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With a certain sense of dread and morbid fascination, I am watching a tragic natural disaster unfold: the emergence of the Coronavirus Disease 2019 (COVID-19). Despite some hope that ex-China, the virus will disappear, many public health gurus believe that the contagion is going to continue and that containment efforts will likely fail.
As a critical care physician, I have seen my share of epidemic infections: meningococcal outbreaks in university dorms, SARS, H1N1 ‘flu, just to mention a few. The thing that concerns me the most is the temporal pattern: these types of phenomena are occurring in cycles with shorter and shorter periods of respite in between. For example, H1N1 arose in 2009 and we have experienced 3 epidemic years since then.
The relatively low case fatality rate seems to be reassuring; however, this is a specious conclusion. A high level of mild/asymptomatic illness promotes global spread, hinders containment and prolongs the pandemic. A prevailing view is that the Coronavirus pandemic is of historic proportions and that it may induce social and economic downstream effects that will reverberate for years, perhaps even permanently. Although the full biologic and socioeconomic impacts will only be obvious in retrospect, it’s difficult to argue against understanding the virology as thoroughly as possible. Our financial and physiological welfare may depend on parsing reliable information, while encouraging rational decision-making and strategic preparation.
As of today, 58 countries, 5 continents and over 91,000 reported individuals have been affected directly by the virus. 3200 deaths have been reported although many epidemiologists believe the true number is far higher. To make matters worse for public health officials, minimally symptomatic ‘super-spreaders’ without fever easily cross borders, board flights and catch subway trains going to work without being detected. The daily case count outside China appears to have hit a lower inflection point. Public health officials have to deal with a moving target: the virus is mutating and its biological properties are changing, making containment and treatment development efforts all the more challenging. Hospitals in developed countries often run over capacity in normal times, making many wonder what will happen to non-COVID patients with treatable but urgent illnesses when that capacity is occupied by those stricken by the novel bug. Certain dystopian epidemiologists have suggested that COVID-19 is here to stay permanently and will wax and wane with the seasons as a ‘new normal’. Finally, many political barriers to pandemic counter-measures exist.
There are also some reassuring findings: the disease within China is decelerating and the death rate (initially as high as 3.5%) is dropping, although this may well be due to case recognition. COVID-19 outside of Wuhan may not be as deadly with an incidence of severe and critical illness of about 5-10% (compared to 20% in Wuhan) and a death rate of about 1% (3%). There are bench studies suggesting that over-expression of the ACE2 gene in ethnic Chinese and smokers may be responsible for the very high rate of critical illness and this might explain why fewer have died outside of China. Perhaps that the pandemic will slow down and even burn out by summertime. Only time will tell.
The economic toll exacted by the bug is more straightforward, yet almost as dire. Like most COVID-19 patients, the global economy was not particularly robust and showed early signs of faltering well before encountering the virus.
This satellite photo of the Eastern hemisphere graphically demonstrates N20 emissions which are strongly correlated with industrial activity:
Under ‘normal’ conditions, China is the brightest red part of the map by far. There is no question that commercial activity in the mainland has plummeted more abruptly than at any time in living memory.
Our hemisphere has also paid a price. Last week, North American indices dropped by double digit percentage points: the largest weekly drop since World War 2!
10-year Treasury yields tumbled to record lows, driven by the rush to perceived safety. Blue-chip stalwart companies AB InBev, Microsoft, Apple, Mastercard, HP and Paypal all issued ominous profit warnings. According to George Soros’ theory of reflexivity, systemic stress creates a negative feedback loop that accelerates the distress and erodes the intrinsic value of businesses. Companies with disrupted Chinese supply chains, for example, may not be able to access the capital markets for debt or equity financing critical for their operations.
If the pandemic fails to subside with the onset of the warmer seasons as many expect (hope), many businesses will be adversely affected by the isolation imposed by quarantine and ‘social distancing’ encouraged by the CDC: travel, airlines, cruise/leisure will all suffer and some will fail. Canada, being highly dependent on natural resources along with many developing nations, will endure further economic distress as demands for our exports drop off and our tourism industry gets choked.
A prominent local microbiologist made a prediction during the 2009 H1N1 outbreak to me: the way we currently live, shop and move around will change, and perhaps permanently. She felt that much of the contemporary direction in social and city planning was misguided from a biological perspective: the focus is on ‘densifying’ living space in order to encourage use of public transit and walkable communities. It doesn’t take much imagination to consider how popular large apartment complexes (with single elevators per tower), office buildings, sports stadiums, concerts, subways/trains/buses might be during an established pandemic. Taking this idea further, how do you think the market value of these risky spaces might fare in a ‘new normal’ scenario where coronavirus comes back to create havoc every winter? Even if an effective vaccine or treatment emerges, what about the effect of the emergence of the inevitable next novel pathogen?
Like any massive disruption, along with the negative come some positive consequences. I think that opportunities to reduce infectious risk through innovative technology will arise. If history is any guide, necessity is the mother of invention and the human race performs its best when its members cooperate to a common goal.
Another, more optimistic perspective is that after previous pandemics have peaked, stock markets have historically out-performed.
What Can We Do?
1. Maintain dry powder: Being a value investor, this was pretty straightforward for me. The accumulation of cash equivalents is just a product of the opportunity set. If the market is expensive, a lot of cash accumulates. When it’s cheap, the cash position depletes. Sometimes a hedging instrument can serve as a cash surrogate. There should always be a safety cushion for a rainy day/catastrophe. A side benefit: when the market tanks, I sleep well at night.
2. Make incremental moves: In other words, I like to buy and sell securities slowly, deliberately and in small chunks rather than going for broke. There’s a feeling of urgency in these situations that must be resisted.
3. Focus on quality: highly profitable and well financed businesses run by owner-operators with durable competitive advantages are quite uncommon and even more so if they are reasonably priced. This is the time to find them, buy them and hold them for a long time so it can compound its value.
4. Even when the sky is falling, think long-term: I do NOT try to outsmart short-term traders or the ‘algos’. I have no edge over them; they have enormous resources and will generally come out on top. Your biggest friend is time arbitrage: in other words, if one is willing to hold assets that are probably going to do nothing for a year or longer, you have a durable advantage over your professional (or even AI) competition who need performance today, this week, month or quarter to justify their existence.
5. Create a shopping list: do your research ahead of time. The better you understand a business’ fundamentals, the more conviction you will have to build a position as the share price falls and the more confidence you will have to hold it when it recovers, but hasn’t reached its intrinsic value.
As a value investor, I enjoy seeing the markets correct. For me, investing is like a treasure hunt, detective story and a marathon all rolled into one. On the other hand, there are more important things than making money. The human cost already born by the remarkably resourceful people of China is staggering. I feel deep sympathy for those directly impacted by the ravages of COVID-19, particularly in Wuhan. I haven’t the slightest idea which pandemic scenario will play out and I remain deeply concerned.
I sincerely hope you and your families remain safe and prosperous, even if trying times may be lying ahead.