Good morning,
I actually wanted to break up the earnings reports routine for a day and talk about something a little more current. I know that some of you will favour the earnings season reports more than others and vis a vis. However, i wanted to break up the constant flow of earnings reports as to allow for some diversity.
On that note, we still have the following earnings report to issue, which will be coming your way over the next two weeks:
Before we get started, i post content like this daily to subscribers of the newsletter, so if you would be interested to subscribe for $10 per month, you can do this using the below button:
The Vaccine
So, today i wanted to discuss some of what we saw across the broader markets yesterday on November 9th, as Pfizer announced they had some positive news on the vaccine front.
So the two firms developing the vaccine, Pfizer and BoiNTech, came out yesterday and stated that they had developed the first effective coronavirus vaccine, which can prevent more than 90% of people from getting COVID. Important to remember that this is based on their preliminary analysis.
I will leave the official announcement link here: Pfizer and BoiNTech
After discussion with the FDA (Food and Drug Administration), the companies recently elected to drop the 32-case interim analysis and conduct the first interim analysis at a minimum of 62 cases. Upon the conclusion of those discussions, the evaluable case count reached 94 and the DMC performed its first analysis on all cases. The case split between vaccinated individuals and those who received the placebo indicates a vaccine efficacy rate above 90%, at 7 days after the second dose. For reference, the FDA typically requires an efficacy rate of 50%.
This means that protection is achieved 28 days after the initiation of the vaccination, which consists of a 2-dose schedule. As the study continues, the final vaccine efficacy percentage may vary. The DMC has not reported any serious safety concerns and recommends that the study continue to collect additional safety and efficacy data as planned. The data will be discussed with regulatory authorities worldwide.
The vaccine was tested on 43,538 participants across a range of different backgrounds and nationalities, and the companies now plan to apply for an emergency approval to use the vaccine as soon as this month.
So a few things on this.
This vaccine is an RNA vaccine, which contains ribonucleic acid (RNA) which is a polymeric molecule essential in various biological roles relates to the coding, decoding, regulation and expression of genes. RNA vaccines are a fairly new form of vaccine for providing acquired immunity through an RNA containing vector. Just like a regular vaccine, an RNA vaccine is intended to include the production of antibodies which will bind to potential pathogens (ie, the organisms creating the disease) and activate T-cells within the body, which is one of the something that plays a central role in our immune systems.
I have provided a visual for how the RNA vaccine would work below.
Source: Nature (BBC)
Now, i won’t pretend i am an expert on biology or vaccine production, so this is about the extent of my understanding.
Albert Bourla, CEO of Pfizer, stated that:
“Today is a great day for science and humanity. The first set of results from our Phase 3 COVID-19 vaccine trial provides the initial evidence of our vaccine’s ability to prevent COVID-19”
“We are reaching this critical milestone in our vaccine development program at a time when the world needs it most with infection rates setting new records, hospitals nearing over-capacity and economies struggling to reopen. With today’s news, we are a significant step closer to providing people around the world with a much-needed breakthrough to help bring an end to this global health crisis. We look forward to sharing additional efficacy and safety data generated from thousands of participants in the coming weeks.”
This leads to a wide array of questions.
How often will we have to be vaccinated?
Will the vaccine be a one-time cure?
Will there be long lasting side effects?
When will the vaccine be available?
Who would get it?
A lot of these will go unanswered for now, but there are reports that 10 million doses will be available in the UK for 2020, as well as Pfizer stating they are able to provide 50 million doses year end, and around 1.3 billion by the end of 2021. They do state that under this vaccine, people would need two doses.
The Voting Machine
So this news created some obvious turbulence yesterday in the marketplace, and we witnessed a sort-of rotation amongst the overstretched tech names, and the more ‘value’ centric names. To look at it another way, those who will benefit from lockdowns being removed and normal economy function were up, and those ‘stay-at-home’ stocks such as Zoom, Peloton and the likes, were all hit fairly hard. We will touch on that shortly.
Yesterday alone, we saw small cap value (here i am using Vanguard’s VBR) advance 5.8% on the day, with the Dow Jones advancing 2.66%, S&P 500 1.17% and the tech-heavy Nasdaq slump -1.53%.
Typically, at the beginning of a recovery, small cap value has shown to be an attractive place to be for an investor. Now when i saw recovery i am more so relating to a recovery where the impetus is removing the thing that caused the recession. Once that road block has been removed, then the recovery typically can begin. I am not relating this to the “recovery” in the stock market.
