Chad Meyer, CFA President
Inside This Issue
The Fourth Quarter of 2020: The Stock Market Has Gone Viral
Recession and Depression Trends. A Positive? Company Spotlight: Digital Realty Trust, Inc. (Ticker: DLR)
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Greetings from Tufton Capital, where the tinsel has been packed away, the winter weather has formally arrived, and your team of investment professionals has been busy closing the books on a year that will never be forgotten.
Let me first begin with what matters most – your family’s health. In these humbling and unprecedented times – times in which our children and grandchildren are learning “virtually” and food “take out” is the new norm – one cannot help but be reminded of life’s true priorities. As vaccines become increasingly available and a true “reopening” becomes more realistic, it is my sincere hope that this letter finds you and your loved ones in good stead.
Now, onto the market. Even with the stormy seas we faced in 2020, equities continued to sail higher and surmounted Wall Street’s “wall of worry” as investors focused on the brightening light at the end of the tun-nel. For the year, the Dow Jones Industrial Average posted a solid 9.7% gain (total return). Not to be out-done, the S&P 500 shot up 18.4%, resulting in back-to-back years of double-digit returns for the index. But even as market participants rejoiced at these outstand-ing returns, anxious questions continued to rise to the fore. How long will the good times last? What “shape” will the recovery ultimately take? And perhaps most vexingly, how can one account for the much-discussed disconnect between a shell-shocked economy and soaring stocks?
We think about these questions often and address them in the pages that follow with our firm’s outlook for both the economy and financial markets in our article starting on page 2 entitled “The Stock Market
Has Gone Viral”. This quarter’s Tufton Viewpoint also includes an article discussing and analyzing one of our favorite stock ideas, Digital Realty Trust (DLR). This REIT (real estate investment trust) operates in the cloud computing space and should be a leader as the transition to cloud-based data centers continues to grow exponentially.
In prior musings in this space, I have candidly shared my discomfort with macroeconomic forecasting. But with the number of “shots in the arm” increasing and our economy gradually reopening, I hope you’ll forgive me for a note of optimism—if not for the market writ large, at least for your place in it. Take a peek inside this newsletter, and you’ll find the thinking of a driv-en, diverse and incredibly talented team of investment professionals. These are the people who have secured our clients’ trust and safeguarded their interests since day one at Tufton Capital. And they’re the ones work-ing, right this very moment, to ensure that even as the economy changes seasons, your financial future re-mains sunny indeed.
turnout was 66% – 72%, the highest since the election of 1900. Control of the United States Senate shifted to the Democrats following two run-off elections in Georgia. The political differences and competing agendas between the Republicans and Democrats were on display during the protracted negotiation for additional stimulus. Republicans held out for lower stimulus checks and Covid-related liability immunity. The Democrats wanted larger checks and fiscal aid to states and cities. Although compromise was reached to enact year-end stimulus measures, the Democrats now control the agenda. With the change in power, the narrative on Wall Street has changed.
