Of Christmas Lights And Ladders

SL Advisors Talks Markets
SL Advisors Talks Markets
Of Christmas Lights And Ladders

Christmas is a time of traditions, which in turn create nostalgia. Like endorphins, this is a free and harmless narcotic.  

Putting up the external Christmas lights, which we typically do right after Thanksgiving, usefully expends a few calories and kicks off that warm Yuletide feeling. Hunting through dusty boxes in the chilly attic for last year’s lights inevitably evokes Clark Griswold. It reminds me not to get locked up there. 

Draping colored lights over the bushes near our front door easily adds Christmas cheer. 

I’m especially pleased by the wreath, which hangs fifteen feet up above the front door over a window. Its positioning may not look especially challenging, but my first attempt required considerable planning. The stone façade ruled out hammering a nail into the wall. I spotted a hook twenty five feet up near the roof that originally supported a window awning nearly a century ago. I concluded the wreath needed to hang from there. 

I devised specialized equipment, including a long pole repurposed from changing light bulbs too high to reach. I had to ascend most of the way up a twelve foot ladder, then use the pole to snag a looped piece of wire onto the hook. 

Still poised unsteadily on the ladder, I then threaded the wire through the wreath. It was finally secured by reaching out to it through an upstairs window. I have been performing this feat annually ever since. My younger daughter holds the ladder and offers moral support, so between us we project a visible expression of Christmas with no other assistance.  

Over the years I have drawn some pride from solving this installation problem. Most of my accomplishments at home maintenance involve writing a check to someone more skilled than me at resolving the issue at hand. This annual demonstration of practical competence provides modest satisfaction.  

I don’t just keep the house running by changing lightbulbs.  

We live in a neighborhood where it’s becoming increasingly common to have the Christmas lights hung professionally. Landscaping contractors are finding it a useful sideline during the offseason. Snow removal, which some of them also provide, has been unprofitable in New Jersey for the past couple of years. Blame global warming.  

A crew of six armed with long ladders and a staple gun can quickly transform a suburban home into a light extravaganza. Illuminations are effortlessly strung at heights I’d rather not scale. The entire house glows Christmas cheer.  

I am a big fan of progress, but I find this trend towards commercial light installations a disappointment. 

I never considered our lights to be in a competition. We’re doing our bit to show ’tis the season to be jolly, to spread comfort and joy. But I must confess to a slight feeling of inadequacy as I drive back home past displays that wouldn’t look out of place adorning a hotel or in the Magic Kingdom. That I invested greater personal effort seems rather foolish when considering the results. The others put in less work. And less love. They just wrote a check.  

Nonetheless, I am not about to join the crowd and outsource the Christmas lights. Next year I’ll just have to create a more extensive display without climbing on the roof. The neighboring houses offer plenty of inspiration.  

The result will still be less than others nearby. But it’ll be my own work, and infinitely more satisfying as a result. 

I hope this anecdote made you smile and boosted your festive spirit. Normal market commentary will resume on Wednesday. 

Merry Christmas or, if it’s more appropriate, Happy Holidays.  

Churchill, The Greatest Briton

It is the time for nostalgia. I fondly remember Christmases from my childhood in England with a close friend and our two families. Here in New Jersey, my wife maintains many of our English culinary traditions, since they’re from her childhood too. Christmas pudding (also called Plum pudding) was acquired weeks ago. None of our children will touch it, a disdain I’ve wasted little time trying to reverse since it means there’s enough left for Boxing Day too.

Covid has canceled bits of Christmas, including our annual Christmas Eve fish dinner with friends. And a virtual church service remains a poor substitute for live Christmas carols. I admire our rector for gamely pressing on in solitude in front of a camera, but this year organized religion has offered less when some needed more, leaving it with a diminished role.

I’m currently reading These Truths: A History of the United States, by Jill Lepore. It was on Bill Gates’ summer reading list. An engaging read, it covers much but rarely in depth, since it’s a single volume. I have reached the 1940s. Winston Churchill knew that Britain could only prevail against Germany if the U.S. could be persuaded to enter the war. Following World War II, Churchill referred to his bonding with President Roosevelt thus, “No lover ever studied the whims of his mistress as I did those of President Roosevelt.”

