A pandemic with unprecedented social-economic impact
The Covid-19 pandemic has become the one of most devastating global social-economic events in many decades. As of early April, the global death toll has reached almost 90000. The crisis has led to an almost complete shutdown of major global economies and an accelerated shift of most daily activities towards the internet. As our lives, our businesses, and the world we live in change day by day, there are a lot of questions on everyone’s minds.
• How long will we feel the effects of the coronavirus?
• How deep will it impact our life, our job and our economy?
• Is a major economic depression on the horizon?
It is well known that the stock market hates uncertainty. Over the past few weeks, the pandemic has caused widespread anxiety and panic selling of liquid investments. Currently, we believe that the stock market has priced roughly in 2-3 quarters of negative economic impact by the coronavirus. While we do not know how the course of the pandemic will play out, we believe that the crisis will ultimately end with 99% of us still alive.
The human toll of the coronavirus may forever change families, but the economic impact will likely result in a cycle of downturn followed by economic expansion like we’ve seen play out in the U.S. economy many times over. Historical US market data since 1926 shows that US equity returns following sharp downturn have always been positive over one-year, three-year and five-year periods. We believe the key to wealth creation is staying in the market even during these unsettling times.
This is the “Swimming Naked” moment
Warren Buffett once gave a famous warning: “It’s only when the tide goes out that you learn who’s been swimming naked.” With this coronavirus outbreak the tide has just gone out again, and clues to who’s been swimming naked have begun to emerge.
Office space sharing pioneer WeWork, once the poster child of the growth-at-all-cost startup mentality, is now facing an existential threat as gig workers canceled their monthly contract to work from home. Wework is now suing its biggest investor Softbank for breach of contract. In China, Luckin Coffee, a competitor of Starbucks, last week disclosed that its COO and several of his reports have been fabricating sales and expense transactions over several quarters in 2019. Their US-listed stock collapsed 76% in a single day last week, driven by both margin call and panic selling.
During the boom times, many companies and their financial backers were solely focused on growth and have never prepared financially or operationally for a potential market downturn scenario. Management often use their stock holding as collateral for margin loans to purchase real estate and other risky investments. When a sudden crisis comes, many of these risky behavior and their bad actors will get exposed. While everyone suffers during an economic downturn, the weaker companies and the unprepared will get completely wiped out and will never recover afterwards. We have been paying particular attention to avoid these high growth companies with weak fundamentals and unproven risk discipline.
Re-positioning for a cyclical downturn and subsequent recovery
Lives and businesses are being severely impacted by the Covid-19, but we do see a light at the end of the tunnel with testing capacity increase towards tens of millions over the next several months. As the economy slows down due to the health crisis, we should take a deep breath, keep our wit and remind ourselves that this crisis will ultimately pass. Investors should have prepared themselves for such rainy days by having sufficient cash resources and adopting a conservative mindset. Having said that, we believe that now is a good time to deploy excess idle capital to accumulate strong long-lasting businesses at good prices. However, we would also take any rebound opportunity to upgrade the portfolio by selling the weaker businesses as many of them may not survive this recession.
Our investment strategy is to maintain a medium-term perspective that the world and our economy will ultimately recover. It may take three months, six months or two years. The duration depends on:
- How widespread virus testing can become to identify all those infected
- How well we can isolate those infected
- How vigilant we are in our daily lives to stop spreading the virus to others
- Whether we can come up with an effective vaccine treatment in 1-2 years
The Bottom Line
Negative headline news about this health crisis and a recession are already reflected in the stock market prices. It is unwise to liquidate an long-term investment portfolio because of this short-term event. However, one should take this opportunity to upgrade the quality of the investment portfolio. We are cautiously optimistic that human ingenuity and resilience will help us overcome this global health crisis soon so our economy and the investment world would return to its original growth trend.