Life Interrupted

Dear Senderoistas,

I wholeheartedly hope this missive finds you in good health and stoically navigating the havoc wrecked by the Black Swan now known as coronavirus.

As you certainly don’t need me to tell you, life as we knew it back in the good old days of only a couple of months ago has been upended to a stunning degree.

Our portfolios have been decimated (if we are lucky), our businesses have been disrupted, and our travel plans tossed unceremoniously out of the window. And that’s just for starters.

We consider ourselves among the fortunate, as years ago we made the choice to move to a small town in middle of nowhere Argentina which, as luck would have it, has so far been spared from the virus now stalking the land.

And in the entire province there has only been one confirmed case... so far.

I suspect our luck won’t hold out, though to it’s credit (and quite possibly the only time you'll read me giving credit to anything the Argentinean government does), the authorities here were quick to act.

Which means we are even more isolated than usual, as all foreign visitors are now banned, and a general lock down has been put into place on a local level.

Basically, unless you are going or coming from a food store or pharmacy, all travel on public roads is prohibited.

Happily, the people here in Cafayate don’t appear prone to panic, so the fruit and veggie vendors, the local butcher, etc., are still well stocked.

Fortunately the golf course here at La Estancia de Cafayate remains open, and I have three horses on property so keeping active and entertained is not a problem.

Self-Quarantined

The photo here is from my new “office”, in our wine room. The internet won’t reach my actual office and I can’t get it fixed until the quarantine is lifted, so it is here that I am sequestering to escape the noise of my daughter and her friend as they binge watch Brooklyn Nine-Nine in the living room.

So, we’re getting by just fine.

But what about the world?

Markets in Turmoil

Not to make this political, because the origins aren't political, but the Black Swan of coronavirus is probably the Democrats last chance to unseat Trump this fall.

Therefore I suspect they’ll do whatever they can to be quietly unhelpful in the hopes the country tumbles into a deep recession between now and November. A depression would be icing on the cake.

After which, they fantasize, Grandpa Biden will take over the presidency and show just how much gumption the scrappy old fellow possesses!

Could happen.

After all, President Trump has not been shy about taking credit for the success of the stock market.

Yet, it would be more than unfair for him to be assigned  the blame for the gore now coating the streets of the world’s financial districts.

The defining thing about Black Swans is that almost no one sees them coming. One minute it’s dainty cakes and hot chocolate, the next it’s face down in a puddle of puke.

As for the investing environment, well, it’s just plain ugly.

Having grown a bit skeptical about the ability of the market to go up forever, for some time I had been buying bonds, selling stocks and raising cash.

Even so, there have been a few days over the last month where I did one of those Daffy Duck neck snapping double takes at the carnage in our portfolio.

Overall, the losses in that part of our portfolio which I manage total about 17%, but that takes into account our cash position. Looking at just the equities, we are now down about 35%.

However… and it’s a big however, I have long believed it’s not a loss (or a profit) until you sell.  

And I have no intention of selling any time soon. In fact, I have been selectively buying, using the simple strategy of deciding how much I ultimately want in certain investments, and then buying in tranches after big down days.

So far my buying has been mainly of the SPY ETF, a broad bet on the resilience of the United States, as well as Exxon (XOM) which is, imo, massively undervalued and now paying something like a 9% dividend. I am also adding to my position in FGEN, my favorite biotech, and today I put in a low bid on United Airlines (UAL).

I would term all of these as casual speculations based on my belief the coronavirus and the knock-on effect on the global economy will not be the end of the world, though a few people I respect now think we are looking into the jaws of an actual depression.

Which begs the question, where is the bottom in this carnage?

For that, a little perspective won’t hurt.


That is a chart of the Price Earnings ratio of the S&P 500 through 2:45 pm ET today, Monday March 23.

As you can see, while the market was heavily overvalued going into the great financial crisis of 2007-2009, the coronovirus has brought that valuation metric very much in line with historical norms.

Of course, given that nothing about the current market is “normal”, I suspect we’ll see the P/E continue to fall… maybe below 10. But if the data does in fact begin to show a clear turn around in the number of new cases and coronavirus fatalities (virtually all of which are from pre-existing conditions), I think the market will turnaround with surprising vigor.

In no small part due to two other key economic factors: interest rates and energy prices.

Interest Rates

Here’s the interest rate chart, also up-to-date as of today.


As you can see, short-term interest rates are now just a tick above negative, which feeds into pretty much all the key sectors of the economy. Money is pretty much free at the moment and that provides a powerful wind at the back of businesses and households.

