As a firm that has served investors since 1924, Baxter Investment Management has experienced the whole gamut of stock market cycles through the years. Many of these cycles have seen meaningful gains, as the stock market has provided positive returns about 70% of the time. We have also lived through the times when owning securities is gut-wrenching, arduous and even demoralizing. We are in one of those times now. These are the times that you earn your long-term return, because if it was easy, everyone would be an above-average investor. Grit and patience will win the day.
Today, we are facing a virus that is malignant, pernicious and contagious: it needs to be taken seriously. This is especially true for our senior clients. In the early stages of a viral epidemic, infections increase exponentially each day. Importantly, the most elemental social distancing and hygiene practices are the most effective. Wash your hands frequently (this actually kills the virus). Avoid touching your face. Maintain a reasonable distance from other people. Avoid sick people and people you have reason to believe have been exposed to the virus. Try to reduce person-to-person interactions as much as possible. This is especially important, and seemingly largely ignored today by a plurality of the population. During the MERS (Middle East Respiratory Syndrome) epidemic of 2015, a single South Korean businessman started a chain of transmission that infected 186 people and killed 36 of them. About 17,000 potentially exposed individuals had to be quarantined before the outbreak was brought under control after several months. Please keep the grandchildren away for another few weeks. Skype or Facetime your loved ones, the grandkids and your friends who might have been exposed, or are less careful than you are. With these facts in mind, we have reluctantly postponed in-person meetings for now. We do want to hear from you, and are in the office to handle any of your emails, phone calls or concerns. Please let us know if you plan to deposit or withdraw funds over the next quarter.
We believe that the new infection tally and the economic data in the second quarter will be extremely challenging. However, our expectation is that the Federal Reserve will continue to be active in the markets, and continue to provide liquidity in the pockets where it is lacking. Recently, the Fed began a bond buying program to help restore a functioning market for corporations and municipalities. This will greatly help get liquidity throughout the economy.
We think that Congress will (eventually) pass measures to help with additional liquidity for small businesses, challenged corporations and the displaced workers at home. This is also a very important step to balancing our economic well-being and our healthcare needs. There are more hurdles to address in the coming weeks with the virus and economy but we believe we are nearing the point of maximum pessimism.
We know that the coming economic data and earnings numbers will be dismal. But we also know that COVID-19 is largely a problem with a one-year duration. Flattening the infection curve is important in order to scale-up healthcare resources. Getting the economy back to a more normal footing is also important. At their core, stock market valuations are a discounting mechanism that represents the cumulative earnings power of companies. By owning a portfolio of companies that enjoy high market shares, good profit margins and modest encumbrances, you hold the stocks that are most likely to benefit from the eventual economic recovery. Despite the cascade of alarmist headlines, we are confident in the long-term robustness of the American system.
We are reminded of an anecdote that Warren Buffett wrote about several years ago, recounting his first experience purchasing securities. Then eleven years old, Buffett bought his first shares of stock: three shares of Cities Services Preferred. He also bought the same number of shares for his sister, Doris. It was during the early days of WWII, and the news was not good. He wrote:
In that spring of 1942, though, (America) faced a crisis: The U.S. and its allies were suffering heavy losses in a war that we had entered only three months earlier. Bad news arrived daily. Despite the alarming headlines, almost all Americans believed on that March 11th that the war would be won. Nor was their optimism limited to that victory. Leaving aside congenital pessimists, Americans believed that their children and generations beyond would live far better lives than they themselves had led. The nation’s citizens understood, of course, that the road ahead would not be a smooth ride. It never had been. Early in its history our country was tested by a Civil War that killed 4% of all American males and led President Lincoln to openly ponder whether “a nation so conceived and so dedicated could long endure.” In the 1930s, America suffered through the Great Depression, a punishing period of massive unemployment…Our country’s almost unbelievable prosperity has been gained in a bipartisan manner. Since 1942, we have had seven Republican presidents and seven Democrats. In the years they served, the country contended at various times with a long period of viral inflation, a 21% prime rate, several controversial and costly wars, the resignation of a president, a pervasive collapse in home values, a paralyzing financial panic and a host of other problems. All engendered scary headlines; all are now history.
Buffett was right about the remarkable resilience and unbelievable adaptability of the American people and the economic system they have built. As a postscript, young Warren top-ticked his Cities Services stock purchase ($38.25 per share, the high for that trading day) and sold the shares months later at $40.00 per share. His biographer tells us that in the meantime, the shares plummeted to $27.00 before recovering to his $40.00 sale price. His sister Doris asked him about the stock price every day as they walked to school together. Several years later, Cities Services redeemed the shares at over $200.00 per share. Young Warren sold too early. It has haunted him for seven decades. Don’t be Young Warren.
We know it is hard to remain focused on long-term wealth building in these very challenging times. We can assure you that this down cycle will pass. The long-term health of the American economy is not in question. We are much more concerned about the near-term health of our clients. Stay safe and take prudent precautions. We will follow with more updates in the coming weeks. Thank you for your support,
Your Team at Baxter Investment Management