My old country could use Churchill’s leadership today. Most of the population is under virtual Covid house arrest, and they’ve agreed a Brexit deal with the EU very different than voters were led to expect during the 2016 referendum. I have never regretted growing up there, nor leaving for the U.S.

How ironic that British PM Boris Johnson’s wonderful biography The Churchill Factor: How One Man Made History represents a bigger tribute than his current leadership of the country.

Few individuals produce enough lifetime material for a book of humorous quotes, but my library includes The Wit and Wisdom of Winston Churchill, boasting over 1,000 entries. Browsing reveals gems such as, “Although always prepared for martyrdom, I prefer that it shall be postponed.” Another favorite is, “There’s nothing more exhilarating than to be shot at without result.” When a close friend of mine with Covid risk factors survived an extremely mild case, I read this quote to him.

Churchill’s mother was American, and he felt strong affection for our country. During a speech to Congress in 1941, he noted that, “… if my father had been American and my mother British, instead of the other way around, I might have got here on my own.” This overlooked the constitutional requirement that a U.S. president be born here, but still drew appreciative laughter.

Some of Churchill’s descriptions of America remain true today.

“The Americans took but little when they emigrated except what they stood up in and what they had in their souls. They came through, they tamed the wilderness, they became a refuge for the oppressed from every land and clime.”

“There are no people in the world who are so slow to develop hostile feelings against a foreign country as the Americans and there are no people who once estranged, are more difficult to win back.”

In the House of Commons when a veteran member offered disjointed criticism of Churchill’s war leadership, the PM warned that his critic, “…will run a very grave risk of falling into senility before he is overtaken by age.”

Churchill’s ready wit was often deployed in social settings to parry criticism. Nancy Astor was a Virginian who became Britain’s first female member of the House of Commons. Astor was part of a clique that admired Hitler, prompting Churchill to describe appeasers as those who, “…feed the crocodile hoping that it will eat him last.” At a dinner party Astor told Churchill, “Winston, if I were your wife, I’d put poison in your coffee.” To which he replied, “If I were your husband, I’d drink it.”

Perhaps his most famous exchange was with an unknown woman who complained that he was drunk. “My dear you are ugly, but tomorrow I shall be sober and you will still be ugly.” he replied.

It’s been a testing year in so many ways, with little of recent humor to offset it. I hope you and your family are healthy, and that you’ve enjoyed Christmas and the holiday period under whatever Covid restrictions allowed. We all have much to look forward to next year.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Trump’s Odds

The positive Presidential Covid test has provided plenty of material for the media. Trump’s known physical disposition is being compared with tables of statistics to assess his likely prognosis. The Financial Times noted that he is in the “vulnerable” population, and gave him 20% odds of requiring hospitalization with a 5% risk of death. Regardless of politics, writing about a living person’s chances of dying strikes me as rather tasteless, although inevitable since it’s the president and the election is a month away.

More interesting than mortality tables was the reaction on PredictIt, a website that allows modest wagers on numerous electoral outcomes. Many believe that betting markets offer more accurate forecasts than opinion polls, presumably because people are more thoughtful when money is tied to their view. PredictIt showed that the odds of Trump dropping out of the race before November 1 had soared from 4% to as high as 17% on high volume, following his positive Covid test.

This seems odd, because it’s hard to conceive of any sickness that would cause Trump to withdraw. And if he really does succumb to the virus, his name will remain on the ballot. The only plausible way he’s withdrawing by November 1 is if he concludes an overwhelming defeat is inevitable, when he might declare the entire election a sham hopelessly distorted by mail-in ballot fraud, paving the way for a challenge of the results. This has nothing to do with Covid, and the reaction of PredictIt shows that even the commitment of modest sums of money doesn’t assure a rational view. The Robin Hood trading platform offers another rich source of financially irrational actors.

