Yesterday, Ensemble Capital’s CIO Sean Stannard-Stockton was interviewed by MOI Global, a global network of professional investors. This live event was part of  MOI Global’s Investing in Crisis Mode interview series that has featured leading investment managers such as Guy Spier, Howard Marks and Tom Russo. While MOI Global events are typically exclusively available to members, they’ve generously allowed Sean’s interview to be accessible to the general public.

In the interview, Sean discusses:

  • Why “this time really is different,” but why this doesn’t mean investors should abandon the first principals of their investment process.
  • How Ensemble has evaluated whether we are willing to hold a given company through this crisis and why those that make it through will benefit so much on the other side.
  • How we’re thinking about new long term trends investors should consider when thinking about business conditions after Coronavirus.

Click on the image below to visit the open access MOI Global page hosting the interview.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Earlier this afternoon, Ensemble Capital hosted a conference call during which our chief investment officer Sean Stannard-Stockton explained how we are thinking about this crisis, the multiple economic scenarios that may unfold, and why we believe that exceptional companies will emerge from this crisis uniquely well positioned in their industry. The call included commentary about many of our holdings including, Mastercard, Broadridge, Alphabet, Landstar Systems, Paychex, and Masimo.

You can find a transcript and replay of the call here.

Transcript:

We are living through an unprecedented event. While there have been many past viral outbreaks and other worldwide pandemics over the course of history, today the human species lives as part of a highly interconnected global community. Pandemics have never respected national boarders, but only in our era have the people of earth circled the globe, engaging in business, visiting family, meeting people from different cultures, and in the process knitting all of us together into a tightly woven global economy, at the rate of 4.5 billion airline passengers per year, of which 2 billion represent international travelers.

These people have carried with them knowledge, ideas, business plans, and works of art such that today the people of London, and Shanghai, Dubai, and San Francisco share many of the same interests, wear clothes made by the same companies, watch the same shows on TV, and share so many of the same hopes and dreams. It is this tying together of our global shared interests that has driven the global economy to grow by 15-fold since the end of World War II, bringing a level of abundance to much of the developed world that is simply beyond the imagination of the people who fought to save the world from tyranny. And while our society now wrestles with complex and necessary questions about equality, during that same time period the share of humans living in extreme poverty has fallen from over 70% at the end of the war to less than 15% today. But with all of the good this interconnectedness has brought us; it has also provided the Coronavirus with the means to circle the globe at a speed that has no precedent.

We live in exceptional times.

During our call today, I’m going to be discussing how we at Ensemble Capital are doing our best to process the events that are unfolding, the impact this crisis may have on the economy, and why we believe that despite our expectations that a cataclysmic economic event is unfolding, investors in exceptional businesses, but not all businesses, are likely to be well rewarded for making a thoughtful, rational decision to continue to hold or even buy stocks during this time of panic…

Read more here.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Today at 1:30 Pacific (4:30 Eastern), we’re holding a conference call to share our thoughts on how we’re valuing stocks under unprecedented conditions, the impact the crisis is having on many of our holdings, and why past recessions are not helpful guides.

You can register for the call by clicking here.

In the meantime, we invite you to read four of our recent posts on the subject.

We look forward to seeing you on the call this afternoon.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

If you look back over the last century, you’ll find three types of events that have greatly disrupted stock markets leading to market declines and levels of volatility that are reminiscent of the market reaction being triggered by the Coronavirus outbreak. Each of the events mentioned below triggered single day market declines and rallies on the order of the huge swings we’ve seen over the last week.

  • Economic Catastrophes: The Depression in the 1930s, the stagflation of the 1970s, and the Financial Crisis of the late 2000s, were all catastrophes rooted in destabilized economic systems.
  • Social Catastrophes: World War II and the start of the Arab-Israeli War in 1948, were catastrophes rooted in destabilized social systems.
  • Financial Market Catastrophes: The crash of 1987, which saw the US stock market fall 20% in one day, was a stock market disruption that was rooted not in external economic or social factors but was a function of the financial market system itself becoming destabilized.

