RO RO FARM Co.
Investment Partnership
 

Memo - March 22, 2020​

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“When the facts change, I change my mind.” – John Maynard Keynes

 

General

The coronavirus has pressured us to quarantine ourselves. For most nerds like us, we realize that quarantine is our natural habitat. Thus, it is not so bad. However, the constant negative news of the coronavirus can be gloomy, so here is a coronavirus joke. 

One day a son and his father are driving home.

Son asked his dad, "why is my sister's name Paris?"

Dad replies, "because we conceived her in Paris."

Son scratching his head, says, "oh really, thanks, dad."

Dad replies, "no problem, Quarantine."

 

Coronavirus

As of March 22, 2020, there have been 340,408 coronavirus cases around the world. 228,877 cases are still active with 218,342 (95%) in mild condition and 10,535 (5%) in serious or critical condition. 111,531 cases are closed with 96,958 (87%) recovered or discharged, and 14,573 (13%) dead. Note that these are cases recorded after people have been tested. The total cases are likely to be much higher because not all of the people go out and get tested. Many stay home and recover, who will never be recorded. 

 

The number of infected coronaviruses patients has been increasing at an exponential rate. Countries around the world have taken extensive measures at the cost of economic activity. Illustrated below in Figure 1, the social structure established due to the coronavirus can be categorized in the forms of a free-for-all, an attempted quarantine, moderate social distancing, and extensive social distancing (Washington Post). The brown area represents people infected with the coronavirus. The pink area represents people who recovered from coronavirus. The x-axis from left to right represents time. The free-for-all has the fastest overall recovery. However, it comes with the negative consequence of the highest death rate. The best approach to combat the virus is through significant distancing with the lowest infection rate. However, it has a negative impact on the economy and the longest overall recovery

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Figure 1

 

Figure 2 below illustrates the fatality rate of people with underlying health issues (CNN). Contracting COVID-19 appears to be more dangerous for patients with underlying health problems, such as high blood pressure or diabetes.

  

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Figure 2

 

Figure 3 below illustrates the fatality rate by age. Early data suggests that the older the people are, the more dangerous the virus is to them. The fatality rate was higher among older patients.

 

  

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Figure 3

 

The world's healthcare system is on a full focus on finding a cure for the coronavirus. Some of the smartest people and best companies are investing their resources to find a cure quickly. Some drugs have helped to fight the 'duration and severity' of the coronavirus (CNBC). Countries have used anti-malarial drugs to help contain the growth of the virus, which has FDA approval. Companies such as Gilead have drugs showing positive signs in clinical trials. However, the search for the ultimate cure continues. 

 

The Economy

The coronavirus has caused the world economy to slow down to a great extent. Most consumers have decided to stay home to protect themselves from being infected. Thus, consumption has decreased. United States' Gross Domestic Product – GDP – consists primarily of use – approximately 70 percent. Counties with high consumption rates are going to suffer economically. It's expected that the unemployment rate will increase. 

 

Authorities around the world have taken the 'extensive distancing' approach. This approach is the best approach to fight against coronavirus. This approach will have the lowest infection rate and most likely the lowest death rate. However, the significant risk is that the economy will fall into recession. It also an approach that will take the longest to deal with the coronavirus. Given the fact that 30,000 people die every day from hunger, it might be a slight overreaction from consumers to fight coronavirus on a comparison basis. The reaction is a moral obligation to protect the elderly and people with other health issues. Just because people are older and have health issues, it doesn't mean we put a price tag on their age and health for the sake of economic boom. 

 

Everyone will not practice 'extensive distancing.' If everyone around the world practiced 'extensive distancing,' then we would successfully fight the coronavirus in the shortest period. However, the reality is that we will have a mix of a 'free-for-all, attempted quarantine, moderate distancing, and extensive distancing.' Further, more people will die from the combination of unemployment, coronavirus, and hunger. 