The 5% Case Fatality Rate (CFR) referred to by the FT relies on a study from OurWorldInData, which estimated the CFR for different age groups by looking at just four countries (South Korea, Spain, China and Italy). This limited data set took no account of any pre-existing conditions (“comorbidities”). A study in June from the Center for Global Development (“CGD”) took a more precise look, and found that a male aged 70-79, with at least one co-morbidity living in a rich country, had a CFR of 4.35%. Take away any pre-existing condition and the CFR drops by 89%, to 0.48%.

Trump’s pre-existing health conditions, if any, are unknown. He claims to weigh 235lbs, which for his height puts him on the threshold between overweight and obese but well short of severely obese. The 4.35% CFR doesn’t differentiate between one or several co-morbidities.

Trump’s debate performance didn’t show shortness of energy, regardless of whether you found the content appealing or not. There’s little public evidence that he’s chronically sick.

Moreover, the CDG study is from June. CFRs keep improving – although infections are rising again in many countries, fatalities are not. More testing, better treatment and a less fatal strain of the virus are among the possible explanations. It’s likely the CDG study would produce lower figures if the data was updated. And Trump will be receiving the best care available.

On Friday, stocks and crude oil both fell on the news. Pipeline stocks surprised by moving higher, perhaps showing that attractive valuations are finally overwhelming negative sentiment.

The absence of any formal training in virology has not prevented us from offering a data-based view on Covid. So for Trump, the odds are high that he’ll emerge from self-quarantine reporting a mild case easily handled, confirming his assertion that widespread popular fear of the virus is unwarranted.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

Risk and Return Part Ways

More risk more return is a truism of finance, and much else besides. It makes intuitive sense (why bungee jump unless the rush of near-death exceeds the actual risk?) and also has a place in finance, via the Capital Asset Pricing Model (CAPM). This formalizes the relationship between risk and return, allowing securities to be priced, or shown to be mis-priced, relative to one another.

Finding fault in elegant algebraic solutions to markets occupies the minds of many. CAPM has long been known to be flawed – in reality, it turns out that investors pay more than they should for risky stocks, and pay too little for more stable ones. Many of Warren Buffett’s holdings exploit this inefficient bias.

Since taking more risk for less return should leave an investor poorer over time than following CAPM, why does he do it? An explanation that we’ve always liked relies on the misalignment of interests between many asset managers and their clients.

Funds flow in the direction of performance. It’s much easier to find new clients when things are going up, and in that environment it doesn’t pay to deliver middling performance. The simplest way to beat a rising market is to take more risk – hence, actively managed funds are generally found to have a beta above 1.0 (the market’s beta is 1.0).

Such funds should correspondingly underperform when markets are falling – but since it’s harder finding new clients in such an environment, poor relative performance doesn’t hurt much. The  asset manager’s asymmetric business model (“heads I win big, tails I lose a bit”) doesn’t match the investor’s, for whom ups and down of equal magnitude cancel out.

The solution is for clients to reject fund managers who aren’t heavily invested alongside them. This ensures that the linear exposure to market returns is felt by the fund manager and clients, creating a proper alignment of interests. Not surprisingly, your blogger’s fund business fits this model, otherwise you wouldn’t be reading this article.

Recent market performance has turned this relationship on its head – investors seeking more risk are being handsomely rewarded, while those holding more stable names are watching them languish. It’s like CAPM on steroids – not just more return for more risk, but much more. Low vol stocks are delivering less than half of the returns of the market with slightly higher volatility.

This can be seen by comparing the S&P500 Low Vol High Dividend index (LVHD) with the S&P500.

Through 2016, they mostly tracked one another, with LVHD’s underperformance roughly commensurate with its lower risk. Over the next three years the gap widened. Starting in January, perhaps not coincidentally around the time Covid-19 entered into common conversation, the relationship shifted dramatically. Since then, the S&P500 has made new highs, while LVHD remains 20% off its best levels.

