Quarterly Letter, July 2020

By Ron Muhlenkamp, Founder and Jeff Muhlenkamp, Portfolio Manager

Since early March the economy has been driven by public reaction to the unfolding COVID-19 pandemic.  It remains our observation that public perception and actions are in the lead, not government actions, though there is significant feedback between the two.  In the United States, the virus hit the Northeast hardest in the early days and is now continuing to spread in the South and West. The restrictive measures most states put in place in mid-March began to be relaxed in early May. In late June we saw a reversal of that trend as rise in new case counts, particularly in Florida, Arizona, Texas, and California have prompted those and other states to re-impose restrictions.  It isn’t clear when the case count will peak in those areas and whether fatalities will follow the case count with a lag, or if fatalities will remain low as the infected population skews younger than we saw in the March through May period.  It will take some time for that to become clear.  What remains clear is that the virus is deadliest for the elderly and those with pre-existing conditions.  It has also become quite clear that the behavior of the virus defies one-factor models and simple explanations.  There are still very limited treatment options and while many companies are working on a vaccine, they are all still in the testing phase and success remains merely a possibility, not a certainty.

Even as the response to the virus by the individual states continues to shift the response by the Federal Government is now largely in place.  The Treasury has sent money directly to many households, unemployment benefits have been increased, and a loan/grant program was created to help businesses remain viable even as their doors remain closed.  The Federal Reserve did its part by buying government bonds, municipal bonds, mortgage backed securities, corporate bond ETFs, and even individual corporate bonds: ensuring that most businesses could borrow in the markets if they needed to.  The government reaction from a monetary and fiscal perspective was huge, fast, and effective, at least so far.  Proposals to extend the fiscal support have been floated but not approved as our legislators take a “wait and see” approach for the time being.  Unsurprisingly some of the proposals have little to do with the impact of the virus and are thinly disguised attempts to throw money at politically favored groups.  Some things don’t appear to have changed at all.  One risk is that the need for supportive measures from the government outlasts the supply of money and we begin to see problems manifest themselves as the support runs out in late July.  Our base case is that additional support would be made available if needed.  We see no indication from any element of government that they are concerned in the least about how much debt we are racking up or other long-term consequences.  We don’t expect that to change in the near term.

Businesses of all sizes and in all industries are trying to figure out how to best operate under the new circumstances.  For online retailers and providers of streaming services the new conditions are nearly perfect, and they are growing rapidly.  On the other hand, the inability to gather in groups is a disaster for professional sports, movie theaters, musicians, schools, and restaurants.  We expect there will be a very difficult period of experimentation and adjustment as institutions try to adapt to the continually changing level of concern by their workers and customers and frequently changing government requirements.  It is too early to say which changes will be temporary and which will turn out to be permanent.  In the industries hit hardest by the pandemic it is also too early to say which companies will survive and which ones won’t.  Government aid programs and lender forbearance have given at risk companies much more time than is usually the case to try to make things work.  We won’t really start finding out who won’t make it until they run out of resources and support in the next few months.

We expect the uncertainty about the behavior of the virus and uncertainty about how to deal with the virus to continue.  We expect that uncertainty to be amplified by the media and others as political players seek to gain advantage in the upcoming election.  Those uncertainties have been reflected in the market over the past several months and will likely continue to be.  The unrest triggered by the death of George Floyd appears to have had little impact on the markets to date, but that could change.  There is also the potential for “something else” to hit the fan between now and the election.  The markets will also start to anticipate the outcome of the election at some point in the fall and because the stated economic policies of Biden are so different from Trump’s the market may swing significantly if the odds of victory shift between them.  In short, we expect significant market volatility at least through the election.

Over the last several months we have sold those of our holdings whose prospects we believe to be impaired by the virus: we sold our airline holdings, for example, as it looks like airline traffic will be impaired for years, not months.  We held on to other economically sensitive companies if we believed they were likely to do as well going forward as they have in the past: a good example is our holdings in homebuilders, whose business appears to be rebounding quite nicely after tanking in March through May.  We continue to hold gold as a hedge against errors by central banks and several of our technology companies are setting new highs as they benefit from current circumstances.  We continue to look for good investments without being in a hurry to invest our cash.  We think patience is appropriate right now.

With our best wishes for your continued success and good health!

The comments made in this commentary are opinions and are not intended to be investment advice or a forecast of future events.

Refer to the SMA All-Cap Value Fact Sheet for the Top 20 Holdings and performance data as of the most recent quarter-end.