Is it Live or is it Memorex?
Second Quarter 2020
Back in what may seem like ancient times to some—the early 1980s—the Memorex Company ran an advertising campaign for its recording tape. (Memorex? Recording tape? Maybe we are talking about ancient times!)
The campaign included a series of TV commercials featuring famous vocalists. As a singer belted out some incredibly high notes, the commercial would show a wine glass shattering.
The implication was that the high notes shattered the glass. But viewers couldn’t tell if it was a real (live) voice or artificial (a recording captured on Memorex tape). The commercials ended with the question; “Is it live or is it Memorex”?
It strikes us that the stock market is in a Memorex-like situation.
The “market” just registered one of the largest quarterly advances in U.S. history. This has mystified many pundits as it occurred in the face of an economy some contend is in “shambles”. And, COVID-19 remains on the loose.
Is the recent market recovery real…or not?
The stock market is doing its thing
Our view is that the stock market is doing what it typically does:
- It looks ahead.
- As it does so, it’s assessing whether things are likely to get better or worse; not whether things are good or bad.
In last quarter’s Perspective, The Alphabet Debate and Midway, we discussed the stock market’s often uncanny ability to look ahead through serious gloom by examining World War II events through the lens of stock markets around the world.
By way of review, the U.S. stock market started to shake free from the Great Depression doldrums and began a multi-year advance in the spring of 1942. The market’s breakout advance was coincident with the battle of Midway Islands—a key strategic objective of the Japanese in the South Pacific.
The events at Midway marked the first time the U.S. military demonstrated the ability to checkmate Japanese naval and air power. In battles leading up to that point, Japan had proved to be the superior military force.
The Japanese stock market peaked around the same time U.S. stocks bottomed. Japanese investors began to sense the country had awakened the “sleeping giant” and missed their chance to deliver a knockout punch to the U.S. military.
Chart 1: The stock market usually turns up (and often makes new “highs”) well before economic recoveries begin
Even as three more years of World War II horror lay ahead, investors began to anticipate that the Allied forces would prevail over the Axis powers of Japan, Mussolini’s Italy and Hitler’s Nazi Germany.
The stock market’s ability to see the light of better times ahead during challenging periods didn’t end with World War II.
Chart 1 focuses on the twelve U.S. recessions and economic recoveries that have occurred in the post-war period. Notice how the stock market (dark blue line in chart) began to advance well before economic activity turned up in those prior periods.
That “the market” looks ahead isn’t a big surprise. After all, a stock price reflects the assessment of the future prospects of an underlying business. And those prospects, in most cases, span many years into the future.
This doesn’t mean that the next few quarters of business results don’t matter to investors. As we’re presently witnessing with J.C. Penney, Pier One, Chuck E. Cheese, Chesapeake Energy, and Brooks Brothers to name just a few of the more familiar, some weak businesses with precarious finances will not survive beyond the next few quarters.
But for the many, many companies that will survive (and thrive), it’s important to remember that the vast majority (95%+) of most stocks’ current value rests with their business prospects beyond the next year or so.
The stock market’s recovery suggests that the longer-term prospects for many—though certainly not all—businesses will not be permanently impaired by the COVID-19 recession.
Real or Memorex?…Is there really light at the end of the economic tunnel?
As longer-term Perspective readers know, we believe the U.S. economy’s resiliency is significantly underestimated. The resiliency comes in large part by the unique willingness and agility of most individuals and businesses to accept and adapt to change.
Even for an economy that is as resilient as we believe the U.S. is, however, adaption takes time. Immediate adjustments to an abrupt shut down in significant portions of the economy and population-wide “sheltering in place” is not possible.
Still, even within the sharp economic contraction that ensued in March and April, and now in the “re-opening” of the economy, large-scale adaptation and economic renewal was, and is, occurring.
- Spending at restaurants and on travel has sharply declined as people cannot venture out in pre-virus fashion. Meanwhile, sales of boats, RVs, home workout equipment, bicycles, paddleboards, and kayaks and camping equipment have surged.
- Prefer not to touch cash or checks in the COVID-19 world? Payment networks and the digitization of commerce are available solutions. (See Chart 2 below).
- Rather not go out to shop? E-commerce provides an “answer”. Chart 3 (also below) provides some indication of the amazing adaptability of the U.S. economy.
- Need to work from home? Digitization makes it possible for many.
Chart 2: It’s still early innings in the transition to digital payment methods
Chart 3: Adaptability…almost 10 years’ worth in 8 weeks!
Chart 4: Adaptable work force!
As the last three adaptability examples also imply, the COVID-19 recession has accelerated the underlying trend towards the digitization of the economy that we’ve been discussing the past few years.
The challenges created by COVID-19 appear to be forcing a “rethink” of many business practices and structures. More minds appear to be opening to new possibilities enabled by digitization and other innovations that are emerging.
In the race to find COVID-19 vaccines, treatments, and testing, the mindset governing the approval process of new therapies is being reconsidered. Novel approaches are now being encouraged by agencies long characterized by extreme risk-aversion.
