It’s been a while since I wrote an investment-related post, and oh, how the world has changed. There was nothing to write about because there was nothing to buy since the last time I made a new purchase back in December of 2018. The market was getting more expensive and it was hard to come up with any reasonably good ideas.
However, the reason I’m writing is not to offer my thoughts on the next good opportunity. It’s quite the opposite. I am completely out of equities. I sold out of my beloved Ferrari (NYSE:RACE), Facebook (NASDAQ:FB), SoftBank (OTCPK:SFTBY) (OTCPK:SFTBF) (OTCPK:SOBKY), and other positions. The sales were mostly made when the market hit the bear level of around 20%, and I surrendered quite a bit of my profits, but that’s for another post.
I don’t believe it is prudent to hold equity positions today, even in great companies. To save you from reading this whole post: in my opinion, at least in the foreseeable future, stocks are more likely to get a lot cheaper rather than shoot up to pre-COVID-19 levels. At the same time, I hope I’m terribly wrong, because if my thinking proves correct, there will be a tremendous amount of pain in terms of human lives lost, businesses shuttering, people losing jobs and disrupting their lives.
At the time I decided to make a complete exit from the stock market, I was talking to a friend and told him that it looked to me like we’re in the first 10 minutes of one of those zombie movies. You know, when people are out and about, just going through their regular day, staring at their phones, or at their kids’ soccer game, and busy with their lives. However, while focusing on their everyday disruptions, nobody seems to notice that there are zombies all around, about to start running toward them, and all hell is going to break loose.
Just like mostly everyone else, I didn’t pay enough attention to the virus zombie brewing in China. I