To listen in Spotify, click here.
Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s Podcast Series. I’m Rick Calhoun CEO of Laidlaw Wealth Management and I am fortunate again to be joined by David Garrity, Chief Market Strategist for Laidlaw & Co.
Good Morning, David. Thank you again for joining me this morning.
Rick, It’s great to be back with markets rising overseas following last Friday’s rally on Wall Street and news, on balance, is good. Data over the weekend showed COVID-19 Coronavirus (“COVID”) deaths slowed the most in more than a month in Spain, Italy and France, and all three countries have signaled tentative moves to open up their economies.
Meanwhile, there is a lot on deck for investors to consider this week with the Fed, BOJ and ECB all due to announce policy decisions as the battle against the COVID pandemic continues. Several major economies will release GDP numbers, while corporate earnings will keep coming in, including results from names such as Amazon, Barclays Plc, Facebook and Samsung Electronics, among others.
David, a few episodes ago, you referenced the famous Chinese curse “May you live interesting times” for the events we were living through and last week I referenced the quote from Dickens’ Tale of Two Cities, “It was the best of times, it was the worst of times” as a way to define the week.
I think the best way to sum up this week is – Bizarre. We had the oil market in such a pricing collapse due to lack of storage space you could possibly have gotten paid you to store it in your swimming pool and we had a jobless claims report that now shows over 26 million Americans have filed for unemployment benefits in the past five weeks yet the Energy Sector finished up almost 2% for the week while the S&P & Dow were each off less than 2% and the NASDAQ was flat.
Wasn’t this week the type of week that should have scared the hell out of people?
I fully expect investors to have picked more than a few gray hairs of late and last week was no exception, especially when focusing on the energy market where oil prices went to negative levels last Monday. Prior to the COVID crisis, daily world oil consumption was about 100mm barrels. Demand now, however, is somewhere between 65-70mm barrels per day. So, worst-case, roughly a third of global output needs to be shut-in. With WTI now trading at $14.50/barrel, at least we can say prices are positive compared with a week ago, but the dislocations in the market are just beginning to be factored in.
What began as a fight for global oil market leadership between Russia and Saudi Arabia has ended up taking U.S. producers out of the market as they have already started to move to shut-in production ahead of the 9.7mm barrel per day OPEC+ cut coming Friday 5/1. Meanwhile, investors should understand that the break-even oil price for most U.S. shale oil producers is around $45/barrel and Saudi Arabia needs $80/barrel to make its budget, so there is just a sea of red ink sloshing around the oil sector right now. Domestically, major shale oil producing states such as North Dakota are already seeing a rapid retrenchment in production. Oil producers there have already closed more than 6,000 wells, curtailing about 405,000 barrels a day in production, or about 30% of the state’s total volume. Going downstream, U.S. oil refiners processed just 12.45 million barrels a day on the week to April 17, the lowest amount in at least 30 years and looking ahead to May 2020 global refineries could halt as much as 25% of total capacity.
Globally, there is a greater likelihood of Middle East conflict in this environment. Though badly afflicted by COVID, Iran shows no sign of reducing its operations in Iraq, Syria, Yemen and elsewhere. Meanwhile Israel could soon start annexing the West Bank. All in all, the chances of a regional blowout, which America will either be drawn into or castigated for neglecting, are rising again. This is not something investors can disregard as the decimation of America’s shale-oil firms now underway could eventually lead to a renewed dependence on Saudi oil.
Apart from that and the fact that 26mm Americans are filing for unemployment benefits, things are not that bad from a market perspective. Thanks to the massive and relatively rapid monetary and fiscal policy response, COVID has not taken the S&P 500 down as much as the 2008 Financial Crisis did. At this point in the 2008 experience (start the sequence with 9/29/08, the first -5% move for the S&P), the index was down -17.6%. Now, (start with 3/9/20, the first -5% “crash” day), the S&P 500 is actually up +3.3%. So, based on the valuation for U.S. large cap stocks, this indicates a market view that the worst outcomes are off the table.
As such, the stock market believes the US economy will not be shut down again as testing, contact tracing and social distancing successfully contain COVID until better therapeutics and a vaccine arrive. This is underpinned by a view that monetary and fiscal authorities will remain on guard, ready to allocate fresh capital to keep consumers and businesses relatively whole until the US economy restarts. In all this, it is important for investors to understand that big businesses stand to benefit as smaller firms struggle, a real tailwind for the fundamentals of large public companies.