The second chart takes the ratio of returns between the two indices, and volatility (defined here as the average daily move over the prior year). Prior to 2016 the two lines roughly matched each other, confirming the risk/return symmetry of CAPM. Since then, and most dramatically this year, the relationship has broken. Supposedly less risky stocks are moving more than they should relative to the market, and more risky stocks are over-delivering good returns.

It’s well known that the extreme social distancing and other steps to impede virus transmission favored technology stocks, and anything that helps people live without proximity to others. The winners are not low vol stocks, and the recent shift towards growth has been dramatic.

In the late 1990s, tech stocks generated very strong outperformance against the market as investors grasped the internet’s enormous potential. LVHD doesn’t extend back that far, but other work we’ve done shows the same lagging results of stable stocks. Berkshire’s portfolio was among them.

The subsequent 2000-02 bursting of the internet bubble reversed everything.

The market’s inconsiderate recovery since the lows in March (see The Stock Market’s Heartless Optimism) has been driven by the pandemic’s economic winners, even though many find this an incongruous concept during a severe worldwide recession. Nonetheless, as improving treatments and immunity, eventually aided by vaccines, restore much of our former lives, the market will re-sort the winners and losers. Stable businesses with reliable dividends will be back in vogue.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance

The Great Reversal?

Last week the Centers for Disease Control (CDC) told state health officials to prepare for vaccine distribution as soon as November 1. “My fellow Americans, our long national nightmare is over.” was first spoken by President Gerald Ford following Nixon’s resignation under threat of impeachment in 1974. But it could equally apply to Covid in 2020.

The pain has been unevenly distributed. Since March, stocks have defiantly marched higher in the face of relentlessly bad news. Hundreds of thousands of lives have been lost, and billions turned upside down. Yet people have adapted, and technology stocks such as Apple (AAPL) and Amazon (AMZN) have benefited enormously from the shift to socially distanced living. Tesla (TSLA) has shown that stock splits are bullish, even if caused by prior huge gains (see Tech Stocks Have Energy).

The market’s gains have reflected the distasteful reality that the economic impact of Covid is driven by our efforts at mitigation. Public understanding of the actual numbers reveals huge misconceptions (see Covid Exposes Innumeracy) about its lethality and who is really at risk. Recently, the CDC quietly added the following to Table 3 of its Covid website (Conditions contributing to deaths involving coronavirus disease): “For 6% of the deaths, COVID-19 was the only cause mentioned.” In other words, 94% of Covid victims had a pre-existing condition (a “co-morbidity”) which may have contributed to their outcome. It’s still tragic for each person, but as we learn more the seeming randomness of Covid becomes less so.

For an interesting perspective on mitigation efforts elsewhere, see Brazil – Not the Disaster We’ve Been Led to Believe.

Last week’s sharp market reversal around the CDC’s announcement was probably no coincidence. U.S. hospitalizations are down by a third from their recent second peak. Fatalities never reached the levels of early April, and in former hotspots like New York and New Jersey, hospitalizations are down by 95% from the peak.

A vaccine will accelerate the progress towards herd immunity that seems to be already underway. The possibility that the near future may see a modified return of our former lifestyles has hurt technology stocks but breathed new life into stocks like Carnival Corp (CCL). A resumption of cruising might be the final confirmation that we’re post-Covid, that the hospitality business no longer faces quite the same existential threat.

Few will be surprised that the outperformance of energy stocks caught our attention. The least liked and therefore most undervalued sector doesn’t suffer like AAPL from the loss of momentum investors, because there were none. The rubber band between liked and hated sectors is stretched taught. If the imminence of a vaccine has triggered a great unwind, pipeline stocks have substantial upside.

Tech Stocks Have Energy

Relative valuations are provoking comparisons with past episodes that ended poorly, such as the late 1990s tech bubble. Tesla (TSLA) has risen 75% since announcing its 5:1 split on August 11th. Apple (AAPL), and their 4:1 split caused Exxon Mobil (XOM) to be dumped out for the Dow (see The Dow’s Odd Construction).