With Coronavirus we now have a fourth type of catastrophe triggering a market decline and volatility on par with the previously known types of events listed above. While readers with a good sense of history might point to the Spanish Flu pandemic of 1918-1919 as being potentially similar to Coronavirus, the US stock market actually rallied 10% in 1918 and 30% in 1919.

In the case of economic and social catastrophes, the large scale and persistent disruption of underlying economic and social order has generally led to impairment in the intrinsic value of public companies, which is why the resulting stock market declines continued for some time. But in the case of the financial market catastrophe of 1987, the underlying economic and social order was not disturbed and so the stock market was relatively quick to recover. In fact, the two years after the crash of 1987 saw a relentless 60% rally.

While the decline in the US stock market over the last month was not triggered by a financial market catastrophe as the 1987 crash was, the global natural catastrophe of the Coronavirus has, over the last week, triggered a destabilization of financial markets. That has been most clearly evident over the last couple of days with certain segments of stocks falling 20%-30%, while previously even the big down days mostly saw individual stocks trading down along with the market, not going down dramatically more. It is also evident in the stresses that have appeared in fixed income markets, which former Federal Reserve chairs Ben Bernanke and Janet Yellen discussed in a Financial Times op-ed today.

So there is a portion of the decline seen over the last month that is attributable to destabilized financial markets. Even if the global economy rolls over into a severe recession, the financial markets will re-stabilize as they did during the Depression and the Financial Crisis and thus pressure being put on stock prices from a destabilized financial system will abate. But that will still leave behind the very serious concern that Coronavirus will cause such a prolonged shut down of the global economy that we will roll over into a prolonged recession.

It is important for investors to recognize that Coronavirus is a unique and novel event in stock market history. We have never before seen a global natural disaster have the scale and scope of impact that we are seeing on stock markets around the world nor one that has led to global economies literally shutting down in near unison.

When you face a novel situation, it can be very, very difficult to know what to do. The first step is to recognize that the situation is without precedent. The second step is to go back to first principals and assess how the novel situation may impact what you are trying to achieve. The third step is to review the strategies you were previously deploying and make any needed adjustments based on the new level of uncertainty and your best forecasts of the impact of the novel event.

This is the series of steps we’ve been going through at Ensemble over the last month. Our first post on Coronavirus discussed the extremely high level of uncertainty that accompanies the forecasting of pandemics. Our second post on Coronavirus attempted to frame the economic impact of this novel event. Our post earlier this week reviewed our core investment philosophy and confirmed that while we believe Coronavirus will have a very large, meaningful impact on the economic and social environment in which companies operate, it does not invalidate our core investment philosophy of investing in dominant companies, with large competitive advantages, excellent management teams, and business models that we understand deeply.

The question on everyone’s mind now is what is going to happen next. Will the stock market make a relatively quick recovery once Coronavirus cases stop rising and the extent of the outbreak becomes clearer? It is hard to believe that could happen right now, but it is notable that this is exactly what happened in China once new cases stopped increasing and before investors understood that the viral outbreak would impact global economies.

Here’s a chart of the Shanghai stock exchange, which after falling sharply in January and February as the Coronavirus spread, quickly erased all of the Coronavirus related decline by early March.

Now to be clear, we are not suggesting we think the decline in the US stock market will reverse over the next month. We are just observing what happened in China, which is the first country to have been hit by Coronavirus. So it is worth exploring why China bounced back when it did. The chart below shows the growth of cumulative confirmed cases in a range of countries, but the start date for each country is the day when the case count in that country exceeded 100. The lines flatten out once the number of new cases each day starts falling.

Notice how the rate of increase was initially exponential in China, but a couple weeks after Wuhan went into lockdown the rate of new cases slowed dramatically. As the exponential growth rate rolled over and slowed dramatically, it became clearer what the eventual scale of the impact would be and so the level of uncertainty that had knocked down the Chinese stock market was sharply reduced, and the market rallied.

