Recorded on February 28, 2020
In Episode 4, Bryden Teich and Bill Harris discuss the events in the stock market for the last week of February 2020 and how Avenue has been positioned for this.
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Bryden Teich (BT) | Bill Harris (BH)
BT: So if we were to start off, we originally had a different topic that we were going to discuss in this week’s podcast but I think with what’s happened in the market and sort of the extreme week that we’ve had, we thought it would be a great time to sit down and have a conversation about what’s happening out there and what we’re doing about it. And so, if you were to take a look at what the week has been, how would you sum up how we got here and what has led to this kind of period of volatility in the market?
BH: Yeah, it’s as exactly as you framed. This has been an extraordinary week and so it’s actually interesting; I’ll even frame it to the point of view that most people in their daily lives really don’t pay attention to the stock market that much. Then you can even have an economy slowdown and you’ll look at the market on the weekend or a couple days later and say, “oh wow, I didn’t really know this was all happening.” But because you’ve got the virus, and the story of the global proportions, and then the stock market reaction, this is really an extraordinary week. So again, as you introduced we were going to have a different talk today, but thought that this was important to touch on, and certainly in the last 48 hours we’ve had lots of calls and emails, so this is absolutely top of everybody’s mind.
BT: Yeah and it’s a great medium to discuss what’s on our mind and what we’re doing about it. The last conversation we had was almost a month ago now, we talked about this idea of really low interest rates, a lot of money in the financial system, a lot of the money had gone into stocks, and this indexing effect that we hadn’t really seen how it was going to shake out. Our view had been, you would probably hit a wall and the market was going straight down because of this cascading effective indexing and leverage in the system. And so, if you were to sum up that index effect: how big of an impact do you think that has had on what this week has been like?
BH: Yes really standing back and saying over the last couple years, what’s really happened that’s changed the stock market is that there are no longer individual people, individual stock brokers, making individual ideas, or even portfolio managers at insurance companies, pension plans, sitting in a chair saying I want to buy this sell this. More than 50% of participants are participating in the stock market using indexes. So when you make buying decisions, you’ll be making them gradually, how do you feel each day, the market will then work its way up gradually but we’ve always felt over the last two, three years that “oh this indexing thing is really going to change the nature and tone of the market.” When you have an event or a crack, our expectation would be it’s going to go straight down. This is really the first time we’ve tested it, and so going back to where we were just this time last week, we were at all-time highs, incredible ounce of liquidity -jargon [that] just means the central banks can create money, there’s no real place for the money to go but into hard assets like houses or into the stock market, so it gets pushed into the stock market and it just goes into the index and drives the stock market up, and the biggest names get the most money. When it rolls over, there’s just there’s nobody to buy it – everybody is just an incremental seller, and we’ve seen this week -just five days in a row- absolutely straight down.
BT: I think the remarkable thing is sitting at the screens all week, and this and looking at the gapping down of markets to that effect. That’s sort of the technical way of saying there’s just at lower and lower levels there haven’t been buyers, and so you used to have the shock absorbers which were the banking system which would take on positions on the trading desks. The shock absorbers for the market have long been gone with a lot of the regulations that’s happened in the last decade, and then you’ve amplified this with indexing, and you’re just get to a point where there’s just no buyers at certain levels and this idea of when you get it in an overvalued market or extreme valuation market you have sentiment at all-time highs or close to all-time highs, and you hit a wall and the market goes down really fast, really quickly. So, if we take a step back and say, these are things that we’ve been preparing for, for months and how we’ve positioned our strategy. What would be some of the key points that you would touch on in terms of how at Avenue we’ve surgically been preparing for this for quite a while?
BH: Yeah, I’ll absolutely hit that one and I’ll throw it back to you because of the work you’ve been doing. Even though we’re at all-time highs, and sentiment was positive for the stock market, we’d actually seen things that were eroding inside. This is laying out that case that the indexing was going to change the nature of the markets means that you actually have to do it ahead of time. We then as a strategy say we want to own stable income producing companies, but you have to be really careful in valuation that you don’t own anything that’s really expensive. So we’ve spent, certainly last year, that’s where something like Microsoft that we had owned for 10 years, and then coming into this year, we’ve sold Apple, look at trying to move the money into less expensive stocks, but our hit list in the last few weeks of taking off technology, taking about down energy, we’re in a position of being 22% cash and gold ahead of this, which this time last week was actually quite an uncomfortable position, but defending it saying I don’t know what’s going to happen but we have to be ahead. I’ll just comment that first thing on Monday morning, we came in and said, “okay, this is very real and let’s tear the portfolio apart, what is it that you want to do?” – Paul Gardner participating in that meeting. There wasn’t anything that was an obvious air pocket under the valuation. So it’s interesting coming into this week: there wasn’t anything else we were going to do, except then you’re starting -which is very different mental mindset- saying actually let’s spend all week trying to figure out where we want to put this money when we get an opportunity.