Spending and taxation priorities under the new administration will impact the economy and the securities markets. President-elect Biden stumped on the expansion of healthcare access through the Affordable Care Act. Government’s expanded role in healthcare funding may result in greater pricing pressure and expanded coverage. Environmental and climate issues will come back into focus with energy,
T
he stock market posted strong returns in the fourth quarter. The Standard and Poor’s 500 reached record levels in December and finished the year with a total return of 18.4%. The recovery from the March 20 low was a robust 65.2%. The 10-year U.S. Treasury yield continued to march higher with a year-end yield of 0.92%. The yield is up from a low-water mark of 0.50% in March and 0.68% at the beginning of the quarter. We are, however, still a long way from the 1.92% yields offered at the beginning of the year. News flow during the quarter was dominated by the elections and the pandemic. The presidential election was a source of daily speculation by political pundits, and the contested results added to the theater. Bloomberg News estimated that voterThe Fourth Quarter of 2020: The Stock Market Has Gone Viral
Eric Schopf Director of Research/ Partner
U.S. Debt to GDP (%)
0 20 40 60 80 100 120 140 19 38 19 40 19 42 19 44 19 46 19 48 19 50 19 52 19 54 19 56 19 58 19 60 19 62 19 64 19 66 19 68 19 70 19 72 19 74 19 76 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 20 10 20 12 20 14 20 16 20 18 20 20 140% 120% 100% 80% 60% 40% 20% 0% 1938 1944 1950 1956 1962 1968 1974 1980 1986 1992 1998 2004 2010 2016 2020transportation, industrial and utility companies likely feeling the impact of policy reversals. Infrastructure spending on roads and bridges has also been
highlighted, as have student loan forgiveness and free community college educations. In the near term, additional Covid-19 fiscal stimulus via a third round of stimulus checks is almost a certainty. It is just a matter of when and how much. Regulatory changes in the financial and technology industries are also possible. The tax cuts and deregulation enacted during the Trump administration will begin to be reversed. Immigration restrictions are also ripe for change. Additional revenue to pay for the various initiatives could be levied through higher corporate and personal income taxes. Changes to capital gains tax rates are also a possibility. Raising tax rates while the economy is still recovering from the virus lockdown-induced recession is a risky proposition, so we expect little change in the near term. The level of taxation will depend not only on the government’s appetite for risk, but on the willingness of investors to continue funding the debt. Coronavirus fiscal stimulus, along with
enhanced unemployment benefits, have driven fiscal deficits and debt to unprecedented levels. The deficit in the month of December alone was $144 billion. U.S. debt reached 136% of gross domestic product (GDP) in the second quarter and now
stands at about 128%. GDP will continue to grow following the 32% contraction in the second quarter, which will help reduce the debt burden. However, these are debt levels not seen since World War II. The Federal Reserve has filled the demand gap by purchasing Treasury securities, and in the
process, has kept interest rates low. An exit strategy that balances economic growth with inflationary-induced money printing will require a deft hand. Trade negotiations with China under the Biden administration will be very interesting. China was able to string along a tough-negotiating Trump in hopes of his departure after one term. China avoided broad
Continued on page 4.
In the near term,
additional Covid-19
fiscal stimulus via
a third round of
stimulus checks is
almost a certainty.
Federal Reserve Balance Sheet ($Trillions)
0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 $8.0 $7.0 $6.0 $5.0 $4.0 $3.0 $2.0 $1.0 $0.0 2004 2006 2008 2010 2012 2014 2016 2018 2020
trade commitments and their strategy paid off. It is unclear if Biden will maintain the hawkish stance or will acquiesce to assure access to the second largest economy in the world.
The political rhetoric was matched only by news on the pandemic. And the news was not good. From the first reported case in America on January 21, we closed the year with new daily reported cases exceeding 200,000. Reports of variant strains of the virus have been reported and further lockdowns have been ordered. The emotional and financial hardships have been extraordinary. The good news is that Covid-19 vaccines have been approved and are in the process of being rolled out globally. Although infection rates are sure to escalate following the holiday, there appears to be a light at the end of the tunnel.
The restatement of measures to reduce the spread of the virus impacted the economy during the quarter. Initial claims for unemployment began to tick higher, and economic growth began to decelerate. Retail sales contracted in October and November. The additional economic aid passed by Congress late in the year was
a much-needed benefit to the nearly 11 million people still unemployed.
It has been the combination of monetary policy and fiscal stimulus that has prevented the pandemic from becoming a more widespread financially ruinous event. Despite the number of unemployed people being twice what it was in February,
personal income is still well above pre-pandemic levels due to government transfer payments. The move in the stock market has been supported by record corporate profits. Third quarter core profits reached an all-time high of
$2.32 trillion. The prior record of $2.31 trillion was set in the fourth quarter of 2019. But make no mistake, very low interest rates and the economic stimulus have provided the backbone for this record stock market run. President-elect Biden has nominated Janet Yellen
Fourth Quarter... Continued from page 3.
