When Do We Get Out, The Marginal Buyer, Optimism..

April 7, 2020

“I don’t complain about the lack of time....what little I have till go far enough. Today - this day - will achieve what no tomorrow will fail to speak about. I will lay siege to the gods and shake up the world”

- Seneca, Medea, 423-425

A. When Do We Get Out ?

This is what so many of us are asking.

What do you think ?

I found the deck from BCG helpful. If this is correct then we are looking at another +2 months on the back of 2-3 weeks that we have already experienced.

As we go through this, the debate on the marginal usefulness of the lockdown in terms of its contribution to lives saved versus its economic impact will grow.

According to Michael O’Sullivan (author of the great book The Levelling):

More weeks of lockdown in Europe will test the sanity of its citizens and business people. At very least, political leaders will have to outline some kind of roadmap to normalization – the continued isolation of vulnerable members of society, wearing of masks, a gradual return to normal working patterns for example. Balancing this will be incredibly hard to do, and control. At this point, market volatility may give way to a pick-up in social and political volatility.

This is probably true.

One thing I’ve learnt over twenty years is that in times of crises, the equity markets are least useful and most likely to be wrong. At these moments you need to look at the plumbing of the financial system and understand what’s happening underneath.

A podcast I found super helpful around the plumbing of the equity market is: “The Second Leg Down: Strategies for Profiting After a Market Sell-Off”

According to Alan Brazil at SOM (previously head of Cross Asset & HF strategies at GS):

Delinquencies across the economy will shoot up and create concerns about credit losses on bank balance sheets. The moratorium on mortgages will protect borrowers but that pushes the problem to securities servicers that will defaults because they will not have the revenue to pay the coupon on the securities. Further, mortgage borrowers are more likely to continue to not pay even after the moratorium is lifted. The ABS sector such as autos, credit card and airplane leases could melt down. Commercial mortgage loans will be in limbo, will their tenants make lease payments if their stores, offices, and hotel rooms are empty, make rent payments if they have no job? The diversification benefit of CMBS will go away as mortgages backed by office buildings, hotels, retail and multi-family will all suffer for months from missed lease or rent payments. Is there really going to be a V shape recovery in the 2nd half of the year without a vaccine?

On the CMBS / ABS front - worth checking out this chat Tom Barrack, CEO of Colony Capital (and one of the most experienced Real Estate investors in the US) on the crisis in Commercial Real Estate Market.

The longer-term consequences of the virus on our economy will be substantial in ways we don’t even contemplate today, also discussed well in this NYT article.

Alan continues:

Forget about when, the real question is do we really need to go to offices to work, to malls to shop, or to hotels to stay in for work or pleasure? How many new hotels or office buildings will be constructed? When will people start buying cars again if their credit ratings are crushed after missing a couple of payments?

Against all of these short- and long-term economic stresses, weigh the benefits of stimulus. Does one check for $1,200 matter when someone is going to miss a couple of months of paychecks? What is the benefit of zero interest rates for companies or consumers that can’t borrow, or forgivable loans for small business with little or no revenue? You can bail out the airlines and potentially cushion the downside for Boeing but when will people get on a plane or when will these airlines or EM airlines start buying any planes again, including those from Boeing?

So, a pretty bleak picture at least in the short run. The US equity market is clearly caught in the uncertainty between the positives and the negatives. The magnitude of the fiscal and monetary stimulus is a surprise and clearly positive. The death rate is still stunning but orders of magnitude better than what could have happened. There is a promise of antiviral therapies being developed, as well as shortages of ventilators and protective equipment being addressed. But again, containment is a strategy not a cure for the virus. The uncertainty of containment will continue to have a negative headwind in the short run for the economy, while the longer-term impact of the pandemic on the world economy will take month to become evident.

I found the below picture from the Eurasia group useful in thinking about the longer time lines in how this will work through society.

Which leads me to the other big thing I worry about: Erosion of the global middle class and impact on emerging markets.

More on that next time.


B. The Marginal Buyer

But in the end, it’s all about supply and demand. Who is the marginal buyer and who is the marginal seller?

Let me give you two examples. Since 2008, the marginal buyer of treasuries and fixed income assets has been the FED.

