Bullish on Volatility
We’ve often discussed uncertainty, and its impact on stock prices. This week saw the uncertainty of a resurgent virus flare up in the investor psyche, pushing the market prices lower. Price recovery from the March lows has been based on the imagined certainty of economic recovery; once that certainty disappears, prices can’t be sustained. Price movement based on imagined certainty breeds volatility, and in turn can generate even more uncertainty about a rational range for stock valuation.
As a previous colleague of ours used to quip, any analyst with two dots and a ruler can spot a trend. Recently, there has been no shortage of positive trends developing, and much of the April and May melt-up in stock prices has anticipated the continuation of those trends. New unemployment claims have been declining, previously laid off employees are getting back to work, and until recently virus cases and deaths were trending downward. So – is the economy going to be okay, and has the bull market in stock prices resumed?
Rather than a bull market in prices, this is a bull market in volatility, both on the upside and the downside.1 The market is alternately excited about recovery, terrified about the possibility of retreat, therefore volatility will rule the day. The instability is rational insofar as it is responding to an underlying economy going through wrenching dislocation and forced innovation. It is rational to expect a slowdown in revenue growth and profit, and equally rational to expect leaps forward in technical, medical and process productivity as a result of the efforts to respond to new economic opportunities and limitations. There are many possible outcomes, and the path will not be linear.
Radical Changes, Radical Unknowns
Companies whose primary service or product has been sidelined during the pandemic are suffering dramatically, even with aid from the Fed. With the border closures and imposition of quarantine, airlines’ business was gutted even before business and recreational travelers elected not to fly. This suffering ripples outward as well. Without travelers, they have had to cut service and furlough employees. And they don’t need to buy airplanes, so Boeing, Airbus, Cessna and Gulfstream become the next domino of radically reduced production. Key suppliers to the aircraft manufacturers suffer as well, so aircraft engine producer Pratt & Whitney and components suppliers like Collins Aerospace and Honeywell need to cut back. The ripple further continues into the local economies where these vendors and employees live.
Other companies are coping with radical increases in demand. The leap forward in work-from-home technology, increased dependence on the cloud, and a big jump in online shopping and home delivery all favor a wide array of technology companies large and small. This also creates a ripple effect. Jobs are being created to underpin the logistics of home delivery and hardware must be manufactured to support these technologies. As these radical increases in demand create varied winners, the concept of buying technology suppliers and components to profit from growth – think buying Intel rather than choosing a computer manufacturer – translates well from the industrial example above.
For another sector of the economy, adaptation is the order of the day. Rental companies often flourish during difficult economic times, and although the shutdown was hard on many, like Airbnb, Rent the Runway, and Hertz, others are finding surprising resilience in new consumer needs. Office furniture purchases for home use are up, clothing sales for professional tops (but not pants) are doing well2, and peer-to-peer car rental platform Turo is seeing renters using cars in lieu of public transit for local errands. One San Diego host reported that since the pandemic began, 90% of his car rental customers are locals, a reverse from 25-35% before.3
Radical changes in economic activity, consumer demand, public health, and global trade activity have been destabilizing, but spur innovation. Dramatic economic shifts, and certainly downward change in market prices, commonly triggers the desire to “do something.” Contrary to that impulse, a disciplined approach of keeping your long-term portfolio allocation can, at times, feel like doing nothing. Inaction may not feel good, and it may not feel smart. Yet, no action can result in a good outcome when there is no rational basis on which to buy and sell.
As an investor, every time you don’t sell, you are effectively choosing to buy. You are re-committing to future growth, future recovery, future innovation, and re-committing to tolerating the volatility. In the upcoming months, the public and the market are likely to have fits and starts of both hope and panic. We expect more volatility, both on the upside and downside. History shows us, though, that the market is resilient, and we are proud to help our clients navigate the volatility and benefit from persistent economic innovation.
1 Dave Rosenberg, “Breakfast with Dave,” Rosenberg Research, June 11, 2020.
2 Jacob Bogage, “Business on top, pajamas underneath: Walmart is selling work shirts, but not so many pants,” Washington Post, March 28, 2020.
3 Kate Knibbs, “The Pandemic Is Transforming the Rental Economy,” WIRED, June 8, 2020.
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