To provide further insight to our clients & partners, on a quarterly basis we will provide highlights from our various investment sectors, offering specific examples of our holdings and significant characteristics/changes that we are seeing. Though we do not believe we are able to fully "time" market cycles, we pride ourselves on the ability to focus on their trends and what we feel a reasonable, conservative approach might be.

Learn more about our latest acquisition/investment

In partnership with the Luther Group, we have acquired an interest in 10001 West Innovation Drive, a premier office asset in the Research Business Park of Wauwatosa, Wisconsin.

This opportunity was purchased well below current, replacement value and utilizes a moderate degree of leverage in an effort to further mitigate front end risk.

The deal presents a risk-adjusted, value-add opportunity during a high point of the current, market cycle, when it has become more difficult to achieve quality yield.

Details of this investment may be made available upon request.

Key market insight during these uncertain times

From our Partners at Northern Oak:

In these unprecedented times, experts from every sector are bombarding investors with statistics, opinions, and forecasts. Even the heartiest investor has gotten uneasy from what seems to be an endless litany of bad news and dire predictions. Rather than add to that with a flowery piece of literature, we think some concise straight talk from our head and heart would be refreshing. We will tell you what we believe, what we have learned and what to consider doing.

What We Believe

There is going to be a recession. We will soon see jobless claims soar. The lost revenue from our shuttered industries, as well as those that are barely in operation, will profoundly affect the GDP. Wall Street firms are tripping over each other predicting a drop in second quarter GDP between 12-24%. The S&P 500 alone has lost $8 trillion in value from its peak through last Thursday, according to FactSet. This will impact consumer spending, which accounts for 70% of the GDP. Earnings estimates are getting dramatically cut as well. In truth, though, no analyst really knows the impact of the virus on the bottom line; precision is futile in this environment. Suffice it to say, it will be bad.

This will get worse before it gets better. As coronavirus testing increases, and time progresses, the number of cases will rise exponentially. Regrettably, so will mortalities. More states and cities will be “sheltered in place”, further slowing commerce. Economic data will worsen as well – unemployment will rise, earnings will get cut, and shortages of certain commodities will become extreme. The evening news will be somber, with daily updates chronicling the numbers of new cases and deaths.

Panic mentality will not be limited to toilet paper and hand sanitizer. In extreme situations, investors can act like a consumer at the supermarket who runs over people to get the last rolls of toilet paper. Even sophisticated investors can fall prey to this mentality. Last week, we saw a rush toward liquidity not seen for some time. Cash was in demand, whether it was needed for fund redemptions (for professionals), margin calls, or for additional equity collateral. For some, especially individuals, it was a need for some “security.” Our contacts in banking told us of numerous stories of depositors withdrawing large amounts of currency over the last several days. There is probably a psychological aspect, as well. Investors feel powerless in market swings, so this behavior – as well as arbitrarily selling some asset – is doing “something”, giving an investor a feeling of control.

This “cash dash”, as the traders call it, has resulted in indiscriminate selling – even in historically safe havens. The mortgage market, treasury bonds, municipal bonds and corporate bonds all suffered volatility in a pricing throughout last week. Large buying by the Federal Reserve in a number of these markets helped stabilize the credit markets later in the week, but by that time much damage had been done.

Getting ahead of this market move was nearly impossible. There are two frequently asked questions regarding this downdraft. “When things go bad, why didn’t you sell?” and “If your strategy in stocks is to upgrade the quality of the portfolio, why did we have lesser quality stocks in the first place?”

First, the speed of the decline has not only been breathtaking, but also historic. As measured by the S&P 500 Index, the market experienced a 30% bear market decline in the span of 23 trading days! (Source: Bloomberg, as of 3/18/20.) That’s over five times faster than the typical bear market, dating back to 1900. (Source: FactSet as of 12/31/19, as represented by the S&P 500.)

