Greetings!
You’re probably tired of reading “coronavirus updates” from every company you’ve ever done business with. But alas, we just wanted to reassure everyone that we are still here and haven’t lost our sanity. We are still working from the office and will hopefully continue to do so until it seems too risky for our group of under 10 to be together. If we do need to close the office, we are fully set up to work remotely: we will be able to make trades, communicate with you, communicate with our custodians, access all our records and technology, and make wise financial decisions on your behalf.
Taking a step back, it is startling just how quickly everything has gotten canceled…that’s the word of the month. Time will tell whether we did enough to social-distance (wait, that’s definitely the word of the month), or not enough, or maybe even too much, but these were necessary steps that needed to be made. It may be tempting to wonder why we can’t eat in a restaurant when there’s only 5 other people in the restaurant, but hopefully we can all utilize this rare occasion to do life in new ways. Cook something extravagant, order takeout (restaurants need help!) and have a picnic at home, read the book you didn’t have time for, go for a walk and hear the birds singing. Later in life we’ll be telling stories to each other about this time.
Since we have the mic…the market’s action on Monday was utterly shocking. The VIX hit the highest level ever at the close of trading, at 82.69…higher than any closing value during the financial crisis. Then it spent most of Wednesday and early today above 80. As a reminder, the VIX is one of the most telling indicators of panic in the markets. It makes sense that the VIX was that high, given that the Dow fell 2,997 points on Monday. This was the 2nd worst day EVER, IN PERCENTAGE TERMS, at 12.93%. No day during the Crash of 1929 (-12.82% was the worst day), nor the Great Depression, nor the Financial Crisis was worse. Only Black Monday in 1987. To be honest, trading action was very similar to that day, with selling causing panic selling, causing algorithms (program trading, aka computer trading) to kick in and start selling. That has been the case on each of the last 8 days, a stretch when the Dow closed either up or down MORE THAN 1,000 POINTS every day. I guess we should look on the bright side that 3 of those 8 days were up. The S&P has closed up or down at least 4% on all 8 days; this has eclipsed the previous record of 6 during the Crash of 1929. All told, the Dow is (right now) down 33% from its high on February 12, whereas the S&P 500 peaked on February 19, and is down 30% from then. [The Dow is down that much more largely because of Boeing, which is -73% in just 5 weeks.] The depth of the decline from peak to trough is now on par with 1987, which was -36%, and is worse than the average bear market. European stocks are -36%, some emerging markets are down considerably more, although China is down only 15%.
Wikipedia has been doing a good job keeping up their “biggest up and down days,” so instead of reprinting it, we’ll just include the link to the page. It is amazing just how this run in March stacks up against history:
https://en.wikipedia.org/wiki/List_of_largest_daily_changes_in_the_Dow_Jones_Industrial_Average
On the one hand, you only need 7 more days like Monday and the Dow will reach 0. That’s not meant to shock you, but to demonstrate the inanity of this selloff. It is nothing short of shocking, and revolting, to see the stock market turned into a lightning-fast Vegas table churning trillions of dollars. To say that investors are slave to algorithmic traders and hedge funds, though, would be giving them too much sway. Nobody needs to pay heed to them. This is not to say that we know where stocks are going, or even where they should be, but the volatility sucks people into making bad decisions. Just like every other bear market.
The justification for the sharp drop is that we are in unknown territory, both with how long it will take the virus to run its course, how many will die, and how many players in the economy (companies, consumers) will not make it through intact. As we don’t know the first two, we think distinctions can be made in the third. First of all, we have always said we only want to own companies which we are absolutely confident can make it through anything. We are still confident that we have done that. There are times (roaring bull markets) when low-quality companies and hyper-growth companies perform the best. Today they are getting crushed.
It should be said that we own companies in a broad swath of industries, many of which will handle the short-term economic downturn relatively well, but some of which will take a hit. Thankfully we don’t own much in the hospitality/travel/entertainment industries, but one we do own is Sysco. Its business is supplying restaurants, schools, and other food-serving institutions with food and other supplies. Surely they’ll be supplying a lot more cleaning supplies, but a lot less food. Thankfully, it is a financially sound company and should have no problem riding through this. Will its earnings drop? Yes, a lot. Will its earnings go back up eventually? Yes, a lot.
Same for the orthopedics companies—Zimmer and Stryker—who will experience some short-term trauma because elective surgeries are getting postponed. Patients who had surgeries lined up are being encouraged to delay, most are generally not wanting to go to operating rooms if they don’t have to anyway, and hospitals will likely repurpose some operating rooms for what could be a wave of coronavirus patients. Will their earnings drop? Yes, probably a lot. Will those postponed surgeries happen someday? Yes, most assuredly. We see only 2 reasons they would not: if workers lose health care coverage, which we don’t see as likely; even Medicaid covers orthopedic surgeries and most orthopedic patients are covered by Medicare anyway. Or, suddenly their knees or hips feel better and they decide they don’t need new ones. So why are their stocks selling off? Shoot first, ask questions later.
Investors will continue to seize on the daily “new cases count,” and we would not be surprised that as it continues to rise, the markets will continue to be nervous. At some point, the count should go down. Sometime before then, it should be going up at a slower rate…this is the “second derivative,” and it was very useful in 2009 for sniffing out both the end of the bear market as well as the recession. We acknowledge that there are likely a lot of positive cases out there who haven’t been tested, and news that 4 Brooklyn Nets players (including Kevin Durant) tested positive and 3 don’t even have any symptoms, is not comforting. That’s why the social distancing is necessary. On the other hand, so far, less than 20% of people who have gotten tested (most of whom present with symptoms) have tested positive. Since we really just started these containment measures, though, new cases should continue to rise for at least a few weeks. Testing is about to become vastly more available, which will also result in a wave of new positive tests. But they will help to reinforce containment, and will allow Americans to return to normalcy sooner. We still believe these measures will help keep the infection rate relatively low…remember it has only reached 0.006% in China.
While it’s tough to hang your hat on positive developments regarding the virus’ spread, China’s new case count continues to hang close to 0, and 95% of businesses are up and running, including restaurants. Starbucks reported yesterday that 90% of its China stores are open now. Apple’s announcement that it is closing all its stores except those in China, which it had just re-opened, is telling. The stores in China are open for business. Hopefully it means we in the U.S. can get there sometime soon. Guess what was happening in Hong Kong (and other Asian countries who were affected early) on February 5? Yes, consumers were hoarding toilet paper and preparing for a life of closed restaurants and restrictions on moving. What are they doing now in Hong Kong? Getting back to normal life: going to work, riding the subway, and going to restaurants, albeit still taking precautions via face masks, temperature checks, and frequent disinfection. “Normal life” are very strange words considering what Hong Kong has been through.
As we await better news on the virus count, businesses will be busy closing and working remotely when possible. Restaurants and retailers will be undoubtedly be laying off a lot of folks. We all hope that most businesses will choose to retain their employees, and pay them out of their own dwindling profits. A lot of business owners have indeed stepped up to say they will do that. Other retailers, like grocers and Amazon, are trying to hire a lot of people. The key will remain whether businesses which cannot work remotely, like factories, can keep working, keep people employed, and keep them paid, so they can emerge intact on the other side. Hopefully, social-distancing-at-work measures will be sufficient. Some companies, like the automakers, will shut down temporarily to clean and to social-distance, but also because sales are falling so they don’t want to be build inventory too high.
That said, we know a lot of employees are getting laid off now or are about to. Many of them are living paycheck to paycheck. This is where the government can step in with fiscal stimulus, and they are. Unemployment insurance and “helicopter money” will help to bridge to the other side. Helicopter money is a reference to the (fictitious) idea of flying a helicopter over everyone and just releasing dollars out of the chopper. Former Fed Chairman Ben Bernanke once quipped that he felt it would be effective in certain circumstances, which earned him the nickname Helicopter Ben once he became Fed Chair. In this case, the federal government is planning to just give money to everyone, although by the time it gets formal approval, there will surely be strings attached, like an income limit. Normally, we are not proponents of the concept of helicopter money, but in this case, getting cash quickly to folks who need it is paramount, rather than creating a more traditional program which requires an application process, being overseen by the government…that doesn’t sound like quick cash.
In the corporate world, the carnage will be felt most harshly among oil producers, with retail and hospitality nipping at their heels. Heavily indebted companies will be the first to go. Industries deemed to be of national importance will get bailouts; it may be surprising to hear that airlines make the grade, but alas. Banks are working hard to make sure they’ll get paid back and will surely be pressured to restructure loans. The good news for banks is that they should be able to extract better loan terms.
The level of panic and pessimism in the financial markets is unsettling, but it’s also unprecedented. The 30-year Treasury bond yield hit an intraday low of 0.71% on March 9. Today, it’s 1.79%. The poor sap who bought at the low yield now has a 22% paper loss. I know, this is still better than the loss in stocks, but bonds are supposed to be the “safe haven.” The Fed cut interest rates a whole 1% to 0-0.25%, which is where they were for 6 years, until as recently as 2015, and announced they would be buying bonds, which they have done off and on for the last 11 years. They have also announced they are shoring up financing markets like the treasury repos, dollar swaps, commercial paper, and money market fund markets. The Fed used these backstops in 2008-09 and they were very effective. Why wouldn’t they be? The government is literally backstopping entire lending markets! But the headlines generally resounded with the message that the Fed has “used up all its ammunition.” The implication is that the Fed was trying to restore the stock market, and by lowering rates to 0, they can go no lower. No, the Fed was ensuring that the markets which banks and companies use, which we call the “plumbing” of the financial markets, don’t get “clogged.” Once those are settled, banks and companies can be more assured of their lending and borrowing strategies. To further say that the Fed can do no more, if need be (and Lord help us if more is needed) is far from the truth. Look no further than Japan, whose central bank has been buying Japanese stocks for years. There is nothing stopping the Fed from buying stocks in American companies if it felt the need. If there’s anything we have learned about Jay Powell, Fed Chair, it is that he is very attuned to market movements.
We’ll get through this. Please don’t hesitate to pick up the phone and call if you need to talk about anything!