The world just changed narrative is bullshit

COVID-19 has been an issue for weeks. The bond market realised it. Forex markets realised it. So don’t give me the “Italy changes everything” bullshit. And spare me your “black swan” nonsense*.

The reality is that very little has changed with the growth of COVID-19 over the last few days. If we look only at cases caught outside of China:

  • three weeks ago, cases were doubling every five days
  • two weeks ago, cases were doubling every five days
  • now, cases are doubling every five days

COVID-19 Cases doubling every few days

 

That is what a contagious disease does. The growth in cases transmitted outside of China is following the kind of pattern you would expect:

We know the disease is incredibly virulent – the Diamond Princess showed that. We also know that a vast number of patients show little or no symptoms, which means that it spreads easily. We have enough evidence to suspect that the disease is airborne.

We also know the key risk of an epidemic is when hospitals are over-run with patients and can’t properly treat the patients. That is why the mortality rate in Hubei is 5x higher than in the rest of China. And that is why China has put strict quarantines and bans. And that is why Italy has followed suit.

The best hope for countries is to dramatically limit human interaction. This will save lives. It will also have a significant effect on the economy.

ECONOMIC OUTCOMES

The most common bullish argument is:

  • COVID-19 is just a bad version of the flu
  • There will be so much fiscal and monetary stimulus that stock markets will go higher

The risk is that China can’t stimulate much harder – they are already building at incredible levels:

Chinese floor space construction

And so it is likely the stimulus won’t be enough to replace the lost demand. After being through a complete quarantine/lockdown, my expectation is consumer spending will be muted for months and maybe even years.

If a gigantic government stimulus eventuates, then we will reconsider based on how expensive the market is and how targetted the stimulus is.

Going to ground

Our portfolios “went to ground” at the start of February, selling stocks and investing in bonds/cash/international currencies. Our tactical growth fund has been close to 50% underweight equities for a number of weeks. This is a significant deviation and one that we have not undertaken lightly.

On a stock basis, we cleared out of travel and oil stocks, bought up global consumer staples (in particular health and hygiene), global healthcare, and opted for defensive holdings.

Trading going forward

But that is in the past. The question is what to do from here. Our plan at the moment is:

  • Stay focussed on the virus statistics (see here for latest data or here for a more analytical series) to look for changes
  • Hold onto cash, foreign currencies and bonds. Patience, patience, patience. Build up our shopping list. We are looking for high-quality stocks are leveraged to the economic cycle that will become cheap. But, we are in no need to rush out and spend.
  • Make relative trades. When markets get smashed, relative valuations change, and often good quality stocks become cheap relative to other shares. We like to use market volatility to increase the quality of the remaining shares in our portfolio.

If markets shoot higher, then we will underperform, but we think the trade-off is justified. Downside protection is more important at this point in the cycle than chasing stock markets higher.

 

* Black Swan Footnote: I hate when people talk about these sorts of events as black swans. A black swan is an event that is not just unlikely but presumed not to be possible. Say you are playing roulette. There are 18 red numbers, 18 black numbers and one green. If the ball lands on green, that is not a black swan! You knew the green number was there, it was unlikely, but the ball clearly could land on green. If the ball somehow got perfectly balanced on the strip between two numbers and the house decided to take everyone’s money, that is a black swan – i.e. you didn’t even realise that the ball could do that (or the house would do that!).