Chat with the CIO: In Search of Perspective

In this quarter’s Chat with the CIO, Eric P. Leve, CFA reflects on the tumultuous past few months with Thomas J. Mudge III, CFA (Director of Domestic Equity Research) and they both share thoughts on the outlook ahead.

June 30, 2020



Eric P. Leve, CFA: There is no doubt that these are unusual days. And it’s not just the perplexing juxtaposition of a declining economy with rallying markets or the pervasive uncertainty, but the impacts on our lives, families, and communities. Within that context, we as portfolio managers can pause to evaluate the current conditions in search of opportunities that align with the values-driven approach that Bailard and our clients hold dear.

So, Tom, the U.S. stock market’s rise since late March has been described as the “most hated bull market in history.” What explanation do you have for how the market could rally in the face of an overabundance of bad news?

Thomas J. Mudge III, CFA: Studying human behavior reveals numerous instances where sentiment reaches extreme levels. Historically, investors have tended to overreact to bad news and they perpetually hate uncertainty. We have been awash in both bad news and uncertainty. Yet, this created potential opportunities for the disciplined investor, particularly once valuations dropped to exceptionally-low levels in the spring.

Eric: Do tell!

Tom: As an example, when the panic-selling increased in the second half of March, stock prices were driven down, in some instances as much as 90% off their pre-COVID-19 levels. A number of companies in impacted industries like hotels and restaurant suppliers were trading as though they were on the verge of bankruptcy even when they had cash reserves sufficient to keep them solvent for a year or more. With this kind of behavior from the market, we felt that much of the bad news was already priced in, potentially creating buying opportunities.

Eric: But, how do investors operate with that kind of uncertainty? Were there concerns at that time about the possibility of the stock market dropping further, and the danger of buying prematurely?

Tom: That possibility always exists. In the stock market, there is a spectrum that runs between opportunity and certainty. In general, the more certain the outcome, the smaller the opportunity and vice versa. One of my favorite quotes is, “There is simply no room for certainty in investing.” This is because once an outcome is known, any advantage to be had by investing based upon it is diluted.

Eric: Agreed. While the future is uncertain and any situation could always get worse, examining the historical odds and past outcomes of similar events helps investors put the risk in context.

Tom: You got it. For example, the same Florida city could be hit by two hurricanes in a single season but, based upon a long history of observations and improved weather monitoring and forecasting, we know the odds of that happening are very low. Similarly, COVID-19 could have proved (and could still prove) to be the worst pandemic in recent history. But, should that come to pass, what are the potential implications?

Eric: Comparing the economic and stock index performance during past viral outbreaks can help shed light on possible market outcomes stemming from COVID-19. The economic impact of recent flu and other viral epidemics proved in each case to be minor; there was little flu-specific market reaction to either the Asian Flu pandemic of 1957 that killed 1 to 2 million people, or even the Hong Kong Flu pandemic of 1968, which killed an estimated 1 to 4 million people worldwide. While the current crisis has not reached that scale, we readily acknowledge that we are nowhere near knowing the outcome of this pandemic and it is not the same as those above.

Once an outcome is known, any advantage to be had by investing based upon it is diluted.

Tom: Make no mistake, it is impossible to reconcile the effect on lives and families and communities with the economy and the markets. Yet, in search of silver linings, we can look for opportunities for the long-term.

When in late March the S&P 500 had fallen almost 34% in just over a month, all due to COVID-19 fears, it was clear that investors were discounting a very bad outcome. However, the resulting attractive relative valuations alone could not manufacture a stock market bottom. For a market to reverse course and head higher, a shift in investor sentiment is also required. While far from certain at the time, there were some early indications that the odds for a positive sentiment swing were improving. And, Eric, those green shoots first sprouted outside of the U.S.

Eric: They certainly did. Investors in the United States had a small but significant informational advantage due to the virus spreading through parts of Asia and Europe first. Additionally, the U.S. entered the pandemic with a robust economy, record low unemployment, and a generally bullish business climate and investor outlook. Just as a healthy person is typically more resilient to disease, in our view, a healthy economy pre-COVID-19 boded well for a more rapid recovery.

Tom: And, it’s important to note that Congress and the Federal Reserve took reasonably swift and decisive actions to provide both fiscal stimulus and monetary liquidity to cushion the economy and calm the financial markets.

Stock prices are primarily driven by investors’ expectations about the future and not by the current reality. This is why the stock market has historically always begun rising long before the economy shows signs of recovery. With investor expectations very low in late March regarding COVID-19 and the economy, it did not take much good news to begin driving stocks higher.

Eric: So, Tom, what’s your perspective on the U.S. stock market for the remainder of the year?


Tom: There are always too many unknowns to forecast the stock market with any accuracy, but we can lean on current valuations and earnings estimate revisions to get a sense of a possible range of outcomes, if there are no significant unforeseen developments between now and year end (an admittedly very large “if ”).


Looking at valuations, large cap growth stocks (as represented by the S&P 500 Index) appear close to fairly valued at this point, given the prevailing outlook for interest rates and inflation. Wall Street analyst earnings expectations have been rising steadily in recent weeks for stocks both large and small; as long as that outlook prevails, it may act as a tailwind driving the market higher.


Finally, the U.S. consumer has bounced back toward normal much more quickly than was expected earlier in the year, with measures of mall traffic, airport security checkpoint pass-throughs, and hotel stays all surprising to the upside. At the same time, much COVID-19 fear and economic recovery skepticism remains, hence your “most hated bull market in history” designation.

Wall Street analyst earnings expectations have been rising steadily in recent weeks for stocks both large and small.

Eric: At risk of over-using quotations, another investment adage is that “markets climb walls of worry.” This gem suggests that, as long as doubters remain on the sidelines, there are potential investors that may finally be convinced to join in and drive stock prices higher. Although the economic news is generally trending better and there are glimmers of hope for an end to the pandemic, we still see lots of people worrying, and the market continuing to climb that wall.

While this has been a time like none other in our investment careers, I am proud to see Bailard’s portfolio managers, across all asset areas, looking to one another for guidance, pursuing investment results with the discipline that has been our hallmark, and doing so in a manner consistent with the values we hold to as a firm. Thanks Tom for a lively conversation!