 

The most significant risk is that the economy goes into another great recession or depression. In this case, people die not only from coronavirus but form other factors such as unemployment and hunger. However, we have many wise and smart people around the world, and we hope we can all together come up with solutions as fast as possible. 

One another risk would be the economy faces a supply shock. The stimulus package has contained aggregate demand. However, given the fact that many borders are closed, and many businesses are not operating at full capacity because of the coronavirus, the U.S. economy faces the risk of inadequate availability of goods and services. Although low inflation has been the theme for the last 10 years, a supply shock has the ability to produce inflation – or worse hyperinflation. 

 

The Fed 

The Fed has gone all-in with their stimulus package offering $1 Trillion plus a day in the repo market. They have lowered interest rates to near-zero and "opened emergency lending windows to support commercial paper issuers and money market funds (Bloomberg)."

 

The Fed will most likely continue to expand its monetary policy. The Fed is moving aggressively, injecting 1.5 Trillion plus into the U.S. economy. The municipal-bond market and mortgage-backed debt would have broken down without the Fed. On Friday, "the Fed did venture beyond its established playbook, expanding an emergency financing program for money market funds to include those that buy short-term municipal debt – something it avoided doing during the 2008 financial crisis" (Bloomberg). Further, the Fed also pledged to buy $200 billion of mortgage-backed debt to stabilize the market. 

 

The Fed is like a giant – and the greatest – hedge-fund. The assets held by the Fed – from quantitative easing – produces income, which goes to the Treasury. This is a mind twister and a different topic. The Fed is doing what they can to save the American economy – especially the financial system. The action has lowered interest rates for the Government to borrow in times of crisis. 

 

The Government 

In terms of fiscal policy, "Larry Kudlow, a top economic advisor to Trump, went even further in estimating the overall scope of the package Saturday, telling reporters it could top $2 trillion." Further, Kudlow, who is also the director of the National Economic Council and said that the "package is coming in about 10% of GDP, it's very large."

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The three stimulus phases are summarized below (Axios):

• Stimulus Phase 1: In February, President Trump asked Congress to provide $2.5 billion to fight the spread of the virus. But settled on $8.3 billion and signed into law on March 6.

• Stimulus Phase 2: The package of $100 billion, negotiated by Treasury Secretary Steven Mnuchin and House Speaker Nancy Pelosi, was signed into law by Trump Wednesday night. The measure provides:

  • Free coronavirus testing for the uninsured. Two weeks of paid sick and family leave.

  • Increased federal funds for Medicaid and food security programs, like SNAP.

  •  Increased unemployment insurance benefits.

• Stimulus Phase 3: The Treasury Department released a $1 trillion relief proposal Wednesday that would include industry-specific bailouts and payments to individual taxpayers. The proposal would provide:

  • Two rounds of direct payments to taxpayers, on April 6 and May 18, costing $250 billion.

  • $300 billion in small business loans.

  • A $50 billion bailout for the airline industry.

  • $150 billion to other industries affected, including hotels, casinos, cruise line operators, and shopping mall operators.

  • Guaranteed money market mutual funds

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Overall, in the short-term, the stimulus package should help contain the fire from increasing. There is no question the unemployment rate will increase, and people will die because of it. However, we have a government that is taking aggressive action to minimize this risk. It is not going to solve the problem, but it should help. It is good to live in a country with massive firepower, even though it means taking on more debt. 

 

The Markets – Macro

Taking the information, we aggregate how the important variables above effects the economy. Everyone has their own opinion of markets. Our opinion is that no one knows what the markets will do in the short-term. I think the efficient market school is physics envy in terms of how the markets operate. Our understanding is that it's more like a mob in a football game because of human emotion involved. One thing is for sure, the market will respond positively as soon as there is a positive solution to the coronavirus pandemic. 

 

The market recognizes that consumers and producers have changed their behavior in a manner that impacts the economy negatively. It doesn't make sense to sacrifice the lives of elderly adults, people with other health issues, and to save the economy. Most people are not going to take that risk. 

