As we close the books on 2020 and enter the new year, it may be instructive to spend some time thinking about what got us here; how, in the midst of so much pain, can the stock market be at all time highs and at such lofty valuations?
Of course, there is the Federal Reserve. Fully 78% of all the dollars ever printed in the United States, have been printed in the last ten years. Real interest rates (nominal rates minus expected inflation) are negative; in other words, cash is a wasting asset. And the Fed says that they are, “not even thinking about, thinking about, raising rates.” The future value of corporate earnings has improved, so that valuations should expand.
That’s the answer everyone is talking about, and it is highly valid. But I think, it may not be the full answer. Covid 19 has accelerated many disruptions already in place. Most telling, a vaccine has been made available less than one year from the discovery of the virus, and fully one year before the expectations of experts like Dr. Fauci. I believe that the analogous information contained in the distance between reality and those expectations may give us a better handle on the market’s valuation.
What am I driving at here? Our thesis about technology and economic growth is that the pace and extent of interdisciplinary discovery in mathematics and science reinforce and quicken the rate of change; and the virus has accelerated it. Moderna was able to formulate a vaccine three hours after receiving the genetic code of the virus from China because the computational power applied to theoretical science allowed it to do so.
That convergence means that newly created data makes all previously created data, that much more valuable. Facebook provides a clear example. Being a participant in Facebook is only valuable because our friends and family are also participants; we participate only because we actually have someone to correspond with.
I don’t think that the analyst “experts” of individual market segments are institutionally conditioned to think across separate disciplines. One is either a biotech analyst, or a software analyst; software or hardware, etc. The analysts who have traditionally followed Disney (DIS) have not been the same as those following Netflix (NFLX), yet I would argue that Netflix is its best comparable.
As these disruptions occur and reinforce one another, what does it mean for economic growth as a whole? Zoom Video Communications (ZM) went from ten to thirty million users in 2020; video will fundamentally alter the delivery and cost of healthcare and education. 5G and additive (3D) printing will fundamentally change how we produce goods, as well as their cost. How much money (and how many lives) will be saved by the earlier detection of cancer through the liquid biopsy process pioneered by Guardant Health (GH)? These innovations will affect the cost structure of goods and services throughout the economy. We can have a vision of these changes, but cannot fully quantify their interlocking effects.
So are assets over or perhaps under, valued? Consider this. Docusign (DOCU) is a company which arguably has changed how we will sign contracts in the future. No more long, boring trips to the attorney’s office or the real estate closing; a convenient, meaningful detachment from a traditional chore. Docusign today is a $42B company. Crisper (CRSP) has used gene editing to essentially cure sickle cell anemia (a chronic disease diagnosed in more than 100,000 patients each year in the US), in seven patients. The gene editing platform is being used to investigate potential cures in scores of other chronic diseases. Since all value is relative, shouldn’t Crisper be valued at something more than its current $14B?
Warren Buffet is famous in part for identifying the hidden value in corporate goodwill (an accounting term used to describe the value of a brand, Coca Cola for example). Similarly, the stock market may be recognizing the value of all that data just at the time our ability to use it effectively has begun to grow exponentially.
One could make the same kind of argument about many of the basic industrials. These should demonstrate significant operating leverage as the economy reopens because of the structural cost cuts put into place as a result of the virus shutdowns. Each of those in which we have invested, from Honeywell (HON) to Rockwell (ROK), Parker Hanifen (PH), PTC, and Dupont (DD), will also play a large role in industrial automation as the rollout of 5G allows industrial digitization.
So one difference between the late 1990’s and today is that the earlier period was about a much more distant vision. We had many of the building blocks to that vision, but not nearly all, and we overbuilt those which we did have (optical fiber being the most egregious example). The virus has pushed us so much closer to the realization of that vision. Steve Jobs noted the tremendous potential for productivity enhancement that would result from the convergence of technology and healthcare.
We have been positioning for many of these disruptions for more than two years. 2020 has brought their significant out performance. But that success has also engendered a greater propensity to sloppy research on Wall Street, which has further boosted prices and perhaps set the stage for more volatility as less informed investors chase stocks simply because they are going up. This is a trend which occurs in every bull market. We will therefore continue to trim positions by 25-30% when we have the opportunity to realize a 25% or greater profit from those positions, hopefully insulating the remainder from potential loss. Discipline trumps conviction. In this I am reminded of the famous response of Baron de Rothschild when asked the question how he made so much money. He replied, “I always sold too soon.”
As we reflect upon the good fortune experienced by our portfolios this past year, I believe it important to remember those less fortunate Americans who may find themselves in more dire circumstances, through no fault of their own. We have been lucky to anticipate, and profit from, so many of the changes wrought by the virus. As we enter 2021, I find myself rooting especially for the industrial companies, already experiencing nascent success, which we purchased last summer. My hope is that their ultimate success will favor a more broad improvement in the livelihoods of all Americans.
Respectfully,
Timothy Dougherty
Asymmetric Capital Advisory
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