April 20, 2020

By: Harris L. Kempner, Jr. President

Due to the massive effects of the COVID-19 epidemic, I think it is more important than ever this year to try to look forward. This is particularly true as the pandemic affects the economy. I believe that we are presently in a deep recession that will last into the 3rd Quarter 2020, but that we will be improving our way out of it in the 4th Quarter due to several factors. This is crucially different than being in a depression, which would mean years of slow, grudging, economic activity. This is why:

First, remember that at this writing, we are still operating at an estimated 70% – 75% of the economy, and are finding novel ways to cope and be even more productive. The U.S. economy is “not” shutdown – far from it. This is the foundation on which we can build.

Second, I believe that we have taken the necessary fiscal and monetary steps to preserve us from a total collapse, and to set the stage for a return. In this regard, our experience in 2008 – 2009 is instructive. This was also an economic freefall, though for different reasons. It was not as deep as today’s recession will be, but then the fiscal and monetary response was not as thorough as the response this year has been and will be. In 2008 – 2009, looking back, most people believe that when the TARP (Troubled Asset Relief Program) was finally passed in September 2008, we set in motion enough measures and activities so that eventually the worst was prevented. That is precisely similar to what I think has happened this year. The economic effects are worse than the collapse of 2008 – 2009. The recession will be deeper, and the disease will need therapies, but the governmental response has been much more profound as well. We have taken enormous fiscal steps via the Congress (CARES ACT 2020 of $2 trillion vs TARP 2008 of $800 billion), and monetary via the Fed (massive backstopping of credit problems – several trillions of $$), to staunch the bleeding of the economy. We have also begun to find ways of working around the lack of ability of people to come together to work. I believe the economy will benefit enough from these measures to avoid a major collapse (depression), though we will be going through lot of economic pain, both currently and for months and months to come.

The above economic analysis has particular relevance to the investment activities of KCM’s stock portfolios because it is functionally dependent on how we do as a country. This year through February, we became as liquid in this portfolio as we have ever been. That’s logical; we are value managers and when there’s a lot of downside risk appearing because of the markets being higher and higher, we tend to be sellers into that. We were roughly 25% in cash in the middle of February when the market reached its high. As the market fell, it went into freefall from mid-February to late March, and we were gradual buyers of individual stocks considered to be long-term (3 – 5 years) bargains because we specifically did not feel that this was going to be a depression, but rather a deep, difficult recession. We have utilized about half of the reserves that were existent in early February. Remember we buy individual stocks rather than time the market, and we have a long-term view. At this writing, in mid-April, this has been an appropriate activity. However, there may be other lessons here from 2008 – 2009. The economic crash really began in September 2008. The market did not pull out of it until roughly six months later March/April 2009. In between that time, there were several surges in the stock market. In November 2008 there was a 25% increase, in December 2008 there was a 19% increase in the S&P just during those months alone. Yet again, the market did not reach its eventual bottom till March 2009. That is the kind of thing you would expect in a bear market, and possibly in this one.