Surveying the current landscape, ask yourself how long do you think it will be before the Fed raises interest rates again? A year? Two? So that favorable wind will continue to blow life back into the economy for the foreseeable future.

Oil

It’s worth noting that transportation related stocks historically recover first, and go up further, than any other sector after a recession.

When you look at the cost of the sector’s most important cost input, energy, that over performance is understandable.

I’ll bet you not one in a million people thought oil would again fall into the low $20s, ever… but here we are.

While the greenies like to think carbon based fuels are on their last leg, it is still the juice that makes the world go round and cheap energy is key to growth in every economy.

As the world gets back to work and the Soviets and Iran stop playing chicken, oil will bounce back into the mid-30s, but I don’t see energy prices providing any headwinds to economic growth for at least a year or two. Quite the opposite.

So, What’s Next?

Looking at South Korea, where the data is considered more reliable than that coming out of China, it’s clear the active measures applied there, and pretty much everywhere else at this point, should result in the coronavirus beginning to abate within a month or two.

As that happens, investors will look to capitalize on the extreme under-valuations in the most effected sectors, including transportation, hospitality, and energy, among others, and the market will bounce back.

An important thing to keep in mind is that it’s not the real-time numbers that trigger directional changes in markets, but far more subtle shifts in trends.

Consider that back in January of 1981 US inflation was still high, running well over 10%, yet gold prices plummeted. The reason was simply that the spike in inflation of the late 1970s clearly topped out in 1980 and was starting to ease. That set off a scramble to exit inflation hedge investments and the price of gold was cut almost in half within a few months.

Likewise, when the global turn down in coronavirus cases becomes obvious, I believe everyone will dive back in… individuals, hedgies, everyone. And there is a lot of money in the world constantly on the move for a better home, and a ripe opportunity such as we are now presented with.

Between now and then, however, we have some stuff to work through.

In fact, if the extreme volatility of the markets doesn’t settle down fairly soon, I believe there’s a chance major global stock markets will be temporarily shuttered, Maybe for a month, or even longer.

If I’m right, and the coronavirus does start to abate during the market ‘holiday’ then the door may be about to close on the opportunities to buy when everyone else is selling. In which case those with the guts to get in now, or who had the fortitude to hold, will reap a massive reward when the market reopens.

Of course, buying now is a bold contrarian strategy. Personally, I don’t believe in end of the world scenarios, and know in my heart of heart that this too will pass, so continuing to buy after big down days is the approach I'm taking.

A Caveat

As this is an honest-to-goodness Black Swan, we are in unchartered water.

The US government has expressed its willingness to write a bunch of blank checks, and the Fed is now actively nationalizing the risk by expanding its holdings to include commercial mortgage-back securities, corporate bonds, short-term muni bonds and even credit card and automobile loans.

We are hearing talk about government guaranteed income for everyone, picking up the rent for unemployed and more.

Of course, the US government is already up to our eyeballs in debt, and there is no conceivable way any of the trillions soon to be spent combating the coronavirus will ever be paid back.

Therefore, the only ‘asset’ underlying the global currency being used to prop up the US and other major economies is the four words “full faith and credit” of the US government.

Hopefully that will remain enough for the average person to not panic. If it is, then this whole fiction will live to see another day - as will the global economy.

I think they’ll get away with it because other than the Democratic Party leadership, it’s in no one’s interest to see the Last Man Standing do a face plant.

There is no clear alternative to the US dollar anywhere in sight, so if it fails, pretty much everything fails – except hard assets, but at the moment that is not feasible as an underlying asset to base the global economy on.

Yet, there is there a possibility, however small, the current citizens of planet earth will discover in the midst of this crisis that there are limits to the money printing. Should that be the case,  we’re talking shopping carts full of worthless currency notes.

Maybe only useful as an inexpensive toilet paper replacement?

As insurance against that scenario, having 20% of your portfolio in hard assets makes a lot of sense.

On that front, my former co-worker and current portfolio manager, Marin Katusa, put together a briefing on where he sees the best opportunities in the resource sector today (literally, as the video was launched as I am writing this). Marin is always entertaining, and as good as it gets when it comes to resource investing.

Here’s a link to his presentation.  

Until Next Time

This edition of Sendero is shorter than usual, because I wanted to get it out before rapidly changing circumstances made it obsolete.

I hope it is helpful to you, and that you can keep today’s social, economic and investment chaos in perspective.

This will pass, and given the speed upon which it has descended upon the world, probably a lot sooner than you currently expect.

In the meantime, stay as active as you can and enjoy the down time.

More soon…

David

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