And facilitated by low interest rates by the FED, corporates have been the single largest buyer of stocks (companies buying back their own stock).

But this may now be stopping for a number of reasons, one of them being the demonization of companies buying back their shares by everyone from Joe Biden to Bernie Sanders and Liz Warren (see this WSJ article for example). The other reason being to preserve cash. This will take a huge bid out of the market.

The other thing to note is the correlation between markets. Historically during recent market sell offs (think last 10-15 years) bonds and equities have been negatively correlated. One of the amazing things we saw in March was the complete breakdown of negative correlation.

This positive correlation wrecks havoc to most institutional portfolios whether 60/40 or risk parity mandates.

If this continues, it will indicate that market participants don’t have a risk free asset to serve as ballast in their portfolios during times of market stress.

Which will have consequences…..


C. Learning Optimism

A useful book for times like this is Martin Seligman's Learned Optimism. Martin is a psychology professor and researcher at University of Pennsylvania. 

His research is focused on Optimism.

You might know this but it turns that optimistic people show a huge number of benefits, including:

- Health / Longevity / Physical Activity

- Job Success

- Overall Life Happiness

I am intent on making my two daughters humble, but very optimistic kids. 

Optimists differ from pessimists in three ways:

Permanence: when something bad happens, how long will it take for them to recover

Pervasiveness: how likely a bad event is to permeate into the rest of their life

Personalization: how likely are bad events to by internal to them, versus due to external factors

His research shows that while we are all at different points on these scale, there are a couple of simple things you can do to be more of an optimist and therefore get all the benefits of being one

You can take his survey on this Stanford website to figure out how optimistic you are (takes 5 mins). Surprisingly I was much less optimistic than I thought !

In Seligman's model, when an adversity happens, it leads us to have a belief about ourselves, which then leads to some consequences (behavior) - This is the ABC model (adversity - belief - consequence). 

You can help negative beliefs causing negative consequences, by adding two steps:

D - disputation

E - energization

For example:

Adversity: You lost money in the market

Belief: You think, "I can’t believe I was so stupid to let this happen”

Consequence: You are overcome with anger and sadness at yourself.

Disputation for the above example might sound like this: "I am overreacting. What’s done is done, but I can still learn from this, I still have the opportunity to make money in the future. I’m still learning”.

Successful disputation leads to energization, the E in the ABCDE model. 

One is energized, and should indeed try to actively celebrate, the positive feelings and sense of accomplishment that come from successful disputation of negative beliefs. 

Disputation and Energization (celebration) are the keys to Seligman's method.

Hope that leads to a more optimistic you.

To become more optimistic, try to avoid the three Ps that that make us pessimistic as identified by psychologist Martin Seligman: Permanence, thinking that this situation will last forever; Pervasiveness, that everything in life is now a struggle; and Personalization, blaming yourself. Notice when you’re falling into those traps.


D. A Few Things Worth Checking Out:

1. Peter Attia had Ryan Holiday on his podcast discussing Stillness and Stoicism.

2. Morgan Housel article on Why Time Has Slowed.

3. Daniel Yergin (literally wrote the book on Oil) in Foreign Affairs magazine discussing Oil Price War & The Pandemic.

4. Gavin Baker was on the Invest Like the Best podcast discussing Investing Through a Bear Market.


Quote I’m Thinking About:

Bill Watterson, the cartoonist and creator of Calvin and Hobbes, on the difference between ambition and happiness:

“...having an enviable career is one thing, and being a happy person is another. Creating a life that reflects your values and satisfies your soul is a rare achievement. In a culture that relentlessly promotes avarice and excess as the good life, a person happy doing his own work is usually considered an eccentric, if not a subversive. Ambition is only understood if it's to rise to the top of some imaginary ladder of success. Someone who takes an undemanding job because it affords him the time to pursue other interests and activities is considered a flake. A person who abandons a career in order to stay home and raise children is considered not to be living up to his potential-as if a job title and salary are the sole measure of human worth. You'll be told in a hundred ways, some subtle and some not, to keep climbing, and never be satisfied with where you are, who you are, and what you're doing. There are a million ways to sell yourself out, and I guarantee you'll hear about them. To invent your own life's meaning is not easy, but it's still allowed, and I think you'll be happier for the trouble.”