’t be alarmed if they don’t seem to echo your personal outrage. We believe unequivocally that investors who are willing to brave this harsh investing environment and own stocks for the long haul will find that as in previous dark times, American stocks will remain one of the most exceptional and lucrative stores of value in the world.
While the benefit of historical retrospect allows us to dismiss Hobbes’ political prescription and point to the fact that democracies, despite their dramatic fluctuations and processes, have actually been more stable, more prosperous, and better at preventing the ‘state of nature’ that Hobbes uses to justify tyranny than any other system. Despite his erroneous solution, his atomistic approach to demonstrating the value of, and defining, the heart of the social contract was one of the most significant insights in Western Political thought up to that time. One of the useful ideas he had is that by sharing burdens, society can create a much better environment for commerce. For example, the government can and should protect commerce from the realities of living on Earth that can threaten it, such as plague, famine, and war. This, we think, is what the Fed did, and effectively at that. Nothing more, nothing less. We struggle to see the immorality of the Fed acting as the lender of last resort and promoting financial stability in the grievous situation we together face.
Ah yes, even many seasoned Fed watchers forget that, like the Holy Trinity, the Fed often has a mysterious and overlooked third mandate; to promote financial stability in the United States (along with a gaggle of other financial regulators). While perhaps not as awe-inspiring as the Holy Spirit, in the financial universe, the Fed is pretty darn close. So, is it more likely that markets retraced nearly all their losses and are on the verge of imminent collapse? Or that since the financial crisis regulators got better at preventing shadow-banking activities from accumulating into systemically threatening time-bombs that cause forced liquidations and thus mute downward price movement? Does better regulation by the government create dividends and promote financial stability just like Hyman Minsky said? And, is that a large part of the reason markets are functioning not only freely but effectively? We think so.
Hard Times Come, Hard Times Go, Keep Stocks, In Your Portfolio
There are stocks on US exchanges that have not missed a dividend since the War of 1812. When, and in what state Hobbes wrote his masterpiece, Leviathan, illustrates how sound human logic can arrive at false conclusions when surrounded by traumatic events and with fear running high. The first point illustrates that equities are an amazing store of value even though all the turmoil we as humans can come up with and endure. The terrible loss of human life and rampant violence occurring in Hobbes’s world as he authored Leviathan was clearly his primary influence. Similarly, when we are woken up to harsh realities we can have an overly glum and pessimistic response. The factionalism and civil war that was shattering his way of life led him to take an emotionally satisfying but incorrect path in trying to prescribe solutions. We can sympathize with his sentiment, but history has taught us better. Does this make him a fool? No, it makes him human. Like Hobbes, we think the majority of today’s market commentators are by no means stupid, but we do believe they are wrong.
One human’s opinion is subject to bias, error, miscommunication, and miscalculation. However, when you start to aggregate a diverse group of people’s views, you may actually begin to get some insight. Democracy is a messy political process: it is not always pretty, and it is not always easy. Still, the wisdom of many has repeatedly triumphed over the understanding of the one or of the few. We believe that the ‘wisdom of the crowd’ embodied by Democracy is very similar to the reason the market gets right so often what many ‘experts’ get wrong. As Napoleon Bonaparte, once quipped, “The only one who is wiser than anyone is everyone.” We find this a surprisingly humble quotation from a man who is synonymous with egoism. Perhaps some of the world’s great investment commentators who make blanketed and fearful prognostications should take a cue from Napoleon’s humility!
It seems, as human society progressed and technology and innovation have solved many problems and greatly improved our quality of life so much so that we often tend to forget that Hobbes’s state of nature is always, at any time just one black swan event away and that for all of our progress and advancement, the human race is as much as ever at the mercy of nature and our own limitations and flaws. Coronavirus is one of the ‘once-in-a-lifetime,’ exogenous shocks to the economy that renew our innate understanding of our own powerlessness in the face of certain events that can wholly or partially elude our always increasing, but also always limited human faculties. The illumination of remote risks we are usually able to disregard or wholly discount does something to the human psyche that it necessarily should. It makes us reconsider many other threats that we deem remote, and it forces us to reevaluate logical short-cuts as we see the potentially devastating consequences of them in real-time. We also realize we have gained from them and try to protect those fruits. In other words, the risks we face appear more refulgent when we’ve been made painfully aware of our processes’ flaws. The unknown propagates the heightened consideration of more, previously ill-considered, unknowns that have really, if you think about it, always existed.
