Memo - March 15th, 2020
'Cash combined with courage in a time of crisis is priceless." – Warren Buffett
The Economy
Coronavirus has already had a material effect on the economy. The economic impact is different than the 2008 crisis. If the economy is a car and the people in the vehicle are the consumers, then in 2008, the car broke down because of the driver – producer – had too much fun and drove the car too aggressively. The U.S. government and the Central Bank – the Fed, who were the mechanics fixed the car through bank bailout and quantitative easing. Concerning the Coronavirus, this time, the vehicle is not broken. The consumers and the producer are scared to get in the car.
Consumers' and producer's behavior depend on their confidence; however, consumers' and producers' behavior has changed. The U.S. government has not been motivating, but the Fed is taking aggressive action. Overall, the Coronavirus has caused consumers and producers to change their behavior. For example, producers are changing how they operate their business. Many businesses are changing business hours, and employees are working from home. From a consumers' standpoint, economic activity has declined. Consumers are mostly staying indoors, not traveling, canceling vacations, and so on.
Further, insurance companies are reporting fewer accidents. The flow of cars in the street has decreased. It is tough to change the behavior of consumers. Thus, when consumers change their behavior substantially, something serious is going on.
In economics, the critical thing to consider is the ripple effect. One always has to ask the question of what could happen next? In the investment business, it's irrational to make decisions on emotions. Thus, we look at the numbers.
There are about 173,268 coronavirus cases, which keeps increasing. 88,814 cases are active cases with 82,877 patients in a mild condition (93%) and 5,937 patients in a serious or critical condition (7%). 84,454 are closed cases with 77,789 patients recovered or discharged (92%), and 6,665 patients dead (8%).
One thing to consider is that the Coronavirus has not spread widely. Plus, it's more deadly to the elderly. It is good that people are taking precautions steps, and it is negative that many people will die because of the Coronavirus. However, using common sense and looking at the numbers, we can conclude that; 1) it is not the deadliest variable killing people, and 2) most people do recover. The most significant variable that kills people is hunger. Approximately 30,000 plus people die every day due to starvation. That is about 10,950,000 death per year.
Further on a per-day basis, approximately 850 mothers die from giving birth, 2,950 people die from suicide, and 950 people die from HIV/Aids. In conclusion, people are slightly overreacting. The overreaction, in some sense, maybe suitable for humanity; however, it has negative economic consequences.
The fear of Coronavirus has a ripple effect throughout the economy. Economic activity has decreased. Since one man or women's income is another person's income, the decrease in economic activity will reduce disposable income for the short-term. This increases the probability of an increase in the unemployment rate. The tradeoff with regards to coronavirus death is that with a one percent increase in the unemployment rate, approximately an estimate of 40,000 people dies in the United States alone. Worldwide the number will be in the millions. More than a tradeoff, it will be a 'one-two punch.'
The Fed
The Fed has more market influence than ever before in history. Further, they can take action faster and on a large scale. Recently, the Fed has decided to 'inject $1.5 Trillion in Bid. 'Around September 2019, the Fed started to increase its balance sheet; now, this action is going to increase the balance sheet further. The New York Fed 'conducted an additional $500 billion, three-month offering on Thursday, and will offer $1 trillion in short-term funding." "The Fed would offer another $1 trillion on a weekly basis." In all, the Feds' aggressive quantitative easing program has decreased the target range for the federal fund's rate by 100bps to 0-0.25 percent. The valuation of the most asset increases instantly. Now the question is how long will interest rates stay at current levels.
Markets
The outbreak of the Coronavirus has increased the volatility in the financial markets. The market is full of fear. However, everything should be looked at from a valuation standpoint because a good investment can be a lousy investment if one overpays.
The markets' one-two punch' is an increase in valuation to price. Two variables have increased valuation to price. One, the fear of the market sells off below asset valuation levels. Two, the Fed has lowered the Fed Funds rate. The interest rate is like gravity to asset valuation. Relative to interest rates, bonds are overvalued. Stocks were never in bubble territory. Now, looking at interest rates, many companies are significantly undervalued.
The decision to buy or sell is tricky. In this market, one has to be very cautious about using leverage. We don't know if the prices will decline further. We do know that volatility creates opportunity. The best approach is the long-term approach and investing in undervalued securities. The more the companies are undervalued, the greater the margin of safety. No one knows if the market will go up or down. The most important strategy is to position oneself, where if the market declines further, then one invests more aggressively (vice-versa). Thus, it would be wise for investors to start buying the most undervalued securities above the margin of safety of 50 percent. Looking at companies individually across the sector, there are many undervalued companies with a margin of safety above 70 percent. That is a bargain. We end with a quote from Ben Graham, "A market is a voting machine in the short-run and a weighing machine in the long-run.
Cordially,
Rojan Shrestha