Digital initiatives like “big data” analysis powered by cloud computing, AI (artificial intelligence) and advances in genetics and life sciences hold considerable promise to transform (for the better) healthcare R&D and perhaps the entire healthcare sector. Here again, COVID-19 has likely accelerated trends that were already at work.
Innovation requires experimentation. Experiments in new education approaches forced by the COVID-19 shutdowns, while appearing to be disappointing thus far, may well yet yield results in the form of more effective education.
More generally, increased diffusion of the new tools of digitization across the economy bodes well for economic renewal in the form of productivity growth. This is also good news for many of our portfolio companies which are at the forefront of providing many of the new tools and mission critical technology infrastructure.
Since the mandated shutdowns sent what had been a reasonably healthy economy into recession, it’s not surprising to see the economy staging a recovery as the shutdowns recede.
Yes, the recovery will be uneven over the next several months as re-openings trace a step-forward, step-back path in response to rising virus case counts.
But adaption has occurred here, too, and the country is likely much better prepared to those needing treatment and protecting those most COVID-19 vulnerable. Even as case counts rise, related incidence of deaths appears to be ebbing. (see Chart 5).
As a result, another full-scale sheltering lockdown is not likely.
Chart 5: While COVID-19 case counts are rising, the trend in associated death rates is slowing
After a near straight line advance upwards, we expect stock prices to become more volatile as setbacks on the road to recovery are encountered. However, we believe progress towards economic recovery and renewal is underway and “real”.
Was the economy in a “is it real or Memorex?” situation even before COVID?
In the past several years there have been two emerging fields of inquiry that we have been exploring.
One we’ll call human economic progress, and the other, the studies of fear, uncertainty and doubt (FUD). We believe the intersection of these two fields offers important insights and context for investment decision making.
If some of the material that follows sounds familiar, it’s because our thinking has been influenced by these areas of inquiry over the past few years.
Here are the most relevant insights.
The history of human economic progress
As Chart 6 suggests, widespread economic progress has been a relatively recent phenomenon.
Chart 6: The Great Escape and Einstein’s 8th wonder of the world in action
For most of the time humans have walked the earth, life was marked by mass poverty, famine, pestilence, and short life spans. Economic life was mostly a “zero-sum” affair. The main way someone accumulated wealth was through conquest—taking wealth away from someone else.
Parts of the world (U.S., UK, much of Europe) staged the “great escape”1 from this state of being roughly 250 years ago.
The causes of this great escape are a complex cocktail of developments and events. But the most important appears to be cultural evolution that fostered (or at least, tolerated) individual freedoms, innovation and mutually beneficial trade as the basis for commerce.
The interaction between freedom, innovation and mutually beneficial trade was, and is, a powerful dynamic that pushes human economic progress ahead.
Freedom allows someone to come up with an innovation that solves some problem for others in a manner that’s deemed superior to the then-available alternatives. The innovative new product or service is shared with others on terms that makes both parties to each exchange better off.
The farmer grows our food so that we don’t have to. Freed from this task one can apply their skills in other ways that others find of value. Almost always, trade exchanges are “win-win” propositions that break the zero-sum stranglehold we mentioned earlier.
The process repeats over and over in daily life and “works” from a progress perspective much like compound interest—which Albert Einstein called the eighth great wonder of the world. (In Einstein’s words; “He who understands compound interest earns it, he who doesn’t pays it.”)
In the short run, the compounding impact is typically so modest it’s nearly imperceptible. Yet, over time, it’s a very big deal in terms of economic progress and the mass flourishing it triggers.
It’s both interesting and frustrating that progress is apparently easy to take for granted and may be overlooked even as it’s compounded over time.
In recent decades for example, the “great escape” went global. Yet many either don’t realize or appreciate the extent of what’s transpired.
In his book, Factfulness: Ten Reason We’re Wrong About the World,2 the late Swedish scientist Hans Rosling noted:
“Over the past decades I have posed hundreds of fact questions about poverty and wealth, population growth, births, deaths, education, health, gender, violence, energy, and the environment—basic global patterns and trends—to thousands of people across the world. The tests are not complicated and there are no trick questions. I am careful only to use facts that are well documented and not disputed. Yet most people do extremely badly (on the tests).
I have tested audiences from all around the world and from all walks of life: medical students, teachers, university lecturers, eminent scientists, investment bankers, executives in multinational companies, journalists, activists, and even senior political decision makers.
These are highly educated people who take an interest in the world. But most of them—a stunning majority of them—get most of the answers wrong. Some of these groups even score worse than the general public; some of the most appalling results came from a group of Nobel laureates and medical researchers. It is not a question of intelligence. Everyone just seems to get the world devastatingly wrong.
…it is a story of massive ignorance (by which I do not mean stupidity, or anything intentional, but simply the lack of correct knowledge).
It turns out that the world, for all its imperfections, is in a much better state than we might think.”(Bolding added for emphasis).
