Weekly Investment Update (02/05/2021)
Volatility Declines as Margin Requirements Raised and Earnings Remain Robust
As discussed in last week’s Weekly Investment Update, we viewed much of the volatile price action in heavily shorted companies as noise, not signal. Price squeezes across single-name equities are quite common throughout history, regardless of retail involvement, as unexpected buyouts are announced, capital infusions are enacted, and new government policies hit the headlines. Bessemer portfolio managers continue to find our best long-term investments in businesses with strong management teams, pristine balance sheets, robust competitive advantages, and the ability to scale.
Volatility, as proxied by the VIX, traded up to 37% last week, which would imply a daily move in equity markets of roughly 2.3%. Following increased margin requirements at many trading platforms, markets stabilized and the VIX is now trading around 23%. Many (speculative) margin buyers of these heavily shorted names were forced to liquidate their positions, as is often the case during these episodes. As noted last week, we continue to expect bouts of equity market volatility to ensue given the extremely accommodative stance of monetary and fiscal policy. We will continue to stay the course with our long-term investment philosophy.
Fourth-Quarter Earnings: Mega Cap Growth Stocks Deliver
Alphabet and Amazon continue to show their ability to innovate and grow despite their already massive size. As evident from the earnings report, Amazon’s core retail business continues to benefit from and drive the global e-commerce inflection. The company’s logistics and fulfillment investments continue to position the company to grow its one-day delivery business with more SKUs across more cities, which could be the next driver once e-commerce demand slows as the world reopens.
Alphabet showcased accelerating top-line strength at Search and YouTube in the fourth quarter and heavier than expected investment in Google Cloud. Online ad growth appears to be inflecting as ad dollars follow surging online behavior faster than expected. Additionally, despite travel remaining heavily impaired, search revenue produced better than expected results. Travel represents roughly 10%-15% of Google search revenue and is down 50%+, which suggests that search revenues could outperform expectations as travel recovers over the course of 2021.
Bessemer equity portfolios remain overweight Alphabet and have trimmed holdings in Amazon ahead of what is likely to be a tough quarter of comparable earnings when compared to the COVID-related ramp up in e-commerce demand one year ago.
Manufacturing Sector Continues to Grow at a Rapid Pace, While New Challenges Emerge
While the services side of the U.S. economy remains impaired, manufacturing firms cited strength in demand. Meanwhile, some concerns are pronounced, with COVID-related supply chain issues and a shortage of available labor in January’s ISM Manufacturing Survey. Customer inventory levels are at their lowest levels since December 2009, delivery delays are at their highest level since April 2020 (when economic production was largely shut down), and prices paid are rising at their fastest rate since April 2011 (when supply chains were disrupted by the tsunami and associated nuclear accident at Fukushima). All 18 industries surveyed reported paying higher prices for raw materials in January.
Higher manufacturing input prices should be expected given the gains seen across hard and soft commodities over the past year. For instance, copper prices are up 36%, corn prices are up 40%, and iron ore prices are up 60% relative to this time last year. These commodity price increases are typical following a recession and strong policy response, as was seen following the Global Financial Crisis. Copper rallied over 250% from its 2008 low into 2011. Headline CPI breached the 3.0% level in April 2011, two months after copper reached its highest price on record, and then fell gradually over the next four years as the European banking crisis impacted global growth negatively. In contrast, core PCE, the preferred inflation measure of the Fed given its dynamic weighting process, reached a high of 2.1% in January 2012. In our view, we expect core PCE inflation to increase modestly from its current level of 1.5%. Even if inflation should rise above the 2.0% level, we have a Fed that will remain tolerant of higher inflation for longer. Additionally, the labor market remains fragile with total employment lower by 9.9 million since February 2020 and significant bifurcation in the recovery with the leisure and hospitality industry remaining significantly impaired until many more Americans are vaccinated. As such, we remain of the view that this economic cycle has a long runway ahead of it.
Bessemer Reopening Index Also Points to a Resilient Manufacturing Sector; Holiday Boost Seen in Travel and Consumption Data
The Bessemer Reopening Index (BRI), which relies on high-frequency manufacturing, services, and travel-related data, corroborates many of the findings in the ISM Manufacturing Survey. Despite the recent winter COVID-19 wave, the manufacturing components of the BRI index, combined, have continued to average 95% of pre-COVID levels since October 2020. Notably, U.S. freight carloads have remained especially strong with readings since September 2021 surpassing those seen in both January and February 2020.
The overall BRI level for December 2020 came in at 86 relative to our expectation of 83 (BRI is indexed to 100 representing pre-COVID), driven in large part by stronger than expected holiday travel and consumption activity. Despite accelerating COVID-19 cases, TSA passenger throughput reached the highest level since the pandemic began on December 23 and again on December 27. Additionally, credit card spending surprised to the upside; Bank of America’s total card spending increased 2.5% on average in December 2020 relative to December 2019.
When combined with a slowing in COVID-19 case growth, increased vaccination rates, and warmer weather on the way in much of the U.S., we remain of the view that second-quarter GDP growth will be above the consensus forecast of 10.2% year-over-year (4.1% quarter-over-quarter). Recall that the second quarter of 2020 saw -9.0% growth year-over-year (-31.4% quarter-over-quarter), which provides a very low base from which growth can rebound. Notably, consensus growth expectations have begun to rise since we published this view in the Quarterly Investment Perspective.
Israel Is Leading the Vaccine Race and Providing Us With Real World Data
The global race to vaccinate all eligible individuals is well underway. As of this writing, Israel remains well ahead of every other country with 37.0% of the population having received one dose and 21.6% having received two doses using either the Pfizer-BioNTech or Moderna vaccines. In comparison, the U.S. has administered over 36.7 million doses, which translates to 8.7% of the population receiving at least one dose and 2.3% receiving both doses.
Israel’s rapid inoculation progress is driven by several factors, with the main one being its deal with Pfizer. The nation of 9.1 million people agreed to provide real-world vaccine data to Pfizer in exchange for an early and ample supply of the Pfizer-BioNTech vaccine. Thus far, the country has delivered, and the results are very encouraging. The country is reporting a material decline in cases and extremely low rates of hospitalizations and deaths among those who are vaccinated, supporting findings from Pfizer’s Phase 3 clinical trial data. This is of significance given the country began its vaccination campaign by inoculating healthcare workers and people most at risk for severe infections. Israel entered its third national lockdown in December and is set to begin the reopening process in the coming days. This step should provide the world a look into the effect of vaccines on transmission rates, which no clinical trial data has provided us with to date, so we will closely be monitoring Israel COVID-19 data in the coming weeks.
Lastly, Israel has reported that more contagious COVID-19 variants have resulted in an uptick in cases in the country. Israel’s vaccine data should provide us with additional real-world color on Pfizer-BioNTech and Moderna’s vaccine effectiveness on different strains. Based on all available vaccine data, we remain optimistic that the currently available vaccines (Pfizer-BioNTech and Moderna) and Novavax and Johnson & Johnson’s vaccine candidates will provide sufficient protection to materially reduce the number of severe cases for all currently known COVID-19 strains and thereby play vital roles in reducing the number of new deaths and hospitalizations.
— Bessemer Investment Team
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