The InterPrime Newsletter - Issue #5 - 3 Lessons from 2020

We would like to wish all our readers a very Happy New Year! With 2020 now behind us we thought that we would take this opportunity to review the lessons learnt in one of the most challenging years in recent memory. But, first some words of inspiration.

Animal House is a film classic.

Outlandish scenarios, risque behaviour, and general foolishness keeps eyes glued to the screen. The financial markets of 2020 were no different.

COVID-19 would be a Black Swan event in the mind of Nassim Taleb. A once in a lifetime event that will be in our minds for the next 100 years. These events scar and educate us, building resilience to future madness.

Pessimists and chicken littles view these events as the end of civilization. Optimists view them as learning, profitable and opportunistic experiments of life.

We are optimists and will use this InterPrime newsletter to recap 2020 learnings and point out themes for 2021.

The stock market started 2020 hotter than a New York kitchen in August.

President Trump took China to the wrestling mat in 2019 on trade deficits and many viewed the outcome as a draw. No bad news equals good news in the markets. So, the 2019 rally continued at the start of 2020. Then…

Looking back at how COVID took the markets down in Feb/March always replays in my mind. Most won’t remember but it played out like a slow moving car wreck.

China started to report cases and many (including myself) assumed they could contain it. Localized situation. Goes to show you why you never assume.

Initially, the spread was slow enough to not trigger alarm bells. I went through with a two week visit to Spain at the end of February 2020.  During that trip Italy became the canary in the coal mine. Infections rose exponentially and travel restrictions started.

As we made it to the Madrid airport the concerns of Europe lockdown and no flights to the US became real. We made it off the tarmac in what felt like a commando style exit out of a war zone.

Governments were starting to shut down across Europe and my Wall Street contacts started saying high probability the US will do similar.

I was sitting in a SF Starbucks looking at markets on my laptop in my best attempt to be a hipster(or are hipsters only in Brooklyn?). As I sat there I had a moment of clarity. This COVID thing has the whole world locking down so it is not unrealistic to think the US could do similar. But would they?

Two days later the US started lockdowns and travel restrictions. Calamity ensued and I sat in the corner with the dunce cap.

This story is to help suggest that you should always have insurance. The purpose of insurance is to guard against unforeseen events. The small money paid (or time) to have that coverage is worth it.

Insuring your life (life insurance), your portfolio (risk management/hedging) and your business (budgeting and planning) are always important. Take time to consider if you have the proper risk and insurance nets in place.

That was the theme during the over 30% S&P 500 decline in March. Every sector of the market was taking losses. Then the Fed swooped in like the caped crusader.

But why?

When markets and assets are under heavy selling there need to be buyers to sop up the supply. If the buyers do not want to buy, or if they do not have the cash/liquidity to buy. Prices fall until a buyer sees value.

The speed at which asset prices were falling during March kept the buyers WITH cash on the sidelines. They saw blood in the streets, so decided to wait for a real fire sale!

The buyers who normally have cash DID NOT. And were taking heavy losses. Margin calls and lack of available credit were taking them down. They looked to sell to any buyer who would buy their assets to raise capital to protect their company. S.O.S!

During this time the government was shutting down individual business sectors. This left the companies to burn through cash to stay alive. Cruise ships, airlines, and hotels were some of the worst affected.

Like the cavalry comes to the rescue in an old western film - the FED came out guns blazing. Saying we will  “do whatever it takes” to save the economy.

Their method of resuscitation had two parts:

Why?

They did this to make sure investors had confidence in corporate bonds. Without investor capital being lent to corporations they would have to tighten their belts. This would lead to rising unemployment, economic slowdown, and a crawling recovery. And in the worst cases - bankruptcy for those affected companies.

If you want to get into the nitty gritty details of what the FED is buying you can read our breakdown here.

As I write - the FED’s actions appear to be exactly the confidence boost everyone needed. The S&P 500 has rallied since the declaration.

This dramatic bounce and start of the recovery helps solidify the idea that the FED and liquidity are two of the most important (if not the most important) levers in the global economy.

First, If you know where liquidity is going you have a good idea of where you need to be.

Second, having liquidity and access to capital is the lifeline when things go haywire.

Be sure to track what the FED says in 2021 as the COVID recovery moves on. The clues they leave are your beacon for the economy.

The FED does not only use bond buying programs to keep the economy going. They also direct where interest rates are set.

If you want the economy to speed up, you push the pedal down and lower interest rates. This encourages lending and borrowing which should move the economy.

If you want to tame inflation and prevent the economy from overheating, you reduce pressure on the pedal and raise interest rates. This makes capital more expensive which should slow lending, investment and expansion. It also leads to rewarding savers by increasing how much they are paid for keeping their capital in safe assets.

Current FED policy states “lower for longer.” This has short term interest rates nailed near 0% for the foreseeable future.

The FED puts out a forward looking view of when rates will change called the dot plot. The dot plot released on Dec 16 2020 shows rates should remain near zero until 2023. Yuck!

This is causing two impacts to the markets:

In short, if your bank is paying you nothing. You may be incentivized to buy equity in a company who is paying you more in dividends than your bank. You are accepting the risk of stocks for the higher payout.

This market view is being called TINA - There Is No Alternative. We talk about TINA in greater detail here.

Sophisticated investors like Chamath Palihapitiya are also thinking about this. You can read his full Tweetstorm here - and see the start of his twitter post below:

If TINA is in fact happening in the market. Stocks could continue their march higher until the FED raises rates. This could have the US dollar losing value through 2021 and the S&P 500 continuing to go higher.

2020 saw Bitcoin start to grow up. No longer only a tool for the dark web or those worried about government control.

Big name investors have started to make portfolio allocations to Bitcoin. Paul Tudor Jones is one of the most high profile who said his portfolio now has a 1-2% allocation. You can watch Paul talk about Bitcoin in this video from CNBC.

Bitcoin has even started to gain small footing in the treasury management space. Microstrategy and Square recently started to buy Bitcoin for corporate treasury. This is a shocking move for the more conservative cash managers. We will discuss this in an upcoming blog post.

It is still too early to tell how widespread Bitcoin will become. But 2020 showed it is slowly getting accepted beyond a simple trading vehicle.

We started this 2020 wrap up by having you think about the madness in the Animal House movie. Some would call it a stretch to try to link the financial markets to a comedic movie. But it feels right.

Financial markets are never dull. Each day there are events, irrational behaviour, and sights that make you glued to your screen. The key to it all is to realize anything can and will happen. 2020 was a blockbuster movie and 2021 will be no different.

Happy New Year from all of us at InterPrime!