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!