 

The market also recognizes the stimulus package from the Fed and the Government. John Maynard Keynes criticized that the stimulus package was weak during the Great Depression. We think that Keynes would have been happy with the aggressive stimulus package. However, we would argue that Keynes would agree with us with the fact that the main solution is a cure for the coronavirus. The cure for the coronavirus falls in the field of Healthcare. If the coronavirus epidemic endures, then more stimulus will be needed, which might be the case. 

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The good news is that billions of dollars and some of the smartest people in the field of Healthcare is trying to find a cure. People are already going through a trial for the coronavirus vaccine. Plus, people are experimenting with pre-approved drugs, and some look promising. However, this process could take anywhere from months to years. 

 

The Markets – Micro

From a micro standpoint, there are many companies selling at bargain prices. One good thing about the coronavirus is that most people recover. The American economy has gone through severe conditions before. Thus, it is a high probability bet the market and U.S. economy will be back on track 10 years from today. This mindset gives the confidence to invest in securities that are undervalued. Valuing the companies individually, there is more bargain than money. Many companies are undervalued in terms of valuation. Many companies are selling at prices above a 50 percent margin of safety. 

 

In terms of – long-term – valuation-to-price, the spread is wider than it was a year ago. The lower the price for a company, the happier an investor should be in terms of cost to buy. If an investor is unhappy concerning a lower buying price, then that individual is in the wrong field. Value investors have struggled over the last 10 years. Finally, value investors now can come out of there caves. 

 

In the long-term, investors – not all – over the world will not be satisfied with low Treasury yields or sitting in cash. The question is where the flow of money will go. It is a high probability that sooner or later, investors will invest. 

 

The Markets – Financials

Buying cyclical companies at the peak is a sure way to lose money. However, we are not at the peak. Plus, financials usually get hammered during downturns. There is a lot of value in the financial sector. The most important thing to consider is how well the banks are capitalized. Generally speaking, banks in the United States are very well-capitalized. Banks around the world are to be avoided because 1) they are not well capitalized, 2) they are overleveraged to withstand a downturn, and 3) overexposed to derivatives, which are ticking time bombs. 

 

The Markets – Airlines, Hotel, Cruise, Entertainment, and Restaurant

There is a lot of value in the airline, hotel, cruise, restaurant, and entertainment sector. However, many value investors will fall into a value trap. Many of these companies in this sector will withstand the pandemic. However, many of these companies' balance sheets it too weak. Most companies in this sector will need short-term funding – if not a bailout. Value investors dipping their feet in this field should be extremely careful. We like no brainer investments; therefore, most investment in this field goes in the too hard pile. 

 

The Markets – Energy

Energy companies also fall in the category of the too-hard pile. Companies in this sector have been hit one of the hardest because of 1) the coronavirus, 2) supply and demand game, and 3) change in consumer behavior. It is a one-three punch. Many products and services provided by energy companies are commoditized, which means the competition is fierce. The supply and demand game played on natural resources by countries such as Saudi Arabia, Russia, India, and so on has put great pressure on producers. Many of these producers are not going to survive, given a long-term horizon.  

 

Conclusion

In conclusion, considering the known-knowns, known-unknowns, unknown-knowns, and unknown-unknowns, anything could happen to the markets; therefore, you have to prepare all across the board. The faster there is a cure for the coronavirus, the faster consumers and producers will change their behavior. Thus, the quicker the economy and markets will recover. The world, in an attempt to conduct significant distancing, is a moral action, which has negative economic costs. However, the stimulus package should help contain these negative economic costs in the short-term until there is a cure. History tells us that it is the best time to buy for long-term value investors. In one aspect, given one's analysis is correct, the lower the price, the lower the risk of securities.

 

Further, betting against the U.S. has not been a wise move. In times of crisis, the U.S. has always found a way to find a solution. The world is a fantastic movie. Let's see what happens in the future. 

 

Cordially,

Rojan Shrestha