Today we know that just three weeks after the lockdown was declared, the Chinese economy started coming back to life. You don’t have to put your trust in Chinese government statistics to see this. You can simply observe that Apple began reopening stores in China in mid-February and that today all of Apple’s stores in China are open.

The fact is that today we do not know when the US and Europe will hit similar inflections with new cases beginning to slow. The good thing is that the dramatic actions taken this week in the US and Europe are the beginning of what is needed to get new cases under control as quickly as possible.

The panic last week in the US market was about investors coming to terms with the scale of the Coronavirus threat. But the panic that all of us as people feel this week is not actually in reaction to new information about the virus, but to the social panic triggered by the shut down orders imposed in some cities and the closing of borders around the world.

Yet these panic inducing actions are what is needed to get us to the point of declining new case counts as fast as possible.

If people didn’t panic, then the Coronavirus would continue to spread unabated throughout the population. But the panic inducing realization of the scale of the threat has triggered a scattering of the population to distance themselves from each other on a scale never before seen in human history.

We don’t know if the actions taken in the US and EU are enough to cause a slowdown in new case counts. If it is, our understanding is that the slowdown should become apparent over the next two to four weeks. But without widespread testing, we may not even be able to observe whether or not the shutdown is actually working.

There is no doubt that there will be great economic harm as a result of the shutdown. However, there would be even more if the virus was allowed to run rampant instead. The key for investors will be trying to come to understand if the rate of new cases can be slowed quickly enough that shutdowns and other social distancing mandates can be lifted in time for the economic damage to be dramatic, but short lived.

With both monetary and fiscal authorities now taking unprecedented action, there will be a strong boost to the economy that hopefully can jump start it back to growth. To give you a sense of how large this stimulus is and how quickly the political winds have changed, on Friday Congress only barely was able to agree on a $50 billion stimulus package while yesterday the president proposed a $1.2 trillion package or 24 times larger than the package on Friday.

The US stock market has already experienced a 30% decline from the high in mid-February. In a typical recession the market tends to decline about 20% to 30%, or in severe recessions more like 30% to 50%. Investors should recognize that if we “only” get a harsh economic shock that impacts the next six months or so of 2020, followed by a stimulus fueled rebound that begins near the end of the year and carries into 2021, the market may well have already priced that in and a strong rally may begin as this outcomes becomes more clear in the coming weeks or months.

The size of the impact over the next six months is almost certainly going to be large enough to be defined as a recession. We’re not talking about avoiding a recession, only about the potential for the recession to be very, very sharp, but short lived, and followed by a very rapid rebound.

But of course, investors must also always accept that worst case outcomes do occur from time to time. It could be that the US and Europe are unable to get Coronavirus under control soon enough to avoid the economy rolling into a larger more prolonged recession. This isn’t just a risk related to Coronavirus, severe and prolonged recessions are something that have happened multiple times over the last century. They are brutal experiences, but when you think about the long-term rate of return to equites of about 9%, this is inclusive of the severe recessions that have occurred during that time.

If the Coronavirus is going to trigger a global severe recession that persists, we can look back to how the stock market behaved during the financial crisis to see what sort of expectations we should have. Even after the US stock market had declined by 30% in early October 2008, we know in retrospect that there was still much more downside still to come. However, the market hit its bottom in March of 2009, just five months later and from early October 2008 to early October 2009, the stock market generated a small gain. The two-year cumulative return starting from October 2008 was 15% and the five year cumulative return was 79% or over 12% per year.

In the words of Mark Twain, “history does not repeat itself, but it often rhymes.” We do not have a corollary for the global natural disaster of the Coronavirus. We cannot know if the shutdowns sweeping the globe will cause a painful but temporary economic contraction or a prolonged, severe recession similar to the financial crisis. But we do know that at this point in the decline during the last prolonged recession, equity investors who could hold stocks for one, two, five or more years were handsomely rewarded with solid positive returns. Doing so required investors to endure more downside pain from the point we are today, but the risk of a sudden decline in the stock market is an ever-present risk, not one that is unique to today.

