In mid-August Recreational Equipment Inc (REI), the Seattle-based retailer of outdoor recreation equipment and services, announced that it was abandoning its plan to move into its new headquarters complex in Bellevue. Originally conceived 4 ½ years ago, REI cited the impact of the Coronavirus which caused it to think when and how they work and, no doubt, the impact on its brick-and-mortar business which was closed for over two months earlier this year. Instead the company’s new headquarters will consist of multiple smaller offices which provide increased flexibility for everybody. What is perhaps equally striking to us is that it took only one more month for the announcement that Facebook was acquiring the unoccupied REI complex for $368 million. As we thought about this sequence of events it struck us that we could probably not come up with a better way to illustrate the dichotomy that has existed in both our economy and stock market here in 2020. While REI is not a public company, rather it is a co-op owned by its members, and does not report quarterly results, we believe that its sales have been under pressure due to its stores being closed for part of the past 6 months. In addition, the cash infusion of $368 million is quite meaningful for REI. Facebook, very simply, operates a social networking website and continues to grow very nicely through this challenging year of 2020 with projections of 20%+ annual EPS growth over the next 3-5 years. Sales for the most recent 12-months totaled $75.2 billion. The above-mentioned purchase price represents a mere 0.8% of Facebook’s net cash position of $46 billion. REI is rationalizing its business while for Facebook it is full speed ahead with growth.
Looking beyond sector discrepancies in these challenging times, domestic stock markets built upon their advances of the second quarter. The Standard & Poor’s 500 rose 8.9% in QIII with Growth stocks up 13.2% and Value stocks ahead by 5.6%. The most frequently asked question that we have received over this stock market rally of the past seven months is why have prices moved up during this steep recession (in QII) and subsequent recovery. In fact, the U.S. economy powered along in the third quarter despite the extra unemployment benefit expiring at the end of July and a resurgence of COVID cases in the beltway states during the summer. In July, August, and September, the U.S. gained 1.8 million, 1.4 million, and 661,000 jobs, respectively, pushing the unemployment rate down to 7.9%. July’s retail sales were 2.4% higher than the year ago period and August and September retail sales continued to rise month/month, up 2.6% and 2.0% respectively. We believe the economic recovery continues partly because the U.S. economy and consumers were in pretty good shape before the lockdown, and the lockdown mostly affected the low end of the economic sphere. The Federal Reserve now expects U.S. GDP to decline 3.7% and unemployment to hit 7.6% by the end of the year. Three months earlier the Fed was projecting a negative 6.5% and 9.3%, respectively, for these two economic measurements. This is a rather dramatic change of view over just three months, but it does help to explain the increasing optimism on the economy and, in turn, the sharp stock market recovery.
It also helps explain why our domestic stock market has broadened out as more groups and sectors have done better since September 1. It has not been just technology or stay-at-home stocks that have done well over the past seven weeks, but rather the improving economy has had its influence on value stocks (generally deemed to be more cyclical in nature) and the small and mid-cap stocks. From September 1 through October 23, the Russell 1000 Growth Index is down 2.1% while the Russell 1000 Value Index is up 1.8%. More impressively the Vanguard Mid-Cap and Small-Cap ETFs are up 4.4% and 5.6%, respectively, over this same seven-week time-frame. We believe that this broadening of the market is a healthy development which we sincerely hope is not a short-term ‘blip’.
In truth there is no shortage of concerns today in spite of an improving economy and a broader stock market. On the recent rise in Coronavirus cases, we have been warned about this eventuality for quite a while and while it is coming to pass, we have confidence that vaccines and treatments will become reality over the next 6-9 months. As for the election, history has shown that the outcome of the Presidential election is not a good stock market indicator. Over the 1928-2018 time frame (90 years) annual S&P 500 returns were positive for 58% of the years that a Democrat was U.S. President. When a Republican was in the White House the Standard & Poor’s was positive 42% of the years. No weight of evidence here. Looking at more recent years, during the time from Barack Obama’s election (November 4, 2008) through the election of Donald Trump (November 8, 2016); the Standard & Poor’s 500 rose by 12.3% annually. President Obama, of course, inherited a pretty nasty recession prompted by the Financial Crisis. From the point of Donald Trump’s election (11/8/16) through October 23, 2020, the S&P 500 has risen 14.5% annually. Trump, of course, inherited a nasty Coronavirus from China earlier this year. The point is that the stock market has done well no matter what party is living in the White House. For this reason (among others) we remain focused on the fundamentals of the companies that we own across our stock and bond portfolios.