The equity markets continue to be very volatile as the world tries to sort out the long-term effects of the pandemic. As we write this letter the stock markets we follow have just entered their second correction this year. The Nasdaq 100 is down 14% in September and the S&P 500 is down 10%. In the first quarter the S&P 500 ultimately dropped 36% in about six weeks. It then rallied over 60% in the next five months. If it feels like you are on a financial roller coaster, it’s because you are.
We have been keeping an eye on the implied option volatility estimates for the S&P 500 going into the election. The option premiums are extremely high. This means that the market makers are anticipating a lot of big swings in both directions over the next five weeks until the election is over. We hope to take advantage of those should the swings be to the downside.
Our opinion continues to be that the stock markets of the world will offer better value than bonds or cash for the foreseeable future. We think this trend will hold until inflation comes back. At that point, we think cash, value stocks and commodities will be better investments than a basket of stock indexes. When does inflation come back?
This quarter lumber prices went to new 10-year highs. If you are wanting to build a house, we are sure you might have noticed. Copper prices are at two-year highs above $3 a pound. Soybean prices are at their highest level in 2.5 years. Wheat prices are at 5-year highs. Gold reached a record high in all currencies this quarter. These prices indicate inflation may be nearer than we think. What is holding inflation back in a big way is that the oil markets are still suffering from COVID. According to the U.S. Energy Information Administration, transportation represents 28% of the end users who consume energy. Inside that segment we have two sectors that are really struggling: airlines, which consume jet fuel; and diesel trucks, which ship goods on our highways. When those sectors come back (we think in mid-2021), we think so will inflation concerns.
Passenger boarding’s on U.S. flights are down about 70% this quarter. Jet fuel is a big use of oil. We don’t see that trend getting materially better until a vaccine comes out. We are surprised at the decline in diesel fuel consumed by the trucking industry. These numbers are hard to get, but our best estimate is demand for diesel fuel is down 40% from a year ago. We expect this group to come back quicker than the airlines. If we miss on that estimate, it will be later rather than earlier. Watch these two groups for a sign that inflation is coming back.
The U.S. Federal Reserve came out this month and said, we are OK if inflation goes above 2% for a long period of time. The Fed also said they will not worry about how much money they print to accomplish this goal. This is the exact opposite of what Paul Volcker did to stop inflation in 1979. Over the next 12 months, the Federal Reserve is going to print 20% more money to put into circulation. Over the last 12 years, that money printing has ended up in the stock market. We have talked about this phenomenon a lot in past letters, so we won’t elaborate on it in this time. As we stated in April, we think that the money the Fed prints will end up in stocks. We continue to feel that way until the oil market comes back. Once it does, we think that dynamic will change and not be as friendly to financial assets. As we stated above, watch the oil market for signs the economy is overheating.
For most of our accounts, we sold part of your Apple and Tesla stock this quarter. We did that to get those positions down to around 8% of the value of your accounts. For those whom we initially bought Apple in 2013, we ended up making about 6 times our money (not counting dividends). On Tesla it would be around 5 times. We still have large positions in these stocks. We continue to think there is upside in both but felt they were too large a percentage of our accounts assets.
What are we going to do with that cash? Some of it will be allocated to oil stock investments. This is a sector that is universally hated. In 1980 it represented over 30% of the market capitalization of all stocks. Today it is at 2%. We think the market has this wrong, and we will bet accordingly if we get our price. It might seem strange to own a renewable energy stock in Tesla while buying oil stocks. The irony is not lost on us. We will keep you updated on what we do.
We have also become more intrigued with the carnage in retailing. Except for the big box stores like Walmart or Home Depot, this sector is priced as if nothing will ever go right again. We do think there are some winners here that will survive the assault of online sales and COVID. If we buy anything in this area, we will talk about it in our next letter.
CenturyLink has changed their name to Lumen Technologies. The new ticker symbol is LUMN. They did this because they feel they are a technology company more than they are a traditional telecom company. There was no change in the number of shares you own or the structure of the company.
On a sad note, we will not be having the Christmas party this year. We do not want anyone to take a risk this year with their health to see us. We also do not see how a buffet can be served this year (health authorities are discouraging them) to accommodate over 100 people in a two- hour time frame. Make sure your address with us is correct. You will be getting something in the mail.
Sincerely
Mark Brueggemann IAR Kelly Smith IAR Brandon Robinson IAR