“One of the most notable behavioral traits among investors is their tendency to overlook negatives or understate their significance for a while, and then eventually to capitulate and overreact to them on the downside. I attribute a lot of this to psychological failings and the rest to the inability to appreciate the true significance of events. As negatives accumulate – whether they surface for the first time or just are finally recognized as significant – eventually a time comes when they can no longer be ignored, and instead they come to be treated as being of overwhelming importance."
- Howard Marks ("On the Couch," January 2016)
The goal of this weekly email is to discuss timeless ideas, so it doesn’t matter when you read it.
With that lens let’s look at the Coronavirus.
A. Definition of a Pandemic:
Adjective: (of a disease) prevalent over a whole country or the world.
Noun: an outbreak of a pandemic disease.
Previously, we have discussed the impact Coronavirus could have on how we live and the facts as of Feb 1st here.
What has happened since then ?
The virus has gone global and hence can be defined as a pandemic.
The markets have begun to notice and have tried to price it’s impact.
I’m not a doctor and won’t pretend to play one on the internet, so I will leave the details of the virus to the experts, what I do know is that:
The fatality rate is anywhere from 0.5% to 2%.
The R0 (a measure of virality) is somewhere between 2-4. Each person who gets may infect between 2 to 4 other people.
Containment continues to be the best strategy and we have seen this work in China (cases have peaked) and are hoping it works in other regions: Japan, Korea, Iran, Italy being the key ones now.
Clearly it is having an impact at the economic level and therefore in financial markets.
When I speak to people I see and hear concern, but little panic. Some have been selling their public equities, locking in 2019 profits and few have been deploying capital.
What does the world look like in a few months ?
I’ve been speaking to a lot of people on this and one of my leaders at Goldman Sachs, Alan Brazil (who only publishes his State of The Markets research) had some interesting analysis on it, comparing it to prior Influenza outbreaks.
As we are seeing now, it’s not the deaths that cause the economic impact it’s the other ~90% of things we do.
Taken together, the impact both on supply and demand side can be a recession.
Clearly some of that is being priced into equity markets.
So what happens from here depends on a few different players:
What will the Fed do ? They are already cutting rates and more is likely and possible.
What will the US government do ? US fiscal policy is already stimulative with budget deficits of over US$1.3trn. But, Washington is deeply divided, perhaps more than ever before, so unlikely more is coming.
What will other governments do ? Here, the picture appears clearer than in the US. They will spend even more money that they don't have. This will be the case in the UK, across the eurozone, in Japan, in China, and in Hong Kong (although almost uniquely, Hong Kong does have the money, and more).
As a result, compared with 2018, the worldwide relative fiscal stimulus picture will be turned on its head. In 2018, the US was the only major economy stepping on the fiscal accelerator, and Trump's tax cuts duly helped trigger a period of US growth and market outperformance. Fast forward two years and it seems likely that the shoe will now be on the other foot. With this in mind, it is interesting to note that Shenzhen and Hong Kong-listed Chinese H-shares are the only two major equity markets delivering positive returns to investors this month. Could equity markets already be sensing the relative fiscal shift?
What will the US dollar do ? In a world in which the Fed slashes interest rates and in which the relative fiscal boost shifts from the US to the rest of the world, why should investors expect the US dollar to rise? Here, it is interesting to note that in spite of the massive risk-off move in global risk assets, in recent days the US dollar has failed to break out on the upside, and has instead rolled over.
What I’m Watching & Hoping For:
That infections in China are not reaccelerating now that people are returning to work.
The outbreaks in South Korea, Japan, Italy and Iran and international spread is contained.
There is no spread to populous regions like India, Indonesia, Nigeria etc where there are limited resources to test for and contain an outbreak.
A critical issue to watch for is that, if the US suffers an unconstrained outbreak, it will see its relative growth deteriorate and the prospect for accelerated rate cuts will grow.
Both will favor value over growth, likely in a difficult trading market.
Where does Leave Things ?
It’s possible that the current sell-off will mark a major shift in the investment environment.
The key drivers of this shift are likely to be a much easier Fed, a weaker US dollar, and stronger fiscal easing in the rest of the world than in the US.
All of this before Sanders starts climbing in the polls.
What outperforms in this market ?
B. A Few Things Worth Checking Out:
1. McKinsey released it’s impressive 2020 Private Markets update.
2. Credit Suisse released it’s Annual Global Investment Returns Year Book. I always learnt a lot from this.
Two great charts:
a. Look at how the USA has gone from 15% from the global equity markets to ~55% and how the UK has gone from 25% to 5%. What happens next ?
b. Check out how the high tech industry of the 1900’s - Railways - were 50% of the equity market in the US and UK.
The only constant is change.
3. Great & informative Macro Voices podcast on the Coronavirus.
4. MIT on the breakthrough Tech of 2020’s. My favorite are No.4 and No. 7 (Anti-aging drugs and Quantum Supremacy).
C. Don't Design for the Average
A brilliant insight from Rory Sutherland, whose ideas we have discussed previously.
“Metrics, and especially averages, encourage you to focus on the middle of a market, but innovation happens at the extremes. You are more likely to come up with a good idea focusing on one outlier than on ten average users. We were discussing this recently in a meeting when a round of sandwiches arrived. ‘This proves my point exactly,’ I said, pointing at the food.
The sandwich was not invented by an average eater. The Earl of Sandwich was an obsessive gambler, and demanded food in a form that would not require him to leave the card table while he ate. Weird consumers drive more innovation than normal ones. By contrast, it is perfectly possible that conventional market research has, over the past fifty years, killed more good ideas than it has spawned, by obsessing with a false idea of representativeness."
D. Lucky Problems
As I was lying in bed this week trying to get over jet lag, I realized that the jet lag “problem” I was having was a lucky problem.
Lucky problems are solvable problems. With a little time and effort, the problem goes away, with no lasting effect to think about going forward.
Unlucky problems aren’t solvable. They either end something, or keep coming back. If you watch the news regularly, you’ll come across plenty of examples of unlucky problems.
A problem of either type can be hard to get out of your mind when experiencing it. But if your problem is solvable, you can change your focus from a focus on the problem to a focus on what you can do to solve the problem—and then feel lucky for having a lucky problem.
Credit - Sorfis Investments
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