As I mentioned, one of the big highlights of the past week was what occurred in the oil markets, so I’d like to focus on that topic for minute if you don’t mind. In our Laidlaw Five outlook one of our concerns was an exogenous shock that could take the price of oil to over $75/barrel. We truly did get an exogenous shock, but nothing like any of us have experienced. David, beyond the obvious answer of Demand specifically for refined products such as gasoline thru people driving and flying again, how do we see our way out of this mess?
The stock market’s belief that current policy measures are sufficient to support a share price recovery underscores the outlook that the U.S. economy will stage a recovery as we move later into 2020. Over the weekend, Treasury Secretary Mnuchin stated his view that 3Q20 would see strong growth. Summer generally sees a seasonal peak in energy consumption, so demand recovery will be the main driver to clear the current record oil inventories.
Looking out further, though, it is harder to see a rapid drawdown of oil inventories as economic growth is likely to be fairly modest and the path of economic recovery “W-shaped” with slowdowns and restarts around potential subsequent COVID outbreaks. Using the Fed Funds Futures (FFF) curve as a market-based forecast for economic growth, it currently discounts essentially 100% that the Fed maintains its current 0–25 bp interest rate policy through at least November 2021. While not as actively traded, the FFF’s 2022 prices show it is not before June 2022 that the odds of a Fed interest rate increase go above 50%.
Bottom line, with economic growth appearing to be this sluggish, the oil production capacity being shut-in now is likely to remain offline through the end of 2021.
David, I want to turn to a topic now that I know is near and dear to your heart and where you are considered an industry leader as one of the founding partners in BTblock – Blockchain.
There was a fantastic article this week that discussed how Blockchain could be an efficient way to source medical equipment or validate COVID-19 immunity. Now to most of our listeners as well as myself, blockchain is best known as the record-keeping system behind cryptocurrencies like Bitcoin and Ripple. In its simplest terms, blockchain is a decentralized way to keep records that are shared among participants and that cannot be changed.
However, I know it’s not simple so maybe you could offer some insights into the world of Blockchain along with explaining how it could be a potential weapon against the Coronavirus.
At its heart, it is that simple. We are talking about data integrity. Deploying blockchain across the current fragmented state of health data, that is the challenge.
Like all pandemics, COVID has served to highlight human frailty. However, unlike all previous pandemics, COVID is impacting a global economy which depends on the successful operation of highly complex and extended supply chains. Changes in business strategy have resulted in companies that are now more extended enterprises than vertically integrated firms. As such, they need to ensure reliability and consistency. At the same time, consumers have come to demand more information about the goods they purchase.
Distributed ledger technology (DLT), or blockchain, is means to deliver the high level of integrity increasingly demanded. This is especially so as the global economy increasingly deploys sensor networks that enable the “internet of things” (IoT). With an increasingly digitized global economy, cybersecurity needs are becoming of greater importance. In this regard, DLT offers a greater means of securing data, whether enterprise or personal.
In the context of COVID, DLT can offer a means to provide anonymized health data records. Over the weekend, my colleague, Dr. Alex Cahana, published a Medium post “COVID-19 Data Is Valuable Because We Are Valuable.” Dr. Cahana states that to address COVID successfully we need mass testing, crowd intelligence and decentralized tracing. Economically speaking, 35mm tests per day at an annual cost of $100bn, is a fraction of the $350bn in monthly losses due to the ongoing lockdowns and social distancing measures in the US. In terms of health data, clinical notes, lab and imaging results, genomic and wellness data added to insurance claims, purchasing and social media input has contributed to an already saturated 2.7 zettabyte (2.7tn gigabytes) digital universe.
COVID has shown, however, that this digital universe is fragmented, uncoordinated and quite fragile. Health data might be designed for daily operations, but it is not organized for multi-party crisis management, which requires real-time research and analytics. Moreover, the presence of many intermediaries like enterprise data warehouses, data aggregators, administrators of patient and government registries have created an attack-, collusion- and censor-vulnerable environment.
With COVID there is a continued reliance on this fractured data universe to provide information, but it does not leverage the real-time capabilities of federated learning, combined with privacy preserving technologies (like ZKP, TEE and Homomorphic encryption) and blockchain. One of the efforts to protect personal privacy led by MIT, is building an open, interoperable, privacy-preserving protocol called Private Automated Contact Tracing (PACT) which is designed to be a technical standard/specification that anyone can deploy on any smartphone without revealing private information to other individuals, the government, health care providers, or cellphone service providers.