Also, if we were in the practice of reducing exposure every time any existential problem arises or any economic indicator starts to waiver, the portfolio would be constantly in flux. As a result, no long-term plan could be fully executed, and the issue of when the re-enter the market would be perpetually problematic.

As for upgrading the quality of the portfolio, it is important to realize that not all stocks react to market information the same way. In the previously mentioned “indiscriminate selling,” panicked investors sell what they have, not what they want to sell. Facing margin calls, for example, some investors sell what held up the best up to that point. Buying a stock with a stronger balance sheet, for example, at a lower price-to-earnings multiple than one with just an adequate balance sheet provides an opportunity to achieve a better relative value. It does not mean the stock sold was of poor quality, per se, but of lower quality than the newer, higher quality issue.

This pandemic will run its course. Further, stocks will bottom well before the economy bottoms, and the economy will take longer to bottom than the pandemic. We suspect that when the rate of change of new cases flattens, we will start to feel better about our ability to contain the illness. The stock market, being the great discounter of future events that it is, has likely discounted a very negative economic outcome already, and once the virus is stabilized, can refocus on the economic impact and recovery. At some point, all “the other shoes” will have dropped.

A recent study by the investment firm Invesco analyzed six major bear markets in the United States since the 1929 Great Depression. It found that even though investors suffered painful losses during the contractions, an investor would have doubled their money over the next decade had they remained in the market. The simple truth is that the stock market has fully recovered from each one of its declines. In addition, given the speed of the decline, we would expect, at least initially, a violent recovery in the market to the upside.

What Have We Learned?

Leverage does it again. The coronavirus is the problem, but excessive use of debt on both the corporate and financial engineering level was a clear accelerant to the tenacity of the sell-off. Debt laden airlines apparently cannot handle a relatively brief amount of time in passenger-count reductions, while Wall Street’s financial engineers, in an effort to squeeze more yield to entice investors, levered their funds heavily. When the redemptions/margin calls came, selling began a downward spiral that is still being unwound. Leverage inside a corporation is measurable and can be managed in a portfolio context. But leverage used in tradeable securities is vague and begs for increased regulation and disclosure.

Diversification is a good thing, but not necessarily effective in pandemics. In forced, nearly hysteric selling, everything is positively correlated. That is a mathematical way of saying “there is no place to hide.” We know these situations don’t last for long and the key is to recognize this, and not join in the selling frenzy.

Certain things will be permanently changed. After this event, our country will have a blueprint for future pandemic events should they occur. Shortages of key supplies will most certainly be addressed (ventilators, protective equipment, etc.) and new policies and procedures will be born, much like the protocols that were installed after September 11th. Social interactions will be altered in terms of how we travel, where we eat, and the way we socialize. We need to assess how this impacts the businesses and industries we follow.

As managers, we need to be flexible with our allocations and lead with facts and not emotion. We also need to use the price dislocation we have witnessed to identify situations that are attractive long-term investments.

What to Consider

The case for “riding out the storm” is strong from a financial perspective. From an emotional and comfort perspective, perhaps that is not always the case. It is bad enough that we are all worrying about loved ones in this pandemic, much less worrying about further erosion in a portfolio. If you find yourself lying awake at night or physically sick because of the economy and markets, we recommend perhaps raising cash that handles your living needs while the markets recover.

We are not suggesting selling out, but rather a reduction for the cash that is needed. Selling out a portfolio means you think things will never improve. By doing so, you are betting on a result that is unprecedented. As stated before, we believe the market sell-off is banking on a worse-case scenario that we feel is unlikely to be realized.

Conclusion

We think there are tremendous opportunities ahead for the long-term investor, and you have our word that we will continue to actively manage the portfolio to improve its performance and build it to achieve your goals.

In the meantime, please be safe. Take care of yourselves, your family, your friends and other loved ones. As part of our extended family, we are concerned for your physical well-being as well as your financial well-being. All good wishes to you. You will hear from us further as conditions warrant.

Sincerely,

Your Northern Oak Investment Team