There are plenty of articles comparing growth with value. For an energy flavor, consider the comparison with pipeline company Enterprise Products Partners (EPD). As recently as early last year, like AAPL, it traded at under 10X cash flow. Their paths soon diverged, and this year’s Covid-inspired tech rally has led us to the surreal moment at which EPD would need to increase in price by 4.5X, or AAPL drop by 78%, in order for their cash flow multiples to be synchronized once again. AAPL’s net income over the past five years has varied between $46BN and $59BN, with $56BN expected this year. A reduced sharecount due to buybacks makes the EPS figures look better but, unsurprisingly with $50BN+ in anual profit, AAPL is no longer a high growth company.

Technology has been hot to be sure, but in spite of what a cursory glance might suggest, the energy sector has not been completely abandoned. Investors who purchased EPD’s 5.1% 2045 maturity bonds issued in February 2014 have been handsomely rewarded – at least by the extremely modest standards which bond buyers have long accepted. At the time, the cash flow yield on EPD’s stock was modestly higher than the bond yield, which probably convinced some that the bonds, with their fixed coupons and no participation in EPD’s future cash flow growth, weren’t cheap enough.

Those original investors have received their 5.1% coupon and enjoyed some modest price appreciation, since their bonds are now priced at around 120. This is in spite of making their purchase less than six months before energy stocks peaked. Since then, the Shale Revolution has been ruthlessly crushed, leaving energy stocks in disorderly retreat and sweeping EPD down with the rest. Since few bond investors have the flexibility to leap down the capital structure no matter how compelling the opportunity, the holders of this debt with 25 years yet remaining must regard EPD’s equity as altogether divorced from reality.

The change in valuations has been stunningly swift, and when the relationship between EPD’s stock and almost every other non-energy equity security is reverting to the mean, it will have all seemed inevitable. Until then, we can simply gaze at charts like these and wonder how the CFA curriculum will one day turn this into a teachable moment.

We are invested in all the components of the American Energy Independence Index via the ETF that seeks to track its performance.

The Dow’s Odd Construction

Last week’s ejection of Exxon Mobil (XOM) from the Dow Jones Industrial Average looks like another indication of the declining relevance of energy stocks. XOM had been in the Dow since 1928, and until 2013 was the most valuable publicly listed company. Its market cap peaked with oil prices in 2014 at $446BN, and is now around $171BN.

Pfizer (PFE) and Raytheon Technologies (RTX) were also dropped along with XOM, and these three were replaced by Salesforce (CRM), Amgen (AMGN) and Honeywell (HON).

Being dropped from an index is never good. For the much maligned energy sector, it’s tempting to regard this as the bell ringing at the market bottom – the sign that sentiment is so irretrievably poor that the only way from here is up. But the list of such past signals is already long.

The quirky construction of the Dow is the cause of these changes. The Dow may be “venerable”, and still the most widely followed index, but nobody would create anything quite like it today.

This is because it’s a price-weighted index, rather than market-cap weighted like most indices. This means that the price of a stock determines its importance in moving the Dow. Apple (AAPL) is the highest weighted stock in the Dow by virtue of its price. Because of its impending 4:1 split, its weighting is about to drop by around three quarters – for market cap weighted indices such as the S&P500, a stock split has no impact on the weights of the components.

If Berkshire A (BRK-A) was in the Dow, at $326K per share it would dominate the index.

Perhaps when Charles Dow and Edward Jones first published their eponymous average in 1896, calculating the average daily price of twelve stocks without a calculator was already enough work for two financial reporters. But their simple approach remains with us today.

The tables below illustrate the shortcomings. Perhaps the biggest is that a price-weighted index doesn’t reflect market cap weighted moves in its components. This makes it less representative. From next week moves in AAPL’s value will have much less impact on the index. An investor wishing to track the Dow Jones has to sell most of her AAPL’s shares, even though it’s still in the index. Tracking the Dow is more difficult and costly because it requires frequent rebalancing. That’s why there’s far more money invested in products linked to the S&P500, and they have much lower tracking error.  Market-cap weighted indices by definition reflect the experience of all the money invested in their components, and are more easily tracked by portfolios invested in them.

