Stableford Capital— September Review
The S&P 500 closed down 3.9% in September (Figure 1), breaking a 5-month streak of positive moves. The correction was driven by a breakdown in the options-driven euphoria of August as well as fears about the pace of economic recovery. It’s nice to see that there is still some sanity left in the world.
Don’t get us wrong, we’re optimistic. We believe the economy will recover and we’ll eventually get past most of the effects of Covid-19. But that doesn’t necessarily mean the economy (and corporate earnings) will be stronger than they were in 2019 by the first quarter of 2021.
We’re big believers in pricing equities off future earnings potential—but only to a point. We also believe in being prudent and buying good companies at reasonable prices. If we can’t justify the price, we don’t want to put client’s capital at risk. Assessing investments this way provides downside protection, something we view as more important than upside potential. It’s how one differentiates investing from gambling.
Key Election Impacts
A big part of investing is knowing where you stand and what future events might alter your views. The 2020 Election is one such event. Politics aside, the events of the election have what equity-geeks call a high level of dispersion—a wide range of outcomes. We’ve studied the election extensively and remain conservative given the high levels of uncertainty and risks inherent in certain outcomes.
What are the election puts and takes? Well, the presidency looks like a forgone conclusion barring something crazy happening. We have been skeptical of polls since most proved unable to predict the 2016 Election correctly. But even adjusting for some level of error, it is hard to see Trump winning upon close examination of the battleground states.
That brings us to the Senate, the real key to the elections. If Democrats take the Senate (the House seems a foregone conclusion) it makes it much more likely that higher corporate taxes will be a reality. The Senate is a tough call, but most polls have that turning blue as well. We’ll see, but it is hard to get too bullish in front of this kind of uncertainty.
Why? With full control of Congress and the Presidency Democrats are likely to pass something close to Biden’s proposed 28% corporate tax. Among the current proposals, this would have the largest impact on equity markets. Who knows where the rate ends up, but higher corporate taxes will likely mean somewhere between a 5-10% negative impact to the S&P 500. Of course, if the GOP holds the Senate, we’re unlikely to see corporate taxes moving toward the upper end of the proposals.
There are other factors around the election as well. Equities have been counting on more stimulus, though as of early October this seems unlikely. However, it could happen in the lame-duck session. It looks likely in 2021, regardless. This creates risk around owning too many, or too-long-duration bonds. We have begun to take this into account as well.
Lastly, there is the specter of a vaccine becoming widely available at some point during 2021. This is a big potential positive to the markets. Depending on the timing though, we could get more scary news as more people spend more time inside. We’ll look for opportunities to buy on Covid fears.
Stableford’s Positioning in Front of Elections
So where do we want to be in front of the election? We want to own names with big upside as a result of the economy getting better, but not have significant downside risk. For example, we own some banks, which trade in the vicinity of 60% of book value—meaning the banks would have to lose 40% of the value of their assets (i.e. write down loans severely and have little recovery) for a permanent loss of capital.
Similarly, in more economically sensitive areas such as airlines, we’ve picked companies like Southwest Airlines. Southwest is differentiated from the legacy airlines (which have enormous debt burdens, poor management, negative cash flows and are heavily unionized) because it has low levels of cash burn, more cash than debt and access to capital markets in the unlikely event it needs capital.
Will it be volatile? Most likely. But even with multiple years of cash burn it will still be solvent (not all competitors can say that). And should we get to a more “normal” state of travel the upside is tremendous. We prefer to analyze and invest in the high upside / low downside scenarios rather than buy names like United Airlines that might have more upside if they survive, but could also wipe out all the shareholders as well.
A final note on fixed income. Rates have remained roughly flat since March (Figure 2), closing September at 0.68%. Not too exciting. Things should get more interesting though as we approach the election. Higher expected stimulus is beginning to drive rates higher as of early October. We’ve been positioning in expectation of this happening, holding some cash in lieu of bonds (remember rates go up, bond prices go down).
Are you interested in making portfolio changes or getting a more in-depth analysis? Contact Stableford today by calling 480.493.2300 or simply request a copy of our Market Blast.
This market commentary was written and produced by Stableford Capital, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
S&P 500 INDEX: The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.