What a Recovery Looks Like

Wallace R. Weitz, CFA

Co-Chief Investment Officer, Portfolio Manager

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Wallace R. Weitz, CFA

Co-Chief Investment Officer, Portfolio Manager

Partners III Opportunity Fund (Since June 1983)
Partners Value Fund (Since June 1983)
Hickory Fund (Since January 2003)

Investment industry experience since 1970

Wally founded Weitz Investment Management in 1983. Prior to starting the firm, he worked as an analyst and portfolio manager at Chiles, Heider & Co. Previously, he was a security analyst at G.A. Saxon & Co. Wally has a bachelor's in economics from Carleton College.

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Bradley P. Hinton, CFA

Co-Chief Investment Officer, Portfolio Manager

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Bradley P. Hinton, CFA

Co-Chief Investment Officer, Portfolio Manager

Balanced Fund (Since October 2003)
Partners Value Fund (Since August 2006)
Value Fund (Since August 2006)

Investment industry experience since 1990

Brad joined Weitz Investment Management in 2001 as a research analyst. He was promoted to portfolio manager in 2003, director of research in 2004 and co-CIO in 2017. Prior to joining the firm, Brad was a debt manager and trading associate for ConAgra Foods. Previously, he was a fixed income investment manager for Principal Financial Group. Brad has a bachelor's in finance from the University of Nebraska-Lincoln and an MBA from Dartmouth.

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The third quarter was a good one for our equity and conservative allocation portfolios. Mega-cap technology and “work from home” (WFH) stocks continued to pace the market's advance. This is partly because they are better businesses for today's economy, but also because a lot of the cash created by the Federal Reserve (Fed) for its quantitative easing program found its way into the stock market, much of it directed by index investors so it boosts those same stocks. Year-to-date returns for our equity funds reflect their relative exposure to these favored stocks.

While our focus here is primarily on equities, our fixed income portfolios also showed good quarterly and year-to-date returns. Weitz fixed income portfolio managers Tom Carney, CFA, and Nolan Anderson provide bond market perspectives in their Q3 Fixed Income Insights. In addition, you can find more specific information for all of our funds in our portfolio managers' individual fund commentaries.

Where Are We Now?

Controlling the Virus 

The scientific community is still learning about the coronavirus and is working overtime to develop treatments and vaccines. Policymakers are seeking a balance between shutting down for safety and opening up for economic health. In the absence of an effective vaccine, the primary public health measure available today is a regimen of testing, tracing, isolating and wearing masks. With inadequate availability of testing along with a persistent resistance to mask-wearing, we continue to experience new surges of infections (recently in the Midwest and Northwest, as this letter goes to press). Nevertheless, a combination of behavioral changes and medical advances should eventually allow for a relatively open economy. The pace of recovery is likely to be uneven, and it may be years before a majority of people are comfortable in theaters, restaurants and airplanes.

We own several companies (Danaher, LabCorp, Thermo Fisher) that provide COVID diagnostic testing and/or make instruments and supplies used in testing and developing therapeutics and vaccines. We do not own any of the drug companies that are competing to invent vaccines because we do not know how to handicap the race or to estimate the profitability of the winning product(s). As for policy measures, we citizens can have influence by voting and modeling good behavior. But the whack-a-mole nature of outbreaks would suggest that the virus will be with us for some time.

Fiscal and Monetary Policy — Debt and Deficits — Induced “Wealth Effect”

The Fed and Treasury have each injected trillions of (freshly created) dollars into the U.S. economy. Budget deficits are at record highs (by a wide margin) and the national debt has risen sharply. This spending has helped stabilize financial markets and sustain consumer spending, but it has done little to promote economic growth.

Theoretically, this money creation should be inflationary, yet potent deflationary forces (technology, globalization, excess productive capacity) have kept inflation at bay. This apparent contradiction has been puzzling to us. 

One clue to how we might transition from deflation to inflation may lie in consumer expectations. So far, while government spending has risen dramatically, a large proportion of the cash has ended up as savings or debt reduction. In monetary policy language, the quantity of money has increased, but not its velocity. It seems plausible to us that if inflationary expectations rise, spending will accelerate. Spending in anticipation of price increases can create a feedback loop that pushes the inflation rate higher. The Fed is trying to push inflation up to a 2% annual rate, and once it begins to succeed, it may well over-achieve.

We have no idea when, or if, this might happen. But higher inflation generally means higher interest rates and lower P/E ratios for stocks as fixed income securities offer more potent competition for equities. No businesses are immune to inflation, but we have always favored companies that have pricing power over highly competitive and commodity-related businesses that have little control over their (pricing) destiny. Payments companies like Visa and Mastercard whose fees are tied to spending are direct beneficiaries of inflation. Subscription businesses like cable and broadband (Liberty Broadband and Comcast) and satellite radio (Liberty Sirius XM) should find it relatively easy to pass through price increases. Finally, JPMorgan, First Republic and Schwab should be able to increase their net interest margins in a higher-rate environment. 

A by-product (or perhaps a primary objective?) of the Fed's extraordinarily generous monetary policy is that trillions of new dollars have to go somewhere, and, with rates at or near zero, there is no alternative to equities. In October of 2018, when the Fed took its first baby step towards withdrawing the plentiful “free” money from the system, the S&P dropped about 20% in a few weeks. As economist Herb Stein said, “If something cannot go on forever, it will stop.” The end, or the threat of an end, to the current pace of monetary expansion could well cause the stock market some heartburn.

Disproportionate Impact on Poor and Low-Wage Workers

November Election

Whether the election results in the status quo, a Democratic sweep or something in between, there will be plenty of uncertainty as to future monetary, fiscal, tax, pandemic response, foreign policy and any number of other policy matters. The big issues, including those discussed above, will need to be addressed by whoever is in office. From the purely self-interested viewpoint of an investor, it is very hard to say that one side or the other is “best” for stocks or bonds. There are bigger issues involved than one's portfolio, though, so we urge our clients to join us in voting.

Outlook

These are interesting times. We believe some things are different this time. The U.S. economy is resilient, and we are already seeing creative responses to the pandemic and an explosion of new products and businesses. We are optimistic about a return to a recognizable version of normal. Our quibble with the conventional wisdom, at least as reflected in today's stock prices, is the assumption that the recovery will be quick and painless — the “V” recovery.

We believe that there will be surprises along the way and that investors' emotional reactions will ensure plenty of volatility over the next year or two. The virus, the economy, the election, our relationship with China, persistent demands to address issues of diversity and inclusion, and the effects of climate change are all part of the mix that could keep investors off balance. Uncertainty and volatility have a way of creating opportunities for flexible investors. We are excited about the possibilities.

Thanks again to our shareholders and clients who have entrusted their investment capital to us. We appreciate your confidence.