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A Few Things....Coronavirus, Bain on Private Markets, End of Globalization
March 7, 2020
From Los Angeles.
Something to think about in a world full of black swans:
“In the world of modern finance, a love of numbers has replaced a desire for critical thinking. As long as something has a number attached to it, then it is taken as gospel truth. Research shows that people are often fooled by the use of pseudoscience. Simply making things sound complex makes people believe them more! Risk managers, analysts and consultants are all guilty of using pseudoscience to promote an illusion of safety. We all need to be on our guard against the artificial deployment of meaningless numbers. Critical thinking and skepticism are the most unrated (and scarce) tools in our world."
- James Montier ("Mind Matters," April 29, 2008)
A. The Coronavirus
As discussed last week, FED was likely going to cut, and they did on Monday (might be more to come).
I think the market is trying to price three things right now (hence the daily volatility):
a) how severe is ‘community transmission’
b) how fatal is this disease and
c) what are the supply chain and economic impacts.
What happens now ?
The exact answers to the three questions will determine whether the recovery is “V”, “U” or “L” shaped. It will determine the exact nature of supply chain damage, demand destruction and risk premia re-pricing.
In summary: If the peak in new cases comes in July or later, a global recession is likely, with a material effect on supply chains and lasting damage to household and firm balance sheets. Continued central bank action in coming weeks will provide a floor to demand but is an imperfect tool for addressing supply shocks and related financial instability; fiscal policy will need to pick up the slack, testing political and economic limits.
Going back to my old boss at Goldman Sachs - Alan Brazil, who still advises a number of hedge funds, he had some more slides I found useful in gauging the impact of this virus.
If what ends up happening is a global recession with a 2-3% global GDP hit and 5-15mm additional deaths then asset prices can likely re-price further.
At the same time though, governments can throw both fiscal and monetary stimulus at this, and if the supply / demand disruption only lasts a few months, then asset prices (and inflation) can come screaming back when all the stimulus hits an economy already healing itself.
How are you positioning for this ?
Anecdotally, I have seen a lot of concern and caution during my week in LA, but little panic or selling. Most of the action is to delay or defer decisions….demand destruction has begun.
Good reminder to listen to what Paul Tudor Jones was saying at the end of January in Davos.
B. Private Markets
Bain Capital released their 2020 Private Equity report last week. It’s a dense read at 96 pages, but worth it. The charts and ideas that struck me were:
1. Buyout Deals Remain Strong
2. Higher Leverage on Buyout Deals
Here’s a crazy statistic (from the report): “Deals with debt multiples higher than six times earnings before interest, taxes, depreciation and amortization (EBITDA) rose to more than 75% of the total. That comes in stark contrast to the years following the global financial crisis, when their share did not exceed 25% (see Figure 1.5).”
3. Deals At Record Valuations
4. Capital on Sidelines Ready To Deploy
5. Buyout Fund Excess Returns Narrow
The rest of the report covers finer details of private equity such as:
Spreads between public & private returns
Where PE funds put their money
C. A Few Things Worth Checking Out:
1. Howard Marks put out his latest memo titled - Nobody Knows II. Here’s the closing paragraph which I thought was very appropriate.
“Buy, sell or hold? I think it’s okay to do some buying, because things are cheaper. But there’s no logical argument for spending all your cash, given that we have no idea how negative future events will be. What I would do is figure out how much you’ll want to have invested by the time the bottom is reached - whenever that is - and spend some part of it today. Stocks may turn around and head north, and yo'u’ll be glad you bought some. Or they may continue down, in which case you’ll have money left (and hopefully the nerve) to buy more. That’s life for people who accept that they don’t know what the future holds.
But no one call tell you this is the time to buy. Nobody knows.”
2. The amazing Claude Shannon on Creative Thinking (March 1952)
3. One of my favorite authors Peter Zeihan (I’m reading his latest now: Disunited Nations) was on the Hidden Forces podcast.
The big idea that Peter talks about is just how abnormal our world has been for the last 70 years and what a return to a more “normal world” may look like.
This is what I worry about.
It isn’t who is President, Inflation or a virus….but the continued withdrawal of America from the world. This has consequences for governments, business people but especially for people like me and you who are living or invested in countries that have been the primary beneficiaries of the American lead international Order of the past three generations.
Peter lays the foundation for what this new world is going to look like, how it differs from the world we’ve inhabited since the end of World War Two, and what sorts of forces will be driving the changes that we can expect to experience over the next few decades.
4. I highly recommend watching this Real Vision interview with hedge fund manager Dan McMurtrie. My favorite bit was what he had to say about inequality and what it’s doing to our politics (for what it’s worth, my entire family in LA voted for Bernie).
“You can chop the numbers a lot of different ways, but the reality is half the country right now is either financially, I would say close to insolvent, really just trying to get by and it's a tight wire act or is just currently on the tight wire and they see that and that's creating a lot of anxiety, a lot of anger, a lot of blame. I think for a lot of people, I think one of the reasons Bernie Sanders is doing so well and the reason that Trump is doing so well is in the last two years, first premiums went up and then deductibles spiked. As we saw premiums and deductibles spike, we saw all the polling data starts to correlate and what's important to understand is because of the desperation people are in, it is forcing them to become single-issue voters.”
“For a lot of Americans, they have to be a single-issue voter on health care. It's not about ideology. It's not about anything else. This could ruin their lives, it could bankrupt them. It's a very serious problem. That introduces really serious political risk. The biggest risk for any country is when people within the country start acting not out of their own self-interest, but out of hate for the other”
Quotes I’m Thinking About:
"Almost everything will work again if you unplug it for a few minutes, including you."
- The American author and poet, Anne Lamott, on the benefits of rest
“Between stimulus and response there is a space. In that space is your power to choose your response. In your response lies your growth and your freedom.”
– Victor Frankl
“Knowledge can be communicated, but not wisdom. One can find it, live it, be fortified by it, do wonders through it, but one cannot communicate and teach it.”
- Hermann Hesse
To end on a humorous note…we are all going to be making sure this happens.