There is an opportunity in putting in place the health data platform necessary to combat COVID to deploy a decentralized approach, where both contact and location data are collected exclusively in individual citizens’ “personal data stores”, to be shared voluntarily, only when the citizen has tested positive for COVID-19, and with a privacy preserving level of granularity. DLT is a technology protocol that can enable this approach.
Dr. Cahana concludes the article by making a critical observation, “We are our actions and our actions are who we are. These actions are captured by data and every time these data are used, abused or sold by a 3rd party, a part of our dignity is stripped away. These technologies are not merely privacy-preserving, but are dignity-preserving.”
While COVID may have served to highlight again our human frailty, this is now a time where technologies such DLT can be used to maintain human dignity.
David let’s bring it back to the markets and a topic that I have received more than a few questions about – the debut of Draft Kings this past Friday (DKNG) through the use of something called a Special Purpose Acquisition Company, or SPAC. For our listeners who aren’t familiar, a SPAC is a company with no commercial operations that is formed strictly to raise capital through an initial public offering for the purpose of acquiring an existing company. They are also known as “blank check companies,” and have actually been around for decades, it’s just that in recent years, they’ve gone mainstream, attracting big-name underwriters and acquiring companies such as Richard Branson’s spaceship company Virgin Galactic Holdings (SPCE), Twinkie-maker Hostess Brands (TWNK), restaurant chain TGI Fridays and of course the aforementioned Draft Kings. In fact, last year, SPACs raised a record $13.6 Billion in 59 IPO’s!!!
David, what else should our listener’s know about this growing segment of the public markets and is it something that should be part of an investment portfolio as we move forward in this new world?
As you said, Rick, Special Purpose Acquisition Companies (SPACs) have been with us for some time. Note that the SPAC management team has a limited period of time, typically 24 months, in which to identify the acquisition target and structure a deal. Once the deal is set, the SPAC investors have to approve the transaction. If approved, the newly acquired entity becomes the operating business of the company.
While SPAC issuance was typically seen as indicative of a market top, investors should consider that in light of the stock market decline, particularly for smaller companies, the acquisition environment for SPACs has improved in 2020. As such, the deals SPAC teams strike may prove on balance to be more attractive than their historical record which has been more “hit or miss.”
As we come to the end of another great episode, David, I’d like focus our final question on a topic that has been written about a great deal over the years and that is the great value vs. growth debate. In fact, this week in our Quarterly Investment Committee meeting we spent a great deal of time discussing that very topic so I think our listeners would be interested in your thoughts and whether it’s time to rotate out of growth and into value or if you even agree that is a strategy to pursue?
The debate of Growth vs. Value is kind of a “chicken or the egg” argument. Before companies become large established firms they start as small unknown entities that contain within them the seeds of greatness.
I’ve spent enough time over the course of my time on Wall Street to been exposed to both sides of the debate, first in my time as a research analyst covering the global auto industry where value was most times the determining factor in making recommendations and later in following technology companies where the trade-off between a company’s growth prospects in terms of its addressable end market and its valuation drove recommendations.
What I can say is that the pace of disruptive technology innovation has accelerated over time and this inexorable march poses a growing challenge to all established companies, namely either disrupt yourself or risk being disrupted. With that insight I tend to view many companies that fall in the Value category to be those at risk for disruption. It is said that companies earn their valuation over time and with that it helps to recall the hallmark statement from the film “The Shawshank Redemption,” namely, “Get busy living or get busy dying.”
To bring this point back to the context of our discussion today, we noted earlier that the COVID downturn favors larger firms as having an advantage over smaller entities. I would say that this applies most categorically to the tech sector’s mega-cap companies, the “FANG” names who have ample financial strength to take advantage of the present downturn to move into a wider array of businesses.
The stock market recovery in part reflects this as these names represent +20% of the S&P 500, a level of concentration not seen since the 2000 market top. What is different now is that these companies are solidly profitable and as they take advantage of the COVID downturn are very likely to increasingly become so. Obviously, nothing grows to the sky, but for the present the “FANG” names may be relatively unchallenged.
That said, we are happy to be proven wrong as we continue to look for those emerging companies who contain with them the seeds of future greatness.