Watch Italy closely. The third largest country in terms of infections, Italy, has not yet gotten the problem under control. It is too early to tell when they might stabilize. This weekend they announced widespread, dramatic measures, including limiting travel for over 1/6th of their population. We will be watching Italy carefully to see whether the rate of new infections stabilizes.
Source: World Health Organization
What bears emphasizing is that we have yet to see infections spiral out of control (or "hockey stick") to a degree that that would support Dr. Lipsitch's predictions. That does not mean it cannot happen. We will thus calmly continue to seek extraordinary evidence that suggests it might.
What Actually Worries Us
What we do worry about is the potential of a domino effect, with each of the following events triggering the next in succession.
Odds are high that someone in your company, school, or church/synagogue will catch the virus.
The momentum in public fear could meaningfully accelerate in the US.
Compliance/legal/regulatory professionals would likely err on the side of caution and aggressively assert “CYA” measures. This will protect their constituencies, but at the cost of materially curtailing public activity and hence our economy.
We could get a supply shock as economic output slows.
Easy-to-get credit could become hard-to-get credit, which chokes weak, indebted companies. This amplifies the supply shock as capacity shutters.
Central bankers “go nuclear” printing money.
The combination of the declining supply of goods with expanding supply of money could lead to an inflation shock. Investors would likely shift from fearing deflation to fearing inflation, which would cause significant losses in the value of long-term bonds.
Lies, Damn Lies, and Multiplied Probabilities
Importantly, we need to remember that the above events are conditional (meaning each depends on the prior event happening). We thus need to be mindful of the impact of multiplying probabilities. Even if we believe that there’s a high probability of each event occurring (say 80%), there would be less than a coin-toss chance of being right. (80% * 80% * 80% * 80% = 41%)
Here’s another thing to keep in mind: Many of the statistics being parroted in the media are meaningless in isolation as so often presented. Rarely is there any mention of confidence intervals or statistical significance. Granted, the public wants numbers. Clean and easy numbers. The unfortunate truth is that we simply don’t have good data on this virus yet. No one knows the true fatality rates since no one knows exactly how many people are truly infected. And even if we knew that, it’s too early to know how many will ultimately die. A study just published jointly by the University of Hong Kong and Harvard’s school of public health puts the death rate at 1.4%. One of the lead researchers explicitly notes that this death rate would be lower if the calculation took into account infected patients who did not show symptoms.
Packed Subways and Empty Classrooms
Anecdotally, we were surprised to see complacency this week despite the dramatic headlines and market action. The subways were crowded as ever. We witnessed people sneezing or coughing, yet those nearby made no effort to move away. We heard lots of comments from friends and family like, “This isn’t worse than the flu.” In response, we say, "Get ready. Even if your personal odds of catching it are very low, your life is about to get turned upside down by this." Until this past week, very few people have been tested in the US. Now hundreds of thousands of test kits are becoming available across the country. Expect to see the number of confirmed cases rise dramatically in the US in the weeks ahead.
Sentiment has finally started to shifting in past few days (we fear) from one extreme to the other. A school in Westchester announced this week that it was closing for two days to sanitize its buildings. This wasn't because a student or family member had the virus. Rather, a parent was merely “present in a location that was closed due to contact with a person who is under quarantine from the coronavirus”. On Friday Columbia Business School canceled the upcoming 20-year reunion for our class.
This type of “CYA” overreaction is what we fear far more than the virus. When someone cries “fire” in a crowded theatre, the bigger danger can be the stampede of other people more so than the fire.
OK, Now What?
A question we’ve gotten a lot the past week: “Prices are cheaper, should we be buying?” It depends. Surprisingly, in the case of high yield bonds, we have yet to see compelling value. Spreads have widened, but nowhere near what we’d have expected. Stocks, of course, are cheaper, though are nowhere near bargains. The S&P 500 is down approximately 13% from recent highs, but it’s still above where it traded just several months ago. There are, however, some areas within equities that do look compelling. We may be adding selectively in these areas where appropriate for individual clients.
The bond market has had the biggest move of all. Treasuries are pricing in a combination of fear and deflation. We would look to those assets as a source of capital should we get more meaningful dislocations in credit spreads and equity prices. We continue to watch this closely.
We’ve been devoting most of our thinking to reconsidering portfolio structures and asset allocation frameworks. We have historically endeavored to think differently in this regard. Many investors employ traditional portfolio strategies based upon extrapolations of history (returns, risk and correlations) into the future. Admittedly, this worked in the past, but we cannot figure how it can work going forward. It is mathematically impossible given where interest rates are now. We believed this two years ago, and today our conviction is magnified. Now, more than ever, we need to be driving forward, looking closely at the road ahead, not in the rear-view mirror.
We will keep you posted as we learn more and as our thinking evolves. In the meantime, please reach out with any questions.
Yours in the Field,
Frank Byrd, CFA Steve Korn, CFA
Disclaimer: While the information presented herein is believed to be accurate, Fielder Capital Group LLC (Fielder) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Fielder is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Fielder makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Fielder or its employees may have an economic interest in securities mentioned herein.