It is unclear if Biden
will maintain the
hawkish stance or will
acquiesce to assure access
to the second largest
economy in the world.
U.S. After-Tax Corporate Profits ($Billions)
Continued on page 8. 0.0 500.0 1,000.0 1,500.0 2,000.0 2,500.0$2,500 $2,000 $1,500 $1,000 $500 $0 1946 1952 1958 1964 1970 1976 1982 1988 1994 2000 2006 2012 2016 2020
internet. In order for these networks to properly func-tion, large scale server farms need to be located near the main switching stations that serve as the backbone of the world wide web.
Our recent purchase of Digital Realty Trust, Inc. (DLR) is an investment in the continued growth of cloud computing and the never-ending need for cor-porations and individuals to manage the data created as our computer network continues to evolve and grow exponentially. According to Gartner Research, only 10% of enterprises have moved to data centers, but 80% are expected to do so by 2025. As the market leader in data center real estate, Digital Realty is in the perfect position to take advantage of the additional 80% of these enterprises moving to the cloud data centers in the next five years.
Digital Realty Trust is a REIT (real estate invest-ment trust) that was formed in 2004 and has grown to become the second largest publicly traded company operating in the cloud space. DLR is currently the fifth largest publicly traded REIT. Digital Realty owns, acquires, develops and operates data centers with 215 data centers in 35 metropolitan areas across 14 coun-tries. DLR is well positioned to maintain its leadership
O
ver the past de-cade, we have seen incredible growth in our reliance on technolo-gy and the impact it has on our daily lives. Technology has moved away from the individual PC in a closed environment to an always on, interconnected world where the real time delivery of technology applications and data through the internet and 5G communications plat-forms is an absolute must. The worldwide Covid-19 pandemic has further pushed the limits on this need to be connected. Whether using Zoom for “work-from-home” demands or keeping in touch with family for non-traditional Thanksgiving celebrations, the need to remain connected for social and business reasons has never been more important. Like it or not, the concept of “cloud computing” is slowly making its way into our daily lexicons.The term “the cloud” was once used as a metaphor to describe the complexity of our telephone networks, but it has morphed into one that describes a model of computing where servers, networks, storage and applications are all enabled and connected through the
Company Spotlight: Digital Realty Trust, Inc. (Ticker: DLR)
Scott Murphy Portfolio Manager/Partner
Digital Realty Trust, Inc. (Ticker: DLR) Stock Chart
90 100 110 120 130 140 150 160 170 1/5/18 3/5/18 5/5/18 7/5/18 9/5/18 11/5/18 1/5/19 3/5/19 5/5/19 7/5/19 9/5/19 11/5/19 1/5/20 3/5/20 5/5/20 7/5/20 9/5/20 11/5/20 $160 $150 $140 $130 $120 $110 $100 $90 $137.43 As of 12/25/20 Continued on page 8.
I
t is often observed that recessions accelerate trends, and this pandemic-driven recession is not any different. While many workers may return to offices once a vaccine is widespread, it seems that the work-from-home trend will continue as employee productivity has remained stable and companies look to cut operating costs. In terms of consumers, e-commerce should see continued growth while streaming services are becoming the norm. Trend acceleration and product innovation are not unique to this downturn, since they have occurred in several tough times in the past.One hundred years ago, our country embarked on a decade now referred to as the “Roaring Twenties”, a period that encapsulated a new era of consumerism and extravagance to the American culture. New technologies and mass production made new products more affordable to the middle class. Armed with the right to vote, American women felt liberated to try out new fashion trends, which gave rise to the widespread use of makeup. A new trend in the American home emerged with an increased desire for home furnishings and decor.
Though the Great Depression left many Americans out of work, it did not stop the momentum of these trends. Instead, it actually increased the development of new products. Many new items were launched during that recession that we still use today. For example, furniture company La-Z-Boy (LZB) was founded to take advantage of the demand for home furnishings. Consumers were so enthralled by the product that they sold their farm animals in order to buy the new reclining chair. To capitalize on ongoing beauty trends, brothers Charles and Joseph Revlon and chemist Charles Lachman started Revlon (REV) with the
Subsequent recessions were no exception and often led to the acceleration of new product innovation. By the mid-1940s, many Americans were accustomed to President Franklin Roosevelt’s “Fireside Chats” that he delivered via radio broadcast. Like the products mentioned above, radio took off in the 1920s, but listening to it was usually restricted to a consumer’s car or a certain room in the home. During the recession of 1953, Texas Instruments (TXN) released the Regency TR-1 – the first portable transistor radio. Though TXN was first to the punch, it was Sony (SNE) that caught the consumer’s eye with their mass production and high-performance TR-63 that was bought by millions of Americans.
Fast forward to the turn of the century. Music is rapidly being offered digitally, and consumers are impatiently trying to consolidate their compact disc (CD) libraries. The leading electronic titans, including Sony and Compaq (HPQ), were busy developing MiniDisk and MP3 players to take advantage of the changing landscape. Enter Apple (AAPL) with the release of the iPod – in the midst of a recession and barely a month after 9/11 – that revolutionized how we listen to music. With the launch of iTunes, not only did Apple change the way we listen but the way we purchase music as well.
During the Great Recession of 2008-2009, no single company launched a revolutionary product that changed our lives. However, given that many consumers were facing the worst economic hardship since the Great Depression, we witnessed a change in behavior as consumers began to rein in spending. The “bargain shopper” and “treasure hunter” emerged as discount retailers began to flourish, with the likes of TJ Maxx (TJX) and Target (TGT) experiencing record years of sales throughout the downturn and the recovery. In addition, consumers began to find better prices from online retailers. As a result, online shopping grew significantly as we entered the recession (especially on Amazon (AMZN)). What was
Recession and Depression Trends. A Positive?
Ted Hart Research Associate
4.1% exiting the downturn. Today, the percentage is nearly 15%.
This pandemic-induced recession should accelerate some trends dramatically given how quarantines, lockdowns and social distancing have forced consumers to change their behaviors. Many gyms were shut down and people rushed to buy the Peloton (PTON) or the MIRROR (which is now owned by Lululemon (LULU)). In the media world, the quarantine helped introduce millions of viewers to streaming services, and now many are “cutting the cord” all together. While streaming services may have seen a surge in subscribers due to content, the offerings from Netflix (NFLX), YouTubeTV (part of GOOG) and Disney+ (part of DIS) are becoming more attractive and often less expensive options to the traditional bundled cable service. Similar to the last recession, online shopping has continued
to gain market share of retail sales since consumers are avoiding brick and mortar stores. While the online experience has traditionally been dominated by Amazon and Target, Walmart (WMT) has made impressive moves to remain not just relevant, but competitive in the online shopping space.
Lastly, the work-from-home trend could continue, and for some companies, become permanent. This should benefit the more product-specific companies such as Zoom (ZM) and DocuSign (DOCU), while the well-diversified technology companies like Microsoft (MSFT) and Salesforce (CRM) should expect
customer cloud adoption to accelerate. No matter what the trend, good or bad, you can rest assured that your investment team at Tufton Capital will be hard at work identifying the companies that will be the beneficiaries, and we will be ready to buy them at the right prices! n
“Covid Consumer/Work-From-Home” ” Portfolio vs. S&P 500
Source: FactSet
Stocks included in the “COVID Consumer / Work-from-Home” Portfolio: AMZN, ATVI, CHWY, CRM, DIS, DOCU, EA, ETSY, GOOG, GRUB, LULU, MSFT, NFLX, PTON, TGT, TTWO, UBER,
-40% -20% 0% 20% 40% 60% 80% 100% 120% 140% 1/1/20 2/1/20 3/1/20 4/1/20 5/1/20 6/1/20 7/1/20 8/1/20 9/1/20 10/1/20 11/1/20 12/1/20 S&P 500 "COVID Consumer / Work-from-Home" Portfolio
140% 120% 100% 80% 60% 40% 20% 0% -20% -40%
Jan ‘20 Feb ‘20 Mar ‘20 Apr ‘20 May ‘20 Jun ‘20 Jul ‘20 Aug ‘20 Sep ‘20 Oct ‘20 Nov ‘20 Dec ‘20 -40% -20% 0% 20% 40% 60% 80% 100% 120% 140% 1/1/20 2/1/20 3/1/20 4/1/20 5/1/20 6/1/20 7/1/20 8/1/20 9/1/20 10/1/20 11/1/20 12/1/20
Viewpoint is published for our clients and professional associates. Copies will be provided to educators, accountants,
and other professionals upon request. The views expressed are of those by the authors of Tufton Capital Manage-ment, and are subject to change. Any action based on the information in this publication should be taken only after a detailed review of the specific situation. Copyright 2021 Tufton Capital Management, Inc. All rights reserved.
Digital Realty Trust...continued from page 5.
to serve as Secretary of the Treasury. Yellen served as chair of the Federal Reserve between 2014 and 2018 and as vice chair from 2010 to 2014. Her unique perspective should allow a close relationship between the Treasury Department and the Federal Reserve to maintain expansionary policies. Current Fed policies include keeping the federal funds rate within a range of 0.00% – 0.25% and purchasing Treasury securities and mortgage-backed securities at rates of $80 billion per month and $40 billion per month, respectively. The Fed remains committed to an accommodative policy to usher the economy through these difficult times. We do not see this strategy changing in the short term. The stock market is feeling good. Interest rates trending higher is a sign that investors foresee better growth on the horizon. Credit metrics throughout the financial industry are strong, and delinquencies are low due to loan payment deferrals and forbearance programs. Forced saving during pandemic lockdowns has created a mountain of cash waiting to be spent once the economy reopens. However, we are keenly aware that the Fed’s rescue efforts in the past have resulted in asset bubbles, and signs of over-exuberance are beginning to emerge. Equity valuations are lofty. The market value of stock prices relative to corporate profits and to gross domestic product are stretched. The initial public offering market has been white hot as investors monetize positions. Despite this bullish mood, we remain vigilant. We stay grounded by maintaining investment policies and investment objectives in good times and bad.
I concluded my Winter 2019 Viewpoint article by welcoming the New Year and the challenges that it would surely bring. I will not make that mistake again, as I think it is safe to say that we are glad to
Fourth Quarter...continued from page 4.
position in the data center industry.
In 2019, Digital Realty produced FFO (funds from op-eration) of $7.39 per share, and dividends per share of $4.32. FFO per share was essentially flat from 2018 to 2019, while dividends per share grew nearly 7%. The company also advanced its environmental, social and governance (ESG) standing by offering the first-ever data center Green Euro Bond. DLR’s primary source of revenue comes from North American, which is a direct result of the large amount of data centers located on the continent. Operating revenues from properties in the United States were $2.6 billion in 2019, while revenues internationally were $627 million that year. The company’s use of solar power in many of its data centers helps strengthen its customers’ ESG goals which seem to be growing by the day. Since many of Digital Realty’s customers are technology companies, DLR’s ability to leverage its strong balance sheet helps its business objectives above and beyond basic data center offerings, separating them from their peers. We feel that Digital Realty is positioned perfectly and has demonstrated its ability to grow its dividend above that of the S&P for the foreseeable future. With strategically located properties, an experienced man-agement team and a favorable debt/equity ratio, DLR represents a most compelling investment opportunity within the industry. n
bid goodbye to 2020. With the new year will come great change with many moving parts. Your team at Tufton Capital Management will continue working hard to respond to these changes in order to fulfill and hopefully exceed your investment goals. n
