By: Stash Graham
We saw the return of downside market volatility during the final week of October. The month started the first couple of weeks on a strong note with all three domestic indices posting strong gains rebounding after a weak September. The high-water mark in October occurred on the 12th, where the S&P 500 had returned just over 5% since the beginning of the month. From there we saw a decline that accelerated to where the S&P 500 ended in the month in the red (S&P 500 was down -2%). All three of the major indices lost money for the second month in a row. Downside pressure came from two fronts: A lack of a stimulus package and a renewed rise of COVID infections and hospitalizations. Gold and long-dated United States Treasuries also traded lower. Gold was down approximately -0.5% and the 30-year US Treasury was down -2.5%.
We mentioned in the September letter that the prospects of no agreement on a 4th stimulus bill were a very real risk. Throughout October we saw headlines indicating that a deal was coming together and that Treasury Secretary Steven Mnuchin and Speaker of the House Nancy Pelosi were meeting often and making progress. The cheerleading of these headlines saw the markets rally as participants were changing their expectations to include another round of hundreds of billions of dollars being directly transferred to American households. As we approached the end of the month, the markets started to realize that a stimulus was not close to being reached and started to succumb to selling pressure. We believe this caused a systematic realignment of expectations for the economy that showed historically good growth in the 3rd quarter but growth that was completely dependent on the government’s stimulus plan. We have seen and discussed the high-frequency data in earlier letters, the growth rates were starting to turn over towards the end of the 3rd quarter which has caused a lot of downward revisions to the 4th quarter GDP figures.
On a positive note, initial jobless claims fell more than expected in the week ending October 24. The second straight decline is a positive development for the labor-market recovery. On the negative front, initial claims are still persistently elevated (above 700k per week), showing continuing weakness in cyclical members of the business community. A famous cyclical sector company, Exxon Mobil, recently announced 14,000 job cuts. The effect of these continued layoffs puts a lot of pressure on the labor market to create new jobs to just maintain the status quo. This is happening at a time when the pandemic has just started to get worse, it should be expected that a portion of the leisure and hospitality jobs that were recreated during the summer months will be lost again as demand wanes. Whether due to renewed restrictions to combat the spread or people self-quarantining, demand will fall. Since late September, restaurant bookings were already flattening as Americans voluntarily limited their activities. The job report showed that claims under Pandemic Unemployment Assistance (PUA) for the self-employed, gig workers, and part-time workers increased by 15,000, a second consecutive weekly increase. While claims for Arizona and Florida posted hefty declines, Nevada and Ohio increased sharply. The Associated Builders and Contractors’ Construction Backlog Indicator, a forward-looking national economic indicator that reflects the amount of work to be undertaken by commercial and industrial contractors has plumbed to post-COVID lows. September’s 7.4-month average hit a nine-year low.
Finally, we have discussed C-level executive surveys before. We find that they are an efficient way to see what is on the mind of the company chiefs, across different industries, whom are trying to navigate this difficult time. The Conference Board CEO Survey was released during the third week of October covering the July-September quarter. At first glance, the survey headlined a very positive narrative. When we dove into the report specifically looking at employment projections, we were left a little less positive. 34% of CEOs around the country planned to cut their employee workforce over the next 12 months. Another 68% planned to have hiring freezes over the next year. Upcoming wage freezes were expected by 20% of company heads surveyed, while another 5% expected pay cuts. Most importantly, only 25% of company leaders plan to increase spending of any kind over the next calendar year. This is a very low percentage that makes projecting the next year very difficult. For the economy to take this next leg higher, we need to have a sustained, strong return from business investment. As we have mentioned before, relying on government spending to generate economic growth is a dangerous game when Capitol Hill struggles to agree on anything (see lack of 4th stimulus plan as the latest example).
Please see the following updates on existing positions held at the firm:
Intel Corporation (Ticker: INTC)- The company is informally known as “Chipzilla” struggled to produce material growth in the data center sector in the last quarter. The market punished the company giving back the strong gains that we produced from our early August position initiation. We are tentatively still holding these positions as the company has a couple of different levers at their disposal to assist with the price of the common stock. In the August letter, we discussed the large buyback that was been authorized but not used yet. There is almost $2.5 Billion in cash that has been earmarked for share repurchases. The company is still producing a significant amount of cash flow and could be a takeout candidate itself by one of its deep-pocketed customers.
AT&T (Ticker: T)- AT&T remains in transition, but the market welcomed the telecommunications giant’s 3rd quarter numbers rewarding shareholders with a 5% gain on October 22nd (the date they were released). We should continue to expect improved growth in the 2020 4th quarter figures and during the 2021 calender year. In the wireless subsidiary, service revenue fell on lower fees, though equipment sales grew 6.4% in the 3rd quarter. We need to keep an eye on the iPhone 12 rollout, AT&T will be a beneficiary of people looking to trade up their phone. In the media division, Warner Media revenue has been improving throughout the summer and fall months as ad revenue rebounds. A slight surprise was that DirecTV’s subscriber losses eased, which is a welcome sight for the worst-performing subsidiary at AT&T. The dividend yield continues to be high but is still fully covered by operations. The quarterly dividend is being paid to shareholders on November 2nd.
Pinnacle West Capital (Ticker: PNW)- Minor note from the Arizona focused regulated utility. PNW announced that they are increasing the quarterly dividend to $0.83 per share (6+% increase). The higher dividend payment is scheduled to be paid on December 1st to shareholders of record on October 30th. We have every intention of holding onto the position for the foreseeable future as we have a nice unrealized gain “buffer” (over +13%). As the election happens and we have a better idea of what Washington, D.C. will look like in late January and will invest accordingly. If you have any questions or concerns, please feel free to reach out.
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