If you recall from September when i discussed the nature of recessions and corrections, i stated the following:
Traditional Recession
“A traditional recession stems from the build up of some issue, or multiple issues, during bull periods that accumulate and eventually expose some form of weakness in the capital markets. When these recessions occur, it is mostly society that picks up the tab. This can manifest in several different ways from investing losses through to the corrective actions that small and large businesses make during the recessionary period of hardship. Moreover, the economic consequences that follow on from a recession are another way in which society will be the ones who compensate the market.
During a traditional recession, the market will typically spend a lengthy period languishing, whilst the issues have been resolved, in order to build a base for the next expansion.
The 2007/08 real estate bubble for instance, took a mighty 5 years for the S&P 500 to recover.
What i am basically saying here is that the system needs time to flush out the issues that caused the market collapse in the first place.
During 2008 the gear in the engine was the real estate bubble, which eventually lead to some severe illiquidity in the banking system. Before the market could advance, these issues had to be resolved in full so that the problems, now built-in to the system would no longer be an issue.
The market crash in 2020, was perhaps less severe because the banking sector was a great deal more robust and strong than it was back in 2008.”
Okay so this is what i stated back in September. So whilst we may have seen a retracement of the lows in March, the niggling issue that was preventing a full economic recovery was the virus. With hopes of a vaccine now here, that gets the ball rolling on that economic recovery, and this is typically the period when small cap value does best.
If we are inclined to believe that March was the low point, then it should be a roaring broad recovery from the point of vaccination. I still think that is a long way off. However, that does not stop the market pricing this reality in.
One thing to consider is that the S&P 500 is ~25% technology weighted. Thus, if the rotation continues, there are going to be some structural headwinds in the index.
Coming back to yesterday for a moment. You can see below, an array of sector ETFs and their respective returns yesterday. What you can observe is that the more downtrodden and ‘value’ sectors saw a significant reversal yesterday. Energy up 13.96% and financials up 8.05%, far outpacing the rest of the sectors.
You know, this is just one day however, but it reflects what the market is thinking and/or pricing in. Here we have a vaccine, or rather some positive vaccine news. Therefore, we begin to think about what companies benefit from lockdown restrictions being lifted. Starbucks, Coca Cola, Banks, Casinos. Then we think about what companies might see some demand decline, Zoom, Peloton, and those richly valued SAAS companies like Crowdstrike and PayPal.
This is the voting machine in full effect.
Recall that Graham states that markets are voting machine in the short term, and weighing machines in the long term.
Will the need for Crowdstrike’s cyber security services now dwindle? It is not likely. There are certain trends that have taken place, or even existing trends that have accelerated this year, that will not likely revert. Cyber security is one of them. However, you have to understand that a 10% decline in Crowdstrike’s share price does not mean investors think the company will struggle from now on, or under the assumption that the Pfizer vaccine is successful and we are out of lockdown in a few months.
The valuations of a lot of these SAAS names has been bid up to frothy levels due to the uncertainty surrounding the future cash flows of a number of other businesses that, for the most part, rely on physical consumers. You know, Starbucks showed some nice recovery in their Q3 filings, but there was still uncertainty around lower foot traffic in their stores plaguing the company, and subsequently the stock.
In a more dramatic sense, the same can be said for Casinos. Ignoring the online betting units, these casino’s bread and butter is in physical custom. The rooms they allow customers to use, the food they serve them, the casinos they operate which require physical consumers, and so on. With uncertainty surrounding when these consumers will return, investors are more reluctant to buy the stock.
For me personally, i built my MGM Resorts position months ago, as i am confident consumers will return, and i am happy to wait a few years to see out the recovery.
Take a look at the daily price movement, labeled as ‘% day’ in the below visual. Each of these are the positions i currently hold.
American Express up 21%, MGM Resorts up 15%, Bank of America 14%, Starbucks and Coca Cola up over 5.5% on the day too.
Then on the flip side, we have Peloton down 20%, Crowdstrike down 10%, Sea Limited, PayPal, Square, all taking a beating.
This is a classic rotation from the popular to the new-popular, in line with the voting machine thesis. Capital flows out from one, and into another.
This is also part of the reason i chose to adopt a hybrid security selection, in that i own some boring larger cap companies, and some more volatile companies that are younger, and growing at a faster clip.