Should the economy not rollover into a prolonged and severe recession it only makes sense that returns to equity investors will be dramatically stronger.

We know that we can’t predict what is going to happen with the economy. Medical experts can’t predict what is going to happen with Coronavirus. But we do know that the companies we hold in our portfolio are led by outstanding management teams, protected by significant competitive advantages and will steward our clients’ capital as well as possible through this crisis as well as the future crises that occur in the decades ahead.

Importantly, from a business perspective, weak companies may not make it through the unprecedented halt to economic activity that is hitting the US and Europe right now. On the other side of this crisis, the competitive playing field in which our companies operate will be in disarray with many competitors sidelined or even out of business. It is in this period of economic disarray that the very best companies move to the forefront. Their outstanding management teams take the opportunity to spring back into action, serving their customers needs and desires while other competitors are simply unable to do so.

This is when the best companies shine.

We are safe and well here at Ensemble Capital. We hope you are the same.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.

Game’s the same, just got more fierce. – Slim Charles, The Wire

In Sean’s recent posts, he discussed how we’re thinking about the financial impacts of COVID-19 and what we’re doing about it in our portfolio.

This week we received an email asking if the “game had changed” in terms of looking for companies with economic moats, strong management, and long growth runways, so we wanted to briefly address that topic.

There’s a lot of uncertainty right now and asking if we’re changing our process is a reasonable thing to do.

The short answer is “no.” If anything, this is exactly when great companies can shine, communicate value to customers, win market share, and come out stronger on the other end of the downturn.

That said, a few points of our process have stood out more than others during our most recent company-by-company reviews.

First and foremost, we want to make sure our companies can financially get through this challenge. In order to thrive, a great company must first survive. We wouldn’t own a company we didn’t think would do well during a “normal” recession, but this shock required a fresh evaluation. What happens at a retailer, for example, if same-store sales fall 30% this year because people aren’t going out – at all? There’s no precedent for it, but it could happen. Fortunately, we’ve found none of our current holdings are a major cause for concern on this front.

Second, beyond the near-term coronavirus impact, we’ve been asking how the relevance of our companies’ products and services might be impacted by any permanent changes in customer behavior. Because our fair value estimates are primarily driven by the cash flow a company will generate over the very long term, it’s critical that we determine if our opinions about a company’s moat and product relevance have been impaired. For instance, Sean recently highlighted a number of business service companies that we own which are mission-critical to their customers’ operations. We think it’s unlikely those relationships will change because of COVID-19.

Finally, moments like these serve to reemphasize the importance of outstanding cultures. Specifically, companies with virtuous corporate cultures in industries full of dull or destructive corporate cultures should do exceedingly well in the face of unprecedented challenges. Employees at such businesses are better aligned with the corporate strategy and mission. They are intrinsically motivated to create solutions and adapt to new environments.

Bottom line, this is an exceptional period to be an investor in outstanding, competitively advantaged businesses. As Slim Charles’s opening quote implies, investing is the same it’s ever been – it’s just been “more fierce” lately. And that too, shall pass.

Events like we’ve experienced in recent weeks will test anyone’s process. Or, at least they should. It’s in times like this that having a foundational investment philosophy – which for us is moat, management, and forecastability – is the most valuable.

When times become uncertain, you go back to basics. Through this lens, we’ve confirmed our confidence in our businesses’ ability to navigate some tricky waters in 2020.

For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

While we do not accept public comments on this blog for compliance reasons, we encourage readers to contact us with their thoughts.

Past performance is no guarantee of future results. All investments in securities carry risks, including the risk of losing one’s entire investment. The opinions expressed within this blog post are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Nothing contained herein should be construed as a comprehensive statement of the matters discussed, considered investment, financial, legal, or tax advice, or a recommendation to buy or sell any securities, and no investment decision should be made based solely on any information provided herein. Links to third party content are included for convenience only, we do not endorse, sponsor, or recommend any of the third parties or their websites and do not guarantee the adequacy of information contained within their websites. Please follow the link above for additional disclosure information.