It’s not business; it is personal
First and foremost, a shout out to all the sung and unsung heroes fighting an enemy that concerns all of us. We know that, statistically, heroes always rise to a challenge but we don’t always know who and where you are. You make all of us look better and you have our respect and support.
During the first quarter of 2020, we were able to limit our clients’ losses between -3.9% and -11.8% (depending on our client’s individual risk profiles and circumstances). On average, our Q1 2020 losses are limited to approximately -7% on a consolidated basis. Our focus on risk management and preservation of capital remains our most important goal.
So, how are things going for you? Are you like me: anxious; have cabin fever, lockdown fatigue; overloading on food, and overloading on information about virology, politics, working from home, homeschooling, new laws, our civil liberties, healthcare systems, stimulation programs, morbidity statistics, mortality statistics, and economic statistics?
On top of all this, there is the stock market. It did hurt badly to see three years of stock market gains disappear in about 20 days. We know losing money is asymmetrical, as it feels proportionally so much worse than making money. We know that risk and uncertainty are part of the DNA of investing, but it still shakes us to the core when risk comes collecting its dues in such a systematic way.
Long-term successful investors like Warren Buffett and Charlie Munger say you should be willing to lose 50% if you are investing in the stock market. They did lose 50% of their invested assets three times during the course of their career. However, you and I, as well as most people cannot afford losses like Warren and Charlie; in fact, few of us have an aptitude to tolerate losses and most of us break down long before 50% losses are tallied up. We say we are long-term investors but this often does not rhyme with our short-term actions, our current income, our current finances, our fears and unpredictability of the near future.
Winning when the stock market is down, takes cash, courage, stamina, experience and a long-term view to be able to buy when everybody is selling. Yes, investing is so simple on paper, but oh-so not easy in real-time. Acting like we say we will, does not always manifest itself in the way we do things.
It’s not personal, it is just business
Covid-19 is in the business of copying itself. It does not have long-term or short-term goals, just one goal: “multiplying itself”. It does not have a conscience or seek to gain market shares against other viruses. It does not micro-target anybody in specific; does not advertise and does not have an incentive or reward we know of. Covid-19 just looks for a living cell to do what it is programmed to do and will always take the path of least resistance to attain its goal. Covid-19 is a coronavirus and is, as far as I understand, a small loose string of DNA, floating by itself much like an independent program virus in many of our computer systems. It is not personal.
Covid-19 mainly causes respiratory infections because the airways are the easiest path for the virus to transcend itself to the next potential living cells and multiply. Scientists and virologists don’t know why viruses exist, much like we don’t know why humans exist. A virus does not seem to have a higher purpose other than multiplying itself. It almost looks to me like the virus is an ugly vicious rogue rebel without a cause.
You see science is exact; nature is inexact, unpredictable and still has abundant mysterious ways of operating. Once a virus attacks a living cell it uses the cell to reprogram itself to make an estimated 100,000 to 1,000,000 copies of itself. That process takes about 10 hours, but this mutation (copying) process fails about 99% of the time, so only 1,000 to 10,000 copies of the virus end up being effective and will be sent out to find new living cells once the initial cell is used. The virus will rage on to copy itself as long as it finds new living cells that don’t fight back effectively.
Eventually, our immune systems will start to recognize the virus and fight it with antibodies. We, as human species, will win from Covid-19 either by the adaptation of our immune systems or thanks to a vaccine. But this will not end without a horrible fight. Viruses have shown the ability to “shift” or disguise themselves from our immune systems, only to come back in second and third waves. Luckily, our immune systems have still been able to adjust, fight back and win over time. We know this because otherwise, we would not have been able to survive the influenza pandemics of 1889, 1918, 1957, 1968 and 2009.
Decisions and unforeseen consequences
We know decisions have different orders of magnitude and derivatives. We often don’t foresee all the consequences of our decisions. The right decision to fight the Covid-19 virus and to limit the burden on our healthcare systems is to quarantine; a derivative of that decision is the obvious carnage it creates for our economies. Many governments and central banks have therefore collectively engaged in mitigating the economic fallout by initiating stimulation programs, which represent up to 15% of GDP. This is a massive amount of extra liquidity (debt) injected into our global economic system. However, it will most likely not be enough to stave off a sharp downturn and we have no clue as to what kind of unintended consequences (positive or negative) this will have or what the timeline will be. This economic decline combined with very high debt levels (public and private) will cause pain. It is a dangerous cocktail to have on our table. Don’t let anybody convince you otherwise.
We know it all happened before: massive debt increases happened during past wars, so this is not the first time governments engage in very significant spending. Just after the great depression, President F.D. Roosevelt introduced the New Deal, an enormous undertaking, which caused an almost doubling of the national deficit between 1933-1936. As during the ’30s, it could take a long time (a lot longer than many experts talk about now), to see all the effects of today’s stimulus. Some of the effects will most certainly stay with us, like our five-day workweek, which was born out of a necessary production slowdown during the great depression.
We know negative compounded interest is a powerful tool to reduce debt. Negative real interest rates occur when nominal interest rates are lower than inflation resulting in real negative rates. Therefore, it is likely that bondholders will demand higher interest rates if they think a country might be unable able to pay its debt obligations or worse devaluate an underlying currency of the debt obligation to reduce its debt. But if central banks pledge to buy unlimited amounts of bonds, interest rates might not necessarily go up, so the pain is likely to end up in the currency markets. In the end, we will come out of this situation, but someone will pay, whether it is the other guy, the next generations or the current, it has always been this way. There is no free lunch.
It’s the nature of business or is business the nature?
The stock market behaves much more like nature than science. Sentiments, more so than valuations, have always played outsized roles in large market moves. Sentiment is a fickle thing and our collective mood can change on a dime and in force. It resembles animal herd behavior so much that John. M. Keynes coined the term “animal spirits” in 1936 to describe our instincts and our emotions, which influence our human behavior and decisions. General employment, public and private debt levels, consumer sentiment and current media narratives are good indicators of what is happening in the stock market today and are short-term oriented. Beware that a stock market can fall another 50% after a 20-30% negative correction if an economic downturn is going to be steep and long and if sentiment worsens.
As usual, almost everything rides on us, the consumer. Not only does our sentiment count, but we are also the taxpayers who are responsible for generating most of Uncle Sam’s income: 85% of USA federal revenues are generated by income and payroll taxes. We, the consumer, are also responsible for generating most of our GDP: 70% of GDP is consumer spending. Prolonged high unemployment and prolonged negative consumer sentiment is therefore undoubtedly going to hurt sharply and will become a self-enforcing cycle. Animal spirits will rule and there is no way of stopping it: it’s in our nature.
The Truth
We certainly don’t have the answers: there are simply too many variables at play to make an educated guess at this point. We know our limits and therefore simply revert to what we know best, which is protecting assets the best way possible. We do this by concentrating on value not price, holding a lot of cash, acting like business owners of the companies we own, letting our automated strategy do its work without any emotional biases, including greed, getting in the way of a sound investment decision and buying protection against further calamities if available at the right price.
You see, it does not make a lot of sense for us to exert a huge amount of energy to chase maximum performance for a short period just to lose it all in a few days. If you are a long-term investor and you don’t need cash, the coming weeks/months will be easier, because you won’t have to navigate the short-term volatility of the markets. You can simply concentrate on the businesses you want to own for the next 10 years. If you liked them at a certain price, you should like them even more at a discounted price.
We thank our clients for their trust in us. It is an enormous responsibility and we will try our utmost best not to disappoint you. Be safe, be patient, salute our heroes, read good books and be optimistic: it pays!
Let us know your story; we would love to hear it.