A Global Crisis “Unlike any Other”
BY THOMAS FRISBIE, CFA
Every April, this writer looks forward to the playing of the Masters golf tournament—the perfectly maintained golf course, the perfect gallery behavior, the perfect azaleas in bloom and the nearly perfect golf. CBS advertises the event several weeks in advance, with the mellifluous voice of Jim Nantz crooning “a tournament unlike any other—the Masters!” This year’s Masters will certainly be unlike any other since it was postponed from its April dates and rescheduled for this November, the heart of football season. The culprit, of course, is COVID-19, itself a global health challenge “unlike any other”.
As this health crisis sweeps the globe, our stock and bond markets have responded in unparalleled and wildly chaotic ways. The S&P 500 stock index plunged 34% between February 19 and March 23, an almost unparalleled speed of descent. The VIX Index, a mathematical measure of day-to-day stock price volatility, hit readings in March never before recorded in the history of that calculation. Interest rates on U. S. Treasury bills, notes and bonds plunged, while at the same time the prices of lower quality fixed income securities were also plunging. The financial world was seemingly girding for Armageddon. But suddenly, hopes for medical and economic cures overtook dread, and the stock market staged a 28% rally in about four weeks. The challenge for investors is to determine which market move is the “signal” (indicating the prevailing price trend) and which is the “noise” (a price movement that is contrary to the trend that is emerging). In plain English, which team is in charge right now, the bulls or the bears?
Professional investors rely upon analysis to make investment decisions, and analysis requires a basis in facts and reasonable assumptions. But this pandemic is the worst in 50 years or perhaps 100 when it is done, so we have no recent precedent from which to cull data. (The Hong Kong flu in 1969 killed 1 million people 50 years ago; the Spanish flu killed 100 million 100 years ago. Neither pandemic is a helpful precedent since our medical science is vastly more advanced and our financial system institutions greatly changed. And it is still early in data collection based upon our experience with the virus since March 1. Data modeler Nate Silver, famous as the founder of the fivethirtyeight.com website, points out that just estimating ultimate U.S. deaths to be caused by COVID should, in theory, be quite simple-take the number of vulnerable citizens, multiply by the rate of infection per capita and then multiply again by mortality per infection. Voila! But Silver points out that none of these three variables is currently known, and the government’s own estimates of the ultimate death toll have changed dramatically just in the past eight weeks.
Investment pros trying to make simple economic forecasts such as second quarter (April through June) economic growth are similarly thwarted by a lack of reliable data on the quarantine’s economic effects and a lack of relevant historical precedents. Charles Schwab’s strategist recently compiled second quarter GDP forecasts from 17 investment management firms, and the forecasts range from -9% to -50%. We are a third of the way through the second quarter, and Wall Street GDP estimates are all over the map. How is this helpful? In normal times, it’s news when any firm’s economic forecast deviates from the mean by more than 1%. Without sufficient data or relevant precedents, economists are reduced to making intelligent guesses.
In a Quixotic effort to fill the information gap, researchers at UC-Davis and the Federal Reserve Bank of San Francisco this spring published a study of the last 15 pandemics that caused at least 100,000 deaths. To get a sample of 15 major pandemics, the study started with the Black Death pandemic of 1347, NOT a contemporary phenomenon. (See the study here) There have only been five major pandemics since 1900, and, again, the last big one occurred in 1968. What the researchers concluded is that the usual economic effects were subsequent returns on investment lower than normal and subsequent wage growth higher than normal. This could ultimately be good news for workers but definitely not for investors.
So how can a prudent person invest intelligently in stocks amidst a challenge in projecting the ultimate economic effects of the COVID pandemic on consumer demand, production, economic growth and interest rates, effects that might linger beyond the discovery of a cure? There are many different methods to choose from when investing in stocks. One reasonable solution could be to invest in companies that feature four important characteristics: (1) they sell a product or service where demand is resilient, even during difficult times; (2) they are dominant in their industries, either due to scale advantages, patents, favorable regulation, low cost production and/or branding; (3) they have financial strength and will be able to sustain their businesses even in deep recessions and (4) their stocks are not already richly priced to reflect these winning characteristics. The list of potential candidates is large and ranges from mundane businesses such as grocers, drugstores or the local power company to younger sectors such as wireless phone networks, broadband services, online retail and indispensable software providers. We absolutely, positively can’t predict where the market is headed next week, next month or even next year, but perhaps we can make reasonable judgments on which businesses are well positioned to survive the economic pain currently attending the COVID-19 pandemic.
Where does the U. S. economy and the U.S. stock markets go from here? The most candid answer is “we don’t know”. Again, as Nate Silver mentions in a comic strip that the death toll from the virus is a function of the number of people vulnerable, the rate of infection and the fatality rate. But nobody has any of those numbers, to any degree of confidence! Furthermore, nobody can model how consumers and businesses will behave after the “Grand Reopening” simply because this is the first of its kind in our recorded history. Will people cook? Will they order take-out? Will they dine in at a restaurant? Will they sit next to strangers in theaters or airplanes or next to colleagues in offices? Who knows? And will many of us, having had our incomes suddenly interrupted play our finances closer to the vest and ramp up our savings rate, at the expense of economic activity? Every dollar of your spending is a dollar of income to somebody or many “somebodies” else, so if you start saving more, my income gets cut, and if I start saving more in response, your income also gets cut.
There are many different methods for making money in the stock market during normal times, but it is very likely that these will not be normal times for a very long time to come. If that is correct, one approach to investing in stocks is to identify businesses that are so woven into the fabric of our everyday lives that even if their business is soft during this transition time, it will still be intact on the other side. Some such businesses such as Amazon or Google are valued highly in the stock market already, while others, such as your local electric or phone utility or perhaps your local drugstore are not. So for those investors who need the returns that stocks hopefully will produce but can’t stomach any further volatility, perhaps building a portfolio of “essential businesses” would be a low anxiety way to proceed.
As an expression some credit to the Chinese, “May we live in interesting times”.
The information provided is for illustration purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action to be taken. Any securities identified were selected for illustrative purposes only. Specific securities identified and described may or may not be held in portfolios managed by the Adviser and do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable.