Former Vice President Joe Biden speaking in Lancaster, Penn.
Joshua Roberts/Getty ImagesInvestors tuned out a surge in daily U.S. Covid-19 cases this past week and instead took heart from favorable economic data and encouraging news on vaccine development.
The June employment report on Thursday showed that the jobless rate fell to 11.1%, from 13.3% in May, while nonfarm payrolls gained 4.8 million, substantially more than the three million that had been projected. It was the second straight month of better-than-expected jobs results.
Many fear that the economy’s momentum will stall as a number of large states reverse some reopening moves. But Wall Street views the Covid-19 crisis as manageable. My colleagues Lisa Beilfuss and Josh Nathan-Kazis have more to say about the outlooks for the economy and for the pandemic here and here.
Fundstrat’s head of research, Thomas Lee, sees the world as “half-full.” In a note, he writes that the new Covid epicenter states—Texas, California, Florida, and Arizona—are “course correcting” and could be within two weeks of a peak in new cases.
Covid-19 vaccine development, meanwhile, is speeding along, as Pfizer (ticker: PFE) and its German biotech partner reported that all 24 patients in an early-stage trial who got two doses showed neutralizing antibodies that were roughly two times the level present in recovered Covid-19 patients. The Pfizer results raise the chances that a vaccine will be widely available in 2021.
The Dow Jones Industrial Average rose 3.2%, to 25,827, in the holiday-shortened week. The S&P 500 index was up 4%, to 3130, and is down just 3% in 2020. And the Nasdaq Composite advanced 4.6%, to a record 10,207; the tech-heavy index is up 14% on the year.
“People buying stocks are not worried about earnings in 2020 or even 2021,” says Byron Wien, senior investment strategist at the Blackstone Group. “They’re thinking, ‘Am I paying the right price for 2022?’ ”
By 2022, he says, profits might normalize, a Covid-19 vaccine should have arrived, and the economy will have substantially recovered. The S&P 500 now trades for 19 and almost 17 times projected profits of $162 in 2021 and $186 in 2022, respectively. These valuations aren’t cheap historically, but interest rates are very low, enhancing the appeal of stocks.
Investors may soon turn their attention to the 2020 elections and the increasing likelihood of a “blue wave” that would give the presidency to Joe Biden and both houses of Congress to the Democrats.
President Donald Trump has slipped badly in the polls—and the betting sites. He’s now down by eight to nine percentage points in national polls and is given less than a 40% chance of winning the White House, compared with about 50% in May.
A critical development will be the outcome in the Senate, where the Republicans now have a 53-47 majority. Continued GOP control could stymie Democratic moves to raise individual and corporate taxes and adopt proposals such as a Green New Deal.
“If it’s a relatively close election and Biden wins, I would expect the Senate to remain Republican, but if it’s a blowout, then the Senate falls to the Democrats,” says Greg Valliere, chief U.S. political strategist at AGF Investments. He says the odds of a Democratic “trifecta” are rising as Biden’s lead in the polls widens.
Biden wants to increase the corporate tax rate to 28% from 21% and roll back the Trump income-tax cuts for high earners. Valliere thinks there is a reasonable shot that Sen. Elizabeth Warren would be Treasury secretary under Biden. That would mean tougher regulation of banks, regardless of which party wins the Senate.
Wien differs from those who say a Democratic sweep would be a disaster for the stock market. “If Biden is elected, his first priority will be to get the economy recovering to where it was in 2019, and a severe increase in taxes and regulation would work against that,” he observes.
And the veteran strategist adds, “If the markets thought he would shift to the extreme left, they would be reacting more negatively. The markets seem to have accepted the fact that he could be the winner, but adopted my view that he will move gradually on taxes and regulation.”
When Amazon.com went public in 1997, J.C. Penney was considered one of the stronger retailers in the country. Investors were so comfortable with Penney’s prospects that they eagerly bought its new issue of 100-year bonds.
The 7.625% bonds, due in 2097, yielded just a percentage point more than U.S. Treasuries and carried lofty single-A credit ratings. Now, after J.C. Penney’s bankruptcy filing in May, those bonds trade at just one cent on the dollar, as Wall Street anticipates virtually no recovery value for them in a restructuring plan.
Many investors have taken a beating in these century bonds. More than half of the $500 million issue was repackaged into five offerings of “baby bonds” known as Saturns, Cabcos, and Corts and sold to retail buyers by Morgan Stanley, PaineWebber, Lehman Brothers, and Citigroup.
The brokers made money repackaging the bonds, which have a face value of $25. They traded on the New York Stock Exchange, making them easier to buy and sell than the underlying debt.