One result is that although the recent rebalancing reflects the biases of the committee that oversees the Dow Jones, the smaller size of Dow Jones-linked funds limited the rebalancing trades by investors tracking the index.

Energy investors can console themselves that XOM’s ignominious ejection is due to AAPL’s meteoric rise and subsequent split. Several big companies have had a sporadic relationship with the Dow. General Electric (GE) has been spurned three times, most recently in 2018. Since then, GE has lost almost half its value. Given valuations, energy investors are likely to do much better.

Covid Exposes Innumeracy

Labor Day weekend heralds the traditional end of summer in America. School starts shortly thereafter. For the past several months, school districts across the country have been wrestling with modified in-person versus fully online classes.

It’s the most consequential set of decisions of the pandemic. 50 million students attend school from kindergarten through 12th grade. In March, schools abruptly switched to online learning. Few will be surprised that it failed students and piled stress on teachers as well as working parents.  Children are collateral damage, “…many students are struggling and falling far behind where they should be” reported the head of the Los Angeles Unified School District (see The Results Are In for Remote Learning: It Didn’t Work).

The effectiveness of lockdowns is increasingly being questioned – New York City’s was imposed by Mayor de Blasio on March 20th, and infections continued rising for another three weeks. Deaths peaked after four weeks. By early May, two thirds of hospital admissions were from people who had been sheltering at home, in compliance with the lockdown.

Moreover, cases continued to fall and have stayed low after some restrictions were eased, suggesting that the spread had reached its break point without government intervention. We may slow infections temporarily, but ultimately the virus moves through the community.

Lockdowns have turned out to be a “blunt and economically costly tool” according to a recent article. Sweden’s modest restrictions were widely criticized, but its fatality rate is lower than the UK, which imposed tougher controls. Sweden’s Nordic neighbors have done better, but that’s partly due to Sweden’s more expansive definition of a Covid death.

The UK is seeing a 40% jump in non-Covid deaths, suggesting people are delaying seeking medical care. The government has pleaded with citizens to “protect” the National Health Service, by not getting sick. We haven’t yet started to count the cost of mitigation.

It turns out there are such enormous gaps between public perception and reality that statistics ought to be a core requirement for a high school diploma.

Two surveys illustrate: one from Kekst CNC polled 1,000 adults in each of five different countries. The average rate of infection estimated by U.S. respondents was 20% — 66 million people, or 20X the number of CDC-confirmed cases at the time. Serology tests that look for the presence of Covid anti-bodies show that the actual infection rate is many times higher than the number of positive tests, so this result might imply the respondents have a more sophisticated understanding.

Their estimate of deaths shows otherwise, with an average response of 9% of the population. If 30 million Americans had died, rather than 180,000, that would suggest an Infection Fatality Rate (IFR) of 45%. Estimates put it at under 0.5% for all ages and perhaps 0.1% for those under 65.

The Covid IFR is tragically high for the older population, those with co-morbidities, and worse if you’re old and have health problems. But here, another survey shows that people underestimate the proportion of deaths inflicted on older age groups. A Franklin Templeton-Gallup survey found that respondents estimated 58% of deaths were among people 55 and older, whereas it’s 92%. It also found that, “The misperception is greater for those who identify as Democrats, and for those who rely more on social media for information.”

Covid has been the top news story almost all year, feeding or fed by these misperceptions depending on your view. There’s no better example of the primacy of fear over facts than Andrew Cuomo’s upcoming book, American Crisis, which promises an inside view of his handling of the pandemic.

Cuomo’s oversight of the nation’s second worst fatality rate (topped only by New Jersey) is less recognized than his sober daily press conferences.

Dispatching infectious but stable patients back to nursing homes to free up hospital beds that were never needed was leadership that led to thousands of avoidable deaths. A skilled communicator of bad news can dodge accountability.