BT: Yeah, I think the other thing too is that when you get to periods like this, or weeks like this, where if you look at it on a shorter-term indicator, we were oversold three days ago; cascading down Monday, Tuesday, Wednesday, and then to have Thursday and Friday, this capitulation pushed down. I think if you look at one of the indicators we’d like to look at which is how many stocks are above their 200-day moving average, and overlay that with the index, when you get to these extreme levels -I think yesterday was about 32% – as uncomfortable as it is, we know we have to be doing something because with the volatility index -the VIX- at close to 42, with stocks now significantly below their moving averages, as painful as this is, this is actually where, surgically, we go through and implement our plan. I would say we always have a list of stocks that we’re looking at, and we’re always having levels in each one, where we can be buying but you have to methodically have that planned out, you know kind of months and months in advance and now this week has been a great opportunity to start executing on that. The other thing too is when you look at having a bigger plan like this, sometimes it’s easy to sit in a meeting and talk about what you want to do and then all of a sudden that the decision-making process gets accelerated very quickly. So, us having the ability to react on our feet, be quick, execute our plan, know what we’re doing ahead of time, you have to have a Zen-like feel to what we’re doing. I think what was interesting is a lot of market participants the last number of months felt like there was a laundry list of reasons to explain why things were so great, and from an economy perspective, manufacturing, employment, we’ve been watching that a lot of these things have been soft now for months. So, the nature of this virus and the longer tail impact on the global economy is still far from certain -what this looks like even out six months- and so that’s very different than what previous sell-offs had been, where it was a tweet and the market would go down 8%, and there’d be another tweet and the market would go back up; this is very different. In our preparation we’ve been ready for this for a while, and it’s just been a matter of going through and implementing our strategy.
BH: I think this is the one of the harder points about doing this. As you said, we’re at our desks, we’re watching what we own, why we own it, looking at the numbers come in, and from a client’s point of view, I empathize. This is probably the hardest part: you’re seeing the headlines, you’re anxious, and so we know the businesses and say, “we own great businesses. There are fantastic amounts of dividends that are coming into the portfolio. We’re already defensive ahead of time” and so even though there’s this nervousness, it seems counterintuitive that we’ve had an extraordinarily bad week, and today we actually spent this morning -already an hour and a half- saying where we going to spend 2-4% of our money by the end of the day even then knowing it’s still might be worse by the beginning of the summer. And so how can we know that we have a good valuation, make sure we’re getting a dividend, and which case we can ride through, and we’re still going to be constantly be able to add to the portfolio if this does continue. Certainly, our impression today is that it’s the nature of it; [it’s] probably not over.
BT: I think the other thing too is that, as long-term investors like we are for clients, as counterintuitive as it is -as you mentioned- you have to actually embrace periods like this because they create fantastic opportunities, and so what we’ve done is we’ve taken profits on certain positions over the last several months, we’ve reloaded the cash position with those profits, and now we have levels on certain stocks where you start deploying that over time, but I think the best way to describe it is this surgical process that we try to execute with selling it levels that we like, and then having it taking profits, and you’re constantly reloading the portfolio. At the same time, you have all of the high yield portions of the portfolio spitting an income every month, and then there’s more money to deploy over time. The other one -I’ll just push back onto you- is just to square up that the last comment, we discussed about the economic outlook, and what’s your view on the timeframe for this global slowdown to push through? And if we were to look at a chart of 30 year interest rates, you’re at now historical low levels, and so what does that mean for what the Fed likely has to do to this and also the outlook for equities versus bonds now over the longer term?
BH: Yeah wow, we’ve got another 45 minutes.
BT: Yeah, we could talk for hours but we don’t want to bore people.
BH: Interest rates now look like they’re at an extraordinary low. It was just at Christmas time; we were talking about the 10-year because it’s about businesses and how businesses can borrow money. The most important interest rate is the US 10-year rate, which is where a corporation funds -not about us and buying our houses. The stock market is based on businesses and that’s the important number. So, two months ago that was roughly 2%, 1.9 but going to 2%. Now it’s almost 1%, it is down 50% in two months but from an absolute level, 1% is what you’re going to get in the bond market, which is just not a great rate of return for how much risk you’re taking. What’s implied in this for us is that we are equity investors, you’re getting a great deal owning a big stable business that throws off money. A situation like this creates a buying opportunity, knowing again that this is what we do, we’re in the business of buying businesses. We’ve got dividends, we accumulate them, and we keep buying, and buying, and buying stuff so this by definition has to be -ironically- a good thing but it’s just like you don’t want to buy the falling knife. That’s the probably the biggest issue we’re dealing with today and this week is that: is this falling knife? Are we just about to buy it a month from now saying “oh that was a bad idea.” So can we protect ourselves and buying the businesses we’re comfortable with? We know are comfortable at this level anyway. I think the point that I probably would have brought up earlier was that you don’t have to fly into the eye of the storm. This was just last quarterly letter to discussing Microsoft and how expensive it is, and a 1.3 trillion dollar company, and how on earth is it going to double in size, and the answer is well the numbers really were ahead of itself, but that doesn’t mean we have to go right back into Microsoft or Apple. So, we can actually say that this was the eye of the storm, all that money went into these stocks. When it’s going up you have to be over-weighted when you know for an investor that’s trying to beat the market, when the stock is going down you have to be underweight so everybody has to get underweight fast, in which case you don’t really know where Apple or Microsoft is going to settle out. So, let that go to somebody else and we can focus on things that other people aren’t looking at.
BT: So if we were to wrap up on this point of saying so as we discussed, as painful as it is in weeks like this, today is the day we’re actually putting money to work some of the money that we have been storing up for months now -which is a great time to be deploying a little bit. But having cash, having income, having these other different yield sectors, whether it’s real estate, or infrastructure, utilities, generating a lot of a lot of cash in the portfolio, how would you sum up the strategy now for the next six months as we go through this period of what will be slower global economic growth?
BH: We’re in a position now to pick away at things, and so today’s the day, might be two weeks from now where we see things again. We certainly would like to focus on those key parts of the economy which is: health care, technology; these are great businesses, but they’re quite often expensive and so this might be a chance for us to actually get them, or they’ve got these other industrial businesses that are beaten up but they’re very solvent, great long-term, core the economy businesses with dividends, and we can buy them and sit on it, and just accumulate income over time which is really the core of the strategy.
BT: Why don’t we wrap it up there. Thanks for the conversation and look forward to the next one.
BH: Yeah exactly and it will be interesting.