With the Penney bankruptcy, the five issues have been delisted from the NYSE. The largest, the $100 million Corts (COTRP) deal from Citi, traded this past week on the “pink sheets” at about 50 cents, around two cents on the dollar.
Holders of the Morgan Stanley Saturns have fared even worse. The bond trustee sold the roughly $54 million (face value) of underlying J.C. Penney bonds in May and received just $147,000, or about 0.25 cents on the dollar. The payout on each $25 face-value baby bond was only six cents, a pitiful recovery, even given the bankruptcy.
J.C. Penney’s common stock (JCPNQ), meanwhile, looks as if it will be wiped out in the proposed reorganization plan. It continues to trade actively on the pink sheets, however, with the shares at about 30 cents on Thursday.
Warren Buffett turns 90 in August, but investors aren’t in a celebratory mood. Berkshire Hathaway’s Class A stock (BRK.A), at about $267,000, is badly trailing the S&P 500 for the second straight year and is near a 30-year low, based on its ratio of price to book value.
The Class A shares are down 21% in 2020, against a negative total return of 2% for the S&P, and trail the index over five, 10, and 15 years. The Class B shares (BRK.B) fetch about $178.
Buffett’s performance at Berkshire’s virtual annual meeting in May didn’t help. Appearing cautious, Berkshire’s longtime CEO didn’t show much interest in buying back a lot of stock or much confidence in beating the S&P 500.
His investment record hasn’t been stellar in the past decade— Apple (AAPL) is the exception—and that’s not escaping attention. “I’m sure Warren Buffett is a great guy, but when it comes to stocks, he’s washed up,” David Portnoy said last month. Portnoy, a day trader, heads Barstool Sports. Barron’s sent a request to Buffett’s office for a comment but got no response.
Buffett’s miscues include investing in airline stocks (sold near the bottom in April), Wells Fargo (WFC), and Kraft Heinz (KHC).
Barron’s has written favorably on Berkshire, and the stock looks inexpensive, trading for 1.1 times our estimate of its June 30 book value of about $248,000 a share. The shares have rarely traded close to book value in recent decades. One reason is that Buffett has said Berkshire’s intrinsic value “far exceeds” book value. The stock changed hands last year at about 1.4 times book.
Book value probably rose nicely in the second quarter, from about $229,000 a share on March 31, thanks largely to a 43% gain in Apple stock, Berkshire’s largest equity investment, at about $90 billion (assuming no change in the holding in the quarter).
One encouraging sign: Berkshire director Meryl Witmer, a value investor and member of Barron’s Roundtable, bought $2 million of the stock on the open market in May.
“Buffett may be sitting on $150 billion in cash now,” says David Rolfe, chief investment officer at Wedgewood Partners in St. Louis. Rolfe made a well-timed sale of his firm’s Berkshire holding last year. “He’s one of the great investors of all time, but it’s going to be very difficult for him to invest all that money successfully in this environment,” Rolfe adds.
He thinks Berkshire should be buying back 3% to 4% of its stock annually, compared with less than 2% today, and paying a dividend—2% would be a good start.
Berkshire has a good story to tell. It’s a cash- and earnings-rich conglomerate with top-shelf businesses like Geico and the Burlington Northern Santa Fe railroad. Our suggestion: The company should hold its first investor day and introduce itself and the post-Buffett management team to a new generation of investors.
Convertible securities shined in the first half, returning 7.25%, as measured by the ICE BofA All U.S. Convertibles Index, against negative 3% for the S&P 500.
U.S. issuance of the hybrids totaled $67 billion, more than the $53 billion in all of 2019, driven by a mix of rescue deals from hard-hit companies like Carnival (CCL) and American Airlines Group (AAL), as well as tech highfliers like Okta (OKTA). A contributor to the market strength this year has been a surging Tesla (TSLA), the largest convertible issuer.
The outlook looks good. “Convertible bonds offer great downside protection, and, if the stock goes up, you get a majority of the upside,” says Tracy Maitland, chief investment officer of Advent Capital Management, which runs Advent Convertible & Income (AVK), a closed-end fund that trades around $13, a 12% discount to its net asset value.
Maitland is partial to Southwest Airlines ’ (LUV) new $2 billion 1.25% convertible bond due in 2025. Southwest is the strongest of the major U.S. carriers, with an investment-grade debt rating, ample cash, and a greater leisure focus than its peers.
“The pandemic, the election, and the geopolitical situation can create volatility,” Maitland says. “You can sleep better at night with convertibles.”
Write to Andrew Bary at andrew.bary@barrons.com
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