A poor understanding of the figures is about to infect the nation’s schools. Virtual classes are inferior for everyone, but the impact is most severe for younger children. There are over 35 million students in K-8th grade. Their education will likely be compromised. 27 children aged 5-14 have died from Covid. These are all heartbreaking – as are the 2,793 children who have died from non-Covid causes over the same period.

Clearly teachers are more at risk, depending on age and health. A scared teacher won’t teach well, and there are legitimate cases for older teachers and those with compromised health to opt out. But with entire school districts planning for online instruction because of insufficient staff, our collective failure to understand the numbers has millions of young victims.

If you regularly visit The Covid Tracking Report, the Worldometer Coronavirus pages and Covid-19 Data from the CDC, you’ll find most mainstream news media of little use.

Instead, try Twitter where we’ve found some fact-based reporting, including by Alex Berenson, Florian Krammer, Kyle Lamb and a few others hidden behind pseudonyms such as the Ethical Skeptic and el gato malo.

We also found this quarterly letter from David Capital Partners insightful.

The reason stocks continue to march higher is because investors are collectively processing the data and overlooking the popular mood. The gulf between Wall Street and Main Street was never wider.

Stocks Look Past The Recession and Growing Debt

At Berkshire’s virtual annual meeting recently, Warren Buffett mused that their cash hoard of $135BN didn’t seem that much. Stanley Druckenmiller said, “The risk-reward for equity is maybe as bad as I’ve seen it in my career.” The New Yorker thinks stock investors have lost their minds.

To not be bearish is to be insensitive – as if to dismiss the deaths and pandemic as economically meaningless.

Being negative is easy. Just think of all the closed stores, restaurants and sports events that have dramatically reduced options for leisure. I rarely need to visit the ATM because all I’m buying is gasoline, about once a month. It’s cheaper too, although I’d need to drive to a couple of planets for the savings to offset recent losses on my energy investments.

The S&P500 is -8% for the year, a performance seemingly divorced from reality. Following  last year’s +31.5%, it might have been down 8% without coronavirus.

From a top-down perspective it’s usually easy to be bearish. There’s always something to worry about. But S&P500 earnings are estimated to be -20% this year and +27% in 2021, taking them back above last year’s. This is based on analyst estimates from early May, so for the most part reflects first quarter earnings and full year guidance. It’s hard to reconcile with the jump in the unemployment rate from 4.4% to 14.7%, but we must assume that’s incorporated in all those earnings forecasts.

The Equity Risk Premium (ERP, S&P500 earnings yield minus ten year treasury yield) still makes stocks look reasonably attractive. This is partly because interest rates are so low. But even if ten year treasury yields move up to 2% next year, equal to the Fed’s long term inflation target, the expected rebound in earnings will compensate.

If in fact earnings do rebound as forecast, it’s hard to see interest rates staying this low. For years bond investors have seemingly held a less optimistic view than equity investors, but the dichotomy seems as stark as it’s ever been.

To illustrate, Williams Companies (WMB) issued ten year debt at a yield of 3.56%, substantially below the dividend yield on their shares of 8.2%.  Like many big pipeline companies, quarterly earnings were better than expected (see More Solid Pipeline Results). WMB’s quarterly payout is up 5.3% year-on-year.

Although the ERP shows stocks to be cheap, Goldman’s forecast of $44 in 2020 S&P500 dividends is only a 1.5% yield .

We’re heading into a period with no obvious historical precedent. A shut down of large swathes of the economy along with a big increase in debt is most analogous to war. The Committee for a Responsible Federal Budget now expects a Federal deficit of $3.8TN (versus $1.1TN pre-Coronavirus). They expect total Debt:GDP to reach 107% by 2023, exceeding the prior record of 106% hit just after the end of World War II. And these figures exclude any new Federal spending, although the House of Representatives recently passed another $3TN package.

Given the dismal fiscal outlook, the stock market’s recent performance is even more impressive. And if you’re looking for a sector that’s rebounded nicely but is still down over 30% for the year, check out the pipeline sector.