For those interested, the topics covered by Rosling’s tests are captured within the Chart presented in Appendix 1. The chart also reflects world progress—across multiple dimensions over time.
Studies of FUD (fear, uncertainty and doubt)3
How do so many people, to paraphrase Rosling, get the world and its progress so wrong?
Financial writer Morgan Housel likely provides a key part of the answer with his observation that “progress generally happens too gradually for people to notice. Setbacks happen too quickly to ignore”.
As noted earlier, for the vast majority of human existence life was characterized by famine, pestilence, short lives and grinding poverty. With such a thin margin for error in life back then, hyper-focus on potential setbacks was likely a necessary survival skill.
Progress has (thankfully!) delivered a world for many people very different from that which most of our ancestors had to endure. The studies of fear, however, suggest that our brains remain hotwired for life under those earlier conditions.
Take eating for example. Fortunately, (in the U.S. at least) famines are not a regular occurrence. For most people, calories are generally abundant and affordable. Yet the brain still seems programmed to drive us to consume excess calories as if another famine is just ahead.4
Researchers in this field elaborate5:
(There is a) universal tendency for negative events and emotions to affect us more strongly than positive ones. We’re devastated by a word of criticism but unmoved by a shower of praise. We see the hostile face in the crowd and miss all the friendly smiles. (The result is) the existence of a negativity effect. It sounds depressing—and it often is—but it doesn’t have to be the end of the story. Bad is stronger, but good can prevail if we know what we’re up against.
Another researcher, Harvard University psychologist Steven Pinker6, comes to very similar conclusions. Pinker states that human “cognition” and the nature of the news media interact in ways that often make us think that the world is much worse than it really is.
From our perspective, other key “nuggets” from the studies of fear include:
Velcro brain—our brains are like Teflon when it comes to favorable things (economic progress for example). But bad things (setbacks along the way) stick like Velcro in our thoughts.
Various studies estimate that bad news in our Velcro brains outweighs good news by a margin of something on the order of three-to-one. For investors, this translates into a loss being perceived as three times more painful than a gain of the same magnitude is deemed rewarding.
We would add that it’s also important to note that emotionally charged decisions are typically the investor’s archenemy.
Media provides lots of fuel for the Velcro brain and negative emotions—most media is competing for viewers. Bad news and setbacks, especially shocking news, attract viewers’ attention.
The “if it bleeds it leads” characterization of media remains true. 24/7 “news” and social media only seem to make the media impact even more pronounced.
Personal optimism/social pessimism—most people are generally sanguine about their own situation, but they are typically negative about life prospects for “other” people—particularly for folks they don’t personally know.
“Turning point-itis”—as generations age, they’re prone to believe the best days for mankind are in the past.
What can investors learn from the intersection of human progress and the studies of FUD?
Let’s first clarify a few things. We are not implying that the world is under some spell of mass hypnosis resembling Orson Welles’ War of the Worlds broadcast or the David Koresh tragedy several years back. We’re also not saying all is right with the world. Lots of troubles exist, always have, always will.
What we are saying is that we (humans) seem to have a proclivity to adopt an excessively gloomy view of things and often seriously misjudge progress even as it unfolds before our eyes.
As investors we have to evaluate a world full of “is it live (as in real) or Memorex”? situations. Awareness of the implications of studies of fear and recognition of opportunities created by underappreciated progress are important tools in the investment decision making process.
The room where it happens
Our most powerful tool though is having an ear to the ground near “the room where it happens”—to borrow a lyric from the Hamilton musical.
Where is this proverbial room? It’s at the company level where economic progress typically gets its mojo.
The best business minds in the world are at work trying to figure out how to prosper in the evolving world. For investors it’s a matter of evaluating lots of “is it real or Memorex?” situations. Some companies will be the “real” deal and carve out a path that will enable them to prosper. Some will go the way of the Memorex company and leave the scene. Many others will flounder.
To increase the probability of investment success, we constantly have “our ear to the ground” assessing company management plans and strategies. Companies that are intensely focused on solving customer problems via innovative products and services are, in our estimation, where the future rewarding investments will emerge.
What are we currently hearing from our ear-to-ground analysis? Lots of innovation remains in the pipeline. COVID-19 or not, whoever occupies the White House, the best and most rewarding investments will be those that figure out a way to grow.
Appendix 1: Progress—over time!
The World as 100 People over the last two centuries
Source: Our World in Data
1 Angus Deaton, The Great Escape: Health, Wealth, and the Origins of Inequality, Princeton University Press, 2013
2 Hans Rosling, Factfulness: Ten Reasons We’re Wrong About the World—and Why Things Are Better Than You Think, Flatiron Books, copywrite 2018
3 See Daniel Gardner, The Science of Fear, Dutton, 2008
4 Robb Wolf, Wired to Eat, Harmony Books, 2017
5 John Tierney and Roy Baumeister, The Power of Bad, Penguin Press, 2019
6 Steven Pinker, Enlightenment Now: The Case for Reason, Science, Humanism, and Progress, Penguin Random House, 2018