Covid-19 and Investing

teamadminInvestments, Market Outlook

I decided to set some thoughts and observations down on “paper”. There are always risks in life and investing is no different. The world today appears at great risk. But then as a 60 year old it has been at great risk a number of times in my life. The oil crisis of the 70’s. The consequent hyper inflation. The 3 day weeks with the UK system shut down. How about the HIV epidemic. Then 9/11. 9/11 changed the world, because it coincided with great technological change giving us always on access to news. Fear and panic were summoned instantainiously. In came heightened security. In came looking over ones shoulder. In came extremism of both polarities. Are these current times worse? Possibly but we won’t know until we are eventually through it. I recently took the risk to become the major (40%) shareholder in TEAM, an asset manager based in Jersey. I can honestly report I could not be more pleased. We can make very quick decisions and recently we have. The outcome for ourselves and our clients have been beneficial. Life is full of risk but it is also about generating those little and often accretive gains. It is not about “big bangs”. It is about patience and consideration. Hopefully, the below gives a window into mine and our collective experience and thinking.

“First, we must preserve and save lives. Then we must preserve and save the global economy”.

What do we KNOW about COVID-19?

COVID-19 is the name given by the World Health Organisation (WHO) for the disease caused by the novel coronavirus SARS-Co V2, first identified in Wuhan, China in late 2019. It is an acronym for corona virus disease of 2019.

There are only 7 coronaviruses known to cause disease in humans:

Four human coronaviruses cause symptoms of the “common cold.” These are named 229E, OC43, NL63, and HUK1.

The other three human coronaviruses cause much more serious lung infections, or pneumonia: SARS- CoV in 2002 (severe acute respiratory syndrome or “SARS”), MERS-CoV in 2012 (Middle East respiratory syndrome or “MERS”), and SARS-CoV2 (the current pandemic know as COVID-19).

“Novel” means that it is a new coronavirus previously unidentified in humans. So, it is new and different from the others. Like SARS and MERS, it is a zoonotic disease. This means it is one that begins in animals and is transmitted to humans. Scientists suspect that Covid-19 may have come from bats because bats appear uniquely able to harbor many viruses that cause serious human disease: Ebola, Marburg, Rabies, Hendra and Nipah. We can now add Covid-19 to that list.

Covid-19 is a very serious but it becomes most serious because of what it can precipitate. Most deaths occur from secondary bacterial infections, sepsis and kidney failure, often exacerbated by strong antibiotics that can be toxic to the kidneys.

What we do know is themortality rate of COVID-19 is at least 10 times greater than seasonal influenza. Overall, currently, 3.4% of reported COVID-19 patients around the world have died, according to the World Health Organization.

One piece of good news is we know the weight of the virus. It is physically larger and heavier than other known respiratory viruses. This limits its ability to travel through the air. Covid-19 can only travel about one to two metres, or seven feet before gravity takes over and it drops to the floor. Other viruses such as measles or chickenpox can stay airborne because they are lighter and can be carried on tiny dust particles.

What we know is globally there have been thousands of deaths and this number will eventually, if not rapidly go into the hundreds of thousands with or without drastic action. Without action we know this has the propensity to kill millions.

What do we THINK will happen with Covid-19?

It is very difficult to forecast the numbers and geographic spread, together with the mortality rate. Contrary to initial expectations, the spread of the virus around the world is not following the China (outside Wuhan) or Korea experience. Or for that matter Singapore or broader Asia. The European experience is more like the Wuhan or worse the Hubei rates. The US would appear to be conforming with Europe. It looks like the US and Europe are heading towards 1,000 cases per million of population like Wuhan.

Goldman Sachs concluded recently that 50% of Americans will contract the virus (150m people) on a par with the common cold. The next most relevant industrial economy is Germany where 70% will contract it (58M people). Of those impacted 80% will be early-stage, 15% mid-stage and 5% critical- stage.

With a mortality rate of circa 2%, heavily skewed towards the elderly and immunocompromised this means up to 3m people will die worldwide.

It’s estimated we won’t have a vaccine for 12–18 months. What we KNOW about Covid-19 and the global economy.

Coronavirus is both a public health problem and an economic problem. The measures being taken to save lives necessarily mean shutting down large parts of the consumer-driven economy.

We also know it has and will continue to severely impact the supply or manufacturing side of the economic equation. People are losing jobs and businesses are losing revenue. This is known as an “externality” induced shock to the economy.

Does that mean we should simply ignore the virus and let people get sick and possibly die? No, because the global healthcare system can’t handle what would happen. It would collapse and be unable to help anyone with anything.