I witnessed a lot of portfolios being down double digits yesterday, for those who operate a full-tilt growth basket. For me, i was up on the day. This comes with downsides however. During most of the mania this year, my portfolio has certainly underperformed compared to someone with a concentrated SAAS portfolio. However, it has outperformed someone operating a value-orientated portfolio.
I am hopeless at timing market cycles, and so i like to own a little slice of companies i think are super strong like Facebook, Starbucks or Alphabet. However, i also like to own disruptors like PayPal, Square and Crowdstrike.
This satisfies my needs as an investor, and is in line with my own risk tolerance whilst still managing to beat the market, i am aware its not for everyone.
But the point i wanted to make today is that if you are feeling emotional, step away from the screen. This is true both on down days and up days. This being if you are long term orientated. For traders, i can’t help you.
I often repeat myself when discussing the market’s pricing tendencies. The market is a pre-pricing machine. It will typically price out 3 to 30 months into the future at any given time.
As i have said before, during a period where some large event takes place, whether that be a vaccine or an outbreak, the market will typically draw-in the pricing range towards the closer end of the timescale, pricing the near-term future more heavily.
We saw this in March. Okay, so in March the pandemic was broken out. For a week or so, the market sold off in a manic fashion. We know that eventually the pandemic will be over and normality will resume, but the market stopped pricing out 30 months, and started pricing in 1,2,3 months ahead, albeit overzealously.
Then after the dust settles, we saw a huge retracement of the lows. In this way, the pendulum of the pricing mechanism swung outwards towards the later-term future and began pricing in a future whereby the crisis is over. This always leads to confusion, when we have an economy in tatters and an advancing market.
I discuss this market pricing behavior in this article:
Back to today. So yesterday, the vaccine news broke out, and the market then immediately swings that pre-pricing machine into action and heavily prices in the vaccine news, by allocating to companies that stand to benefit the most from that vaccine news.
If a casino is trading at 8 times earnings with no vaccine in sight, then investors are willing to pay $8 per $1 in earnings.
If the reality of a vaccine then becomes a reality, and the future of that outcome becomes; A) more certain and B) appears closer, then investors might be more likely to pay more dollars per dollar of earnings for a casino.
It is interesting to speculate and try and rationalize why a market moves in a given way, on a given day, but it is likely an activity that will drive you insane if you are attempting to invest accordingly.
It is important to remember that the market is a voting machine in the short run, and whilst the trend can be your friend, it can also be hard to time when that pivot will take place.
Let us say that the vaccine undergoes further testing and turns out to be a failure, how do you think the markets will react to that? We could assume that the same stocks that benefitted from the positive vaccine news, will give back some of those gains, if not all of them.
I just think if you are investing longer term, you should be focusing on the business fundamentals, and the thesis for investing, and be largely concerned with that.
Back in May when i acquired a position in MGM, i liked the discount it was trading at, at around 60 cents per $1 in sales, it was trading below book value, it had great liquidity, and i believed once consumers were back, the business would be back in full swing and perhaps even reinstate the dividend.
My thesis is still unchanged on that investment today. So for me, it really doesn’t matter that the stock increased 15% yesterday, i am more so interested in where it will be in 2 years.
It can be tempting to get caught up in the hysteria. For those of you holding Peloton, you might have saw the news, assumed gyms would be open sooner than we thought, and then been tempted to sell Peloton as it was down 20%. This is how the brain typically processes that kind of scenario.
It can help to take a step back and do nothing, as sometimes the best activity in no activity. Peloton were growing pre-covid, and they will continue to grow post-covid. They experienced excess demand this year due to lockdowns, that is certainly true. Their valuation inflated far past their intrinsic value, that is also true. This is why valuation matters. Buying Peloton at $130 per share, because the share price keeps rising, in the short term, seemed like a bad idea. For me, my cost basis is about 40% lower than the market price, so a 20% down day doesn’t hurt.
It is not normal for a stock to advance 100% per year, nor is it normal for your entire portfolio to do the same. Many impressive long term returns, are filled with 20%, 30%, or even 40% + pullbacks throughout their trajectory. Volatility is the price of admission.
Buy great companies, and try to buy them at reasonable prices. I am not an advocate of ‘buy it at any price’. I think that looks great in hindsight, but as humans we can’t venture that far into the future.
To sum up, great news on the potential for a vaccine, but just be aware its not finalized. It is better to make investing decisions based on the company, rather than the environment specifically.
If you have any questions, feel free to leave them below. This concludes today’s newsletter, and i hope you don’t mind that i wanted to voice some insights i was pondering over this morning.
Until next day,
IT
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