Unknown Unknowns

Although much more is known to us about the Coronavirus today, we trust you would agree that as of last Christmas, its existence and threat were totally unknown.  We refer to the virus as a Black Swan, a theory which is a metaphor for a complete surprise.  Black swans don’t exist – until they do.  Nassim Taleb describes the Black Swan as “high profile, hard-to-predict, rare events that are beyond the realm of normal expectations in history, science, finance and technology.”  As we’ve discussed, predictions of this novel virus and the ramifications for US health, wealth and economy were not mentioned in the annual missives from Wall Street’s brightest.  It was simply an unknown unknown.

We can argue whether we were adequately warned and prepared for the virus. But that’s a waste of time best left to politicians and their unwavering quest for the truth.  We should spend all our efforts staying healthy and thinking of how our future might unfold as the virus loses its grip.  And yes, that day will arrive. Interestingly, who would have believed in February that today interest rates would be zero, shopping centers, restaurants, schools closed, airports empty, and the Masters postponed?

Equity markets peaked in mid-February and by mid-March lost 35% of their value. As of this writing, approximately half of the decline has been erased.  Certainly you, as we, hope the worst is behind us.  For the record, the US has endured 15 bear markets since 1950 (a bear market defined by securities prices falling by 20% or more from recent highs).  In only one instance did the market not retest the bottom over the ensuing three months.  We wouldn’t be surprised by a retest. However, the Federal Reserve and Congress appear intent on providing money and programs which will render economic conditions much different than those which followed the Crash of 1929.  For the moment we have financial stability but economic uncertainty.  That uncertainty remains correlated to the path of the virus. As professed before, predicting market direction over the next several weeks and months is possible but not probable.

We do have cash which we will reinvest over the next several months.  Stocks should continue to respond and adjust to news relative to stimulus efficacy, details of damage to the economy, prospects for a cure and expectations of a grand reopening.  

Howard Marks recently penned “these days everyone has the same data regarding the present and the same ignorance regarding the future.” This week marks the start for first quarter earnings reports and revised expectations for the second. We will be looking for weakness in companies that continue to have great prospects on the other side of the mayhem. 

Now for some good news. Credit markets have improved as the Federal Reserve has unleashed policy directed at providing liquidity and support to the fixed income markets. Importantly, they have indicated, if needed, they will do more. Last month bond prices tumbled as investors rued risk and coveted cash.  Prices of the highest rated bonds were falling due to lack of liquidity – not fundamentals. The riskiest of bonds were sold as expectations of lengthy shutdowns ignited bankruptcy concerns.  The Federal Reserve is buying via open market operations -treasury securities, corporate bonds, municipal securities and high yield ETFs.  They have expanded commercial paper facilities. They have reduced short -term rates to zero. The Fed has become not only the lender of last resort but also the buyer of last resort.

In 2008 the federal reserve took three months to initiate quantitative easing following Lehman’s bankruptcy.  During the Great Depression, the Fed compounded the malaise by raising rates.  Chairman Powell is presumably a student of history.  We won’t worry for the moment about the long-term consequences of Fed activity over the past month.  It may certainly loom ugly one day.  

The new normal will have characteristics of the last normal.  It will also exhibit some new ones.  Recognizing and evaluating the changes will guide future investment options.  Some stocks will look attractive today simply because they are trading at significant discounts to their highs.  We can’t be seduced by this fact alone. For instance, let’s look at the airline industry as an example.  Is it possible that we will travel less for business and leisure?  Certainly that is possible if not probable.  And if so, airlines will have far more capacity than they need. Certainly, expectations for more healthy considerations will lead to greater costs. Tepid demand could lead to dramatic fare reductions.

The world is changing not ending.  Stay safe and stay healthy!