The global economy needs to be sustained for however long it takes to beat the virus. We know that means massive fiscal stimulus spending. We are going to have to do for everyone the kind of things that have long been implemented for natural disaster victims: emergency grants, subsidized loans, exemptions from rules, and more. We know this means massive very significant increases in Government and global debt. There is no choice.

What do we THINK the impact on the global economy will be and what will it look like post Covid-19?

The Covid-19 pandemic has very quickly hit global economic activity and caused a world recession. While the virus is perhaps abating in Asia, Europe has become the epicenter of the outbreak and now there is a significant outbreak in the U.S. and Canada.

The current recession has the propensity to develop into a depression. It won’t because Governments in every major economy will guarantee unlimited fiscal compensation for lost revenues and wages. Maybe not 100% but say 75%. They will pump liquidity into the nooks and crannies of the economic system.The result is we have zero interest rates, low inflation and we have become tolerant of unprecedented levels of national debt and borrowing. The financial system as such will not fail, even if we end up with “helicopter” money. For many years the stresses and financing burdens of battling Covid-19 are going to severely compromise the internal and external financial systems of the developed world and particularly Europe, with its weak economic starting point.

In the absence of a most unlikely financial system collapse or crisis, there will be a recovery. The question is when, how fast and of what magnitude. If we use pre Covid-19 expectations for GDP growth I would summarise the outcomes as the two below. There clearly are more. They are sourced from different research houses including McKinsey Global Research Institute to Goldman Sachs.

  1. Rapid and strong public health response. Virus spread controlled in each country within 3 months. I.e. Virus contained and slow recovery.

Goldman Sachs concluded recently that 50% of Americans will contract the virus (150m people) on a par with the common cold. The next most relevant industrial economy is Germany where 70% will contract it (58M people). Of those impacted 80% will be early-stage, 15% mid-stage and 5% critical- stage.

With a mortality rate of circa 2%, heavily skewed towards the elderly and immunocompromised this means up to 3m people will die worldwide.

It’s estimated we won’t have a vaccine for 12–18 months. What we KNOW about Covid-19 and the global economy.

Coronavirus is both a public health problem and an economic problem. The measures being taken to save lives necessarily mean shutting down large parts of the consumer-driven economy.

We also know it has and will continue to severely impact the supply or manufacturing side of the economic equation. People are losing jobs and businesses are losing revenue. This is known as an “externality” induced shock to the economy.

Does that mean we should simply ignore the virus and let people get sick and possibly die? No, because the global healthcare system can’t handle what would happen. It would collapse and be unable to help anyone with anything.

The global economy needs to be sustained for however long it takes to beat the virus. We know that means massive fiscal stimulus spending. We are going to have to do for everyone the kind of things that have long been implemented for natural disaster victims: emergency grants, subsidized loans, exemptions from rules, and more. We know this means massive very significant increases in Government and global debt. There is no choice.

What do we THINK the the global economy will be and what will it look like post Covid-19?

The Covid-19 pandemic has very quickly hit global economic activity and caused a world recession. While the virus is perhaps abating in Asia, Europe has become the epicenter of the outbreak and now there is a significant outbreak in the U.S. and Canada.

The current recession has the propensity to develop into a depression. It won’t because Governments in every major economy will guarantee unlimited fiscal compensation for lost revenues and wages. Maybe not 100% but say 75%. They will pump liquidity into the nooks and crannies of the economic system.The result is we have zero interest rates, low inflation and we have become tolerant of unprecedented levels of national debt and borrowing. The financial system as such will not fail, even if we end up with “helicopter” money. For many years the stresses and financing burdens of battling Covid-19 are going to severely compromise the internal and external financial systems of the developed world and particularly Europe, with its weak economic starting point.

In the absence of a most unlikely financial system collapse or crisis, there will be a recovery. The question is when, how fast and of what magnitude. If we use pre Covid-19 expectations for real GDP growth I would summarise the two poles in outcomes as the below. There clearly are more. They are sourced from different research houses including McKinsey Global Research Institute to Goldman Sachs.

  1. Rapid and strong public health response. Virus spread controlled in each country within 3 months. I.e. Virus contained and slow recovery.
    • China 2020 GDP down 0.4% returns to pre crisis level Q4 2020.
    • US 2020 GDP down 2.4% returns to pre crisis level end of Q4 2020.
    • Eurozone 2020 GDP down 4.4% returns to pre crisis level end of Q1 2021.
    • World 2020 GDP down 1.5% returns to pre crisis level end of Q4 2020.
  2. Healthcare systems succeed in containment but not sufficiently to stop a second or third wave. Consequently, social distancing continues regionally for 6 to 8 months. Equals slow long-term growth with very subdued global growth.
    • China 2020 GDP down 2.7% returns to pre crisis level Q2 2021.
    • US 2020 GDP down 8.4% returns to pre crisis level beginning of Q1 2023.
    • Eurozone 2020 GDP down 9.7% returns to pre crisis level end of Q3 2023.
    • World 2020 GDP down 4.7% returns to pre crisis level end of Q3 2023.

What do we THINK the outcomes will be post virus?

What will not change are the powerful secular megatrends:

  • Economic power
  • Demographics
  • Urbanisation
  • Technology
  • Scarcity of resources

However, I would particularly highlight the following:

Healthcare: In most economies, the healthcare system has little changed since their creations post World War 2. Now they will need to determine how to meet such a rapid surge in patient volume, managing both in-person and virtual care.

In our interconnected and highly mobile world (5G), we must rethink the speed and global coordination with which healthcare systems need to react. Policies on critical healthcare infrastructure, strategic reserves of key supplies, and contingency plans for critical medical equipment will all need to be looked at and will be invested in.

Education: Educational institutions will need to consider modernizing to integrate classroom and distance learning.

Social: These will range from working from home to large-scale surveillance (5G).

We will see an advance in Digital Identity Cards. The further growth and use of digital payments and contactless. For me, this will be much like the aftermath of 9/11. 9/11 forced much heightened security through scanners at border control points. So, we may get thermal scanners at airports and sea ports, etc to identify those with high temperatures to be sidelined for testing.

Consumer: A shock of this scale will create a big and lasting effect in the preferences and expectations of us all as world citizens, as employees, and as consumers. As above, the online world of contactless digital commerce and e-commerce will be much strengthened in ways that will change consumer behavior forever. It is happening as I write.

Will coronavirus spell the end of cash in Britain?

Fears around the virus being distributed to notes and coins has led to many businesses sticking to contactless payments for the time being” The Telegraph, 23/03/20

Work life: From Alibaba to HSBC and Google to Unilever, companies around the world are telling staff to work from home in a bid to combat COVID-19.

This remote working on the current scale is unprecedented and will leave a lasting impression on the way work forever. This will supercharge growth in mobile digital office facilities. “The virtual office”. The “Business in a box”. This is will be empowered by Software as a Service tools. 5G will aide this acceleration. The Cloud service providers will experience significantly increased demand. IT infrastructure will need enhancing at national and company level.

Security concerns will add further complications to the technology side of remote working and will have serious consequences. Investment in cyber security will be stepped up.

What do we THINK this all means for savers, pensions and investors?

  1. Interest rates will stay low (0%) for a lot, lot longer. Possibly 3, 5 plus years. Even 10 years. The income returns from Fixed Interest will remain unappealing, even capital destroying for longer. The hunt and demand for income continues and gets more demanding. There has to be a risk of inflation further out. Possibly, hyperinflation towards the end of the decade.
  2. We have learnt that “fireproof” funds are not “fireproof”. These absolute return funds supposedly designed and constructed to protect savers from market shocks do not. The BMO Global Equity Market Neutral fund fell 33.5% between 1st January and 6th March. One of the largest now has an annualized return over 3 years of -6.5%.
  3. The violent market correction has demonstrated that an index tracking or passive fund investment is exactly that. Some areas of the market have been less impacted while oil stocks are down 40% 50%. You own the market and all of it indiscriminately.
  4. Having identified the above, active, traditionally managed funds have not covered themselves in glory. Some have appalling returns.
  5. The supposedly well diversified Equity Income Funds with 50/60 holdings, effectively index hugging, will fail. There will be widespread dividend cuts from balance sheet compromised, cash flow challenged and thin margin businesses. I include the the banks and other financials. We live in a zero interest rate world.

“Only when the tide goes out do you discover who’s been swimming naked.”

Warren Buffett

The Pareto Principle:

The Pareto principle states that 20% of the inputs are responsible for 80% of the outputs. It’s named after Italian economist Vilfredo Pareto, who in 1906 found that 80% of the land in Italy was owned by 20% of the population.

In the US, Morningstar, identified that only 7% of U.S. large-cap mutual funds have outperformed the S&P 500 index over the past decade. It is similar in the UK and Europe. Why? Well in the States, two thirds of stocks underperformed the index. 40% of these gave a negative return. Between 1926 and 2015, the S&P 500’s outperformance to Government Bonds was attributed to the best performing 4% of stocks.

So, what’s the lesson?

  1. Accept there will be disappointments, like all decisions in life. Things go wrong. When they do, recognize and in the case of a stock, sell and move on. Much the same as life.
  2. Increase your chance of success by owning a vital and limited number of stocks. 30 to 35.

1. Mistakes commonly made.

  • Sitting on the side-lines
  • Catastrophic risk /economic externalities (Covid-19)
  • “Investing” in commodities (currently oil)
  • Excessive stock picking and trading
  • Focusing on Emerging Markets
  • “Emotion” – “stocks you like or fall in love with” (common in investment managers is my experience)

We need to find just a few, 20, possibly 30 to 35 companies we can have faith in. That will ride the unforeseen such as today’s world. The strong and it is the strong that capitalize in distressed times. They gain market share in their products and services. And we need to be global.

We need to be invested in those undeniable global megatrends.

Where are these vital few? Well let’s start with your (for 2) average weekly shopping basket:

Let’s create a portfolio comprising of just our above shopping basket:

Now let’s introduce the concept of compounding. This is the process in which an asset’s earnings, from either capital gains or income (dividends) are reinvested to generate additional earnings over time.

The benefits of generating income from equity markets:

  1. Get paid to invest
    • Historically dividends have provided 43% of the S&P500 total return.
    • Dividends provide an ongoing return while waiting for capital appreciation
  2. Capital preservation
  3. Generate an additional income stream
  4. Inflation hedge
  5. Reduces risk & volatility
  6. Compounding returns

Next, lets get a bit gloomy. The stock prices do nothing and dividends do not grow across all 5 years in this case. But GBP250 monthly contribution continues. Yes, you can keep those going.

Now let’s get very gloomy. Anymore gloomy and you need to get to know Bear Grylls or just stock up on hard spirits.

How about stock prices go down an average of 2.5% per annum for all of those 5 years (very unlikely). The Crash of 1929 and subsequent bear market lasted 2.8 years and sliced 83.4% off the value of the S&P 500. Anyway, you keep reinvesting and no dividend growth. Regular GBP250 continues:

Not the worst result.

How simple is it. Is the stock market cheap today? Probably. Personally, I think there is a lot more downside. Maybe 10% to 15%. I don’t know. I leave that to the well paid expert Investment Managers. But actually, I want it to stay cheap for as long as possible (until I need the income) to give me more time to benefit from the most powerful law in mathematics.

The point is that it is the income you receive at the end of the period. It is not about the starting income yield. Don’t chase apparent but probably unsustainable big dividends. In my experience, in normal market conditions any share yielding more than 4% is so for a very good reason. RISK. The risk it will be cut at some point.

My portfolio contains all of our shopping list plus another circa 18/20 companies that I think will benefit from whatever our new world looks like.

Lastly, I have 12 Rules

1. Do what you love

In the world of business, the people who are most successful are those who are doing what they love”. (Warren Buffett)

2. (KISS) Keep it simple, stupid – (can I understand it?……probably not)

It makes sense that if you limit your investments to those situations where you are knowledgeable and confident, and only those situations, your success rate will be high” (Joel Greenblatt)

Know what you own, and know why you own it” (the great investor, Peter Lynch)

3. Audits – be able to evidence a company is meeting your expectations.

There’s a reason that God gave us two ears, two eyes, and one mouth. It’s so you can listen and watch twice as much as you talk. Best of all, listening costs nothing” (Sir Alex Ferguson)

4. You don’t need to own the mine

During the gold rush it’s a good time to be in the pick and shovel business” (Mark Twain)

5. Practice saying “No”

The difference between successful people and really successful people is that really successful people say no to almost everything” (Warren Buffett)

6. Listen to life

Not everything that can be counted counts, and not everything that counts can be counted” (Albert Einstein)

When I am travelling in a carriage, or walking after a good meal, or during the night when I cannot sleep; it is on such occasions that ideas flow best and most abundantly” (Wolfgang Amadeus Mozart)

7. You want to own the company – all of it

There are plenty of attributes that separate the great leader from the good manager. Both may put their work before their family and friends, survive on little sleep, endure a lifetime of red-eye flights. Look more closely and you will find that the great leader possesses an unusual, and essential, characteristic – he will think and operate like an owner, or a person who owns a substantial stake in the business, even if, in a financial or legal sense, he is neither” (Sir Alex Ferguson)

8. Visualisations

Imagine and think like the management, employees, the other shareholders, suppliers, the business partners, the competition, the threats and the customer.

9. Don’t trade

Thousands of people have tried, and the evidence is clear: The more you trade, the less you keep” (Benjamin Graham)

Most investors hate to take losses and they grab most gains far too quickly.

10. ‘Good’ companies make good investments

Good companies tend to make good investments. Bad companies tend to turn out to be bad investments (ESG)

11. Capitalism without capital

The growing dominance of the intangible economy” (Haskel, J and Westlake, S)

12. The ‘Rolex’ rule – liquidity, ability to sell as close to immediately.

The market can remain irrational longer than you can remain solvent” (Keynes)

Stay safe