- November 11, 2020
- Blog , The Trusted Navigator - Bernhard Koepp
Post Election Market Commentary & Outlook by Bernhard Koepp – C.J. Lawrence – 11/10/2020 – YouTube Video & Transcript
In this video, Bernhard Koepp, CEO of C.J. Lawrence discusses his economic outlook post election, the game-changing covid-19 vaccine and its implications for GDP growth in 2021, potential black swan events, worries about inflation and the US Dollar, as well as the debate on growth versus value investing.
Video Transcript
Bernhard Koepp:
Yeah. Hi, there. This is Bernhard Koepp at C.J. Lawrence corporate headquarters. As you can see, I am back in the office here in Midtown Manhattan. It’s been a long summer. There’s some people coming back to the office. I mean, it’s quite interesting here in our building. We get the data on a daily basis where they tell us what, how many people are in this building. This is a pretty good sized building here on in Midtown Manhattan. And the utilization rate of the building is about 10%, so there are only about 10% of the workers coming to work every day. Look, I wanted to give you an update on the outlook for the market.
Bernhard Koepp:
Obviously, we had some big events last week. We had the election and we had the incredible news yesterday on the vaccine from Pfizer. They reported a 90% efficacy rate for their vaccine. This is pretty a game-changing event. Number one, we’ve been following a vaccine development for many years. It’s very rare that you have a vaccine that has a 90% efficacy rate. If you compare that to flu vaccines, for instance, the success rate is a lot lower than that. If this really is 90% and it works and we can roll this out, this is really a game changer in the pandemic and everything we’ve been going through.
Bernhard Koepp:
I wanted to give you a quick update and an outlook where we, what our thoughts are on the economy and the markets, because we’ve got some data as well. The third quarter data, and also new employment data last week. The employment data on Friday was quite strong, so we went from an unemployment rate of 7.9% to 6.9%. That’s a pretty significant change in the employment picture. To move 1% is pretty significant. I mean, the numbers are still pretty large, so we’re talking about a large segment of the population that’s still out of work. That is certainly concerning. It concerns us, and will be a drag on the economy going forward. But if you think about where we came from, I think everybody underestimated the ability of the economy to actually function under these conditions. Some of the things were data points we’re watching are … The consumer obviously drives this economy. Anything that affects the consumer, whether it’s another COVID shutdown or disposable income, these things are very important in the U.S. economy. Much more so than other economies that are much more driven by trade or industrial activity and so forth.
Bernhard Koepp:
If we look at where the consumer is, the stock market rise, the rise in home prices, especially in suburban areas have created a picture where the balance sheets are actually of the consumer is quite good. It’s interesting to us to watch the savings rate of the American consumer. Typically, Americans are not very good at saving money. We typically make the money, and we spend it. And certainly what we witnessed in the 2008 cycle was that we overspent. We were even taking money out of our homes through home equity loans and spending that on new cars or expanding our homes and all sorts of lavish things. It’s quite interesting that the latest data on the savings rate is 14%.
Bernhard Koepp:
People who are from countries like Japan or Germany are quite used to savings rates that are double digit, but for our economy and our country, it’s quite abnormal to have a savings rate that is in the double digits. The typical savings rate is about a couple of percent. That’s sort of the historical range. It’s really 1% to 4%. 14% is quite significant. Why has that occurred? It’s quite obvious that we had quite a shutdown, so the consumer wasn’t able to spend any money so the savings rate actually went above 20%. There’s a lot of cash if you’re employed, if you’re fortunate enough to not be in the part of the economy that has was displaced or permanently impaired by the pandemic, you’re in quite good shape. You didn’t go on your vacation. You were not able to go out shopping when you wanted to so the disposable income as well as savings has come up quite a bit. There’s a lot of pent up demand there.
Bernhard Koepp:
The other side of the equation is quite interesting as well if you look at inventories. Typically, when an economy is doing well, retailers or manufactories. Manufacturers start ramping up inventories, and you typically see this in the September period in the run-up into the Christmas season, which tends to be the high activity season for the consumer. What’s very interesting this cycle is that inventories are at a historical low level. If you have a lot of cash on the one side and a high savings rate, and you have low inventories, typically that sets up a pretty good and very supportive scenario for GDP growth going into the next cycle, which is 2021.
Bernhard Koepp:
Other things that we’re watching are obviously fiscal policies. There was an expectation if there was a Biden sweep with the Senate and the Congress that the likelihood of fiscal stimulus would be much higher. We have an interesting scenario now where we may have a split government so the fiscal, the expectation on fiscal is a little bit lower. But if you look at the base case for economic activity, we can calculate an economic growth rate around 2% or 2 1/2% without any stimulus for 2021. If we add stimulus in that fiscal stimulus, which is really that bridge that we’ve already enacted in the previous stimulus, that bridge to get that unemployed population 7-8 million people to the other side of this pandemic to hopefully where they can get jobs again, we can actually calculate a GDP growth rate that is closer to 5% or 6%.
Bernhard Koepp:
I mean we follow our good friends, our favorite economists quite closely, and there’s quite a range. The most bullish economists that we follow are using 8% for 2021. If we get the full fiscal stimulus and the more conservative ones are actually using a base case 4% to 5%. All of this assumes we don’t get another shutdown, which is certainly a big if, but it sets up a pretty good environment actually for the next phase of this cycle. We’re asked a lot, what are the black swan events here? What are the unforeseen dislocations that we look at? Number one is certainly the COVID spike. I mean, we’re seeing some pretty dramatic numbers now in terms of infection rates. We saw that, and the market was worrying about this a couple of weeks ago already, because we saw this playing out in Europe.
Bernhard Koepp:
You saw the economies in Germany and France actually shutting down partially again, which is of course worrying for economic activity. We’re seeing cases rise dramatically in the United States as well, but the death rates have still have come up, but they’re not quite as dramatic. Certainly if we have any kind of partial shutdown and so forth, that would be a negative for our outlook and is not priced into the market as we speak. The second thing is we had the election. The markets like certainty, and it’s unclear whether we got certainty out of the election. Biden is forming his team, but we have no concessions so certainly a black swan event would be if we have a contested transition and certainly social unrest.
Bernhard Koepp:
I mean, if I look around here in Midtown Manhattan, the windows are boarded up. There was some expectation in New York City in a lot of the urban areas that there may be civil unrest. I don’t see anybody taking down the protections on the windows yet. Hopefully, this will be resolved soon that there will be some certainty about the election in terms of certainly about the administration. And in terms of the Senate, I mean at the moment there is a Republican majority in the Senate and there will be a run-off election. Certainly that will be resolved by January, but this will be a close call to see whether the Georgia senators will flip to Democrat or not, so there’s quite a way to go.
Bernhard Koepp:
The last part of this black swan event is the dollar. We’re watching the dollar very closely because a persistent weakness in the dollar would be a red flag, and weakness in the dollar going forward would also raise the question of inflation. I mean, there’s a lot of economists out there and market practitioners who are worried about inflation. We certainly worry about inflation because there is this given take. There’s inflation on the one side and valuations of asset classes on the other side. And typically when inflation rises, price to earnings ratios and valuations come down.
Bernhard Koepp:
Our mentor here at C.J. Lawrence, Jim Moltz came up with this incredible, very simple equation, which is the Rule of 20, where you take the market’s B price to earnings ratio, and you add in CPI, which is inflation, and over many years and decades, if you run the data from 1962 to today, you always get about a 20 average. And it’s a very simplistic metric, but if the score, the P/E ratio plus CPI is above 20, that means we have a pretty pricey market, and then you may be better off in bonds. And if it’s below 20, it’s quite an attractive market.
Bernhard Koepp:
If we do the calculation to date based on normalized earnings for next year, so if we price in $185 or $180 for the S&P 500 next year, we get to about a 19 multiple on the stock market or on the S&P 500. And inflation is at a half a percent, so even if we go to 1%, which would be quite a dramatic change, we’re still at about 20. That means it’s not a cheap market, but it’s also not a very expensive market. I think we’re still constructive inequities going forward.
Bernhard Koepp:
The dollar, we watch that closely because if you think about the dollars going forward, if you have a persistent weakness in the dollar given that we consume a lot of goods and services that are produced abroad, the price of these goods goes up, and that would be inflation. If the canary in the coal mine for inflation watchers is really the dollar. We have this incredibly privileged position in the world that our currency, the U.S. dollar is a reserve currency. And we need to be very careful not only as a country, but also as investors to make sure that we understand that role that the dollar plays.
Bernhard Koepp:
If you think about trade, a lot of that is transacted in dollars. And given that we buy so much from abroad, foreigners tend to hold a lot of our debt. If there’s any problem or any worry about the credit worthiness or the role that the U.S. dollar has in the world as a reserve currency, that would be terrible and would create an inflationary event, so we watch that very closely. One more thing. There’s a big debate going on in the investment community, certainly about growth versus value or cyclical exposure versus growth. It’s been a wonderful year to be a growth investor. If you think about the kind of equities that have done well, they tend to be growth stocks without a doubt. But I think this debate between growth and value is a bit outdated. I think it’s more important to think about business models.
Bernhard Koepp:
We spend 25 or 30 years looking at business models at C.J. Lawrence, and one of the things, our bulldog equity strategy really emphasizes is sustainability of earnings, sustainability of business models, so that’s what we do all day. I would say it’s not about growth or value. It’s really, which kind of businesses have sustainability and which don’t? And that we can take a sector like financials, which is a value sector. We find interesting ideas in a value sector like financials as well, but there are winners and losers. If you’re on the digital payment side, for instance, or FinTech side of the financial services industry, you’re doing very well today. If you haven’t been in that digital payment system world and you are dependent on spreads or the yield curve, that’s the old way for banks to make money, then you’re having a problem.
Bernhard Koepp:
We would say forget about growth and value. It’s really about active management within sectors, and let the chips where they fall. There are plenty of interesting ideas in the value side, and certainly plenty of interesting ideas in the growth side. Our message is don’t overthink the growth and value side. Stick with active managers that emphasize sustainable businesses in growing sectors. That’s really the key. I’ll leave you with that comment. If you have any questions, shoot me an email, bkoepp@cjlawrence or give me a call at 212-888-6342. We’d love to hear from you, and have a good day. Take care.
Bernhard Koepp is CEO and Portfolio Manager at C.J. Lawrence. Contact him a bkoepp@cjlawrence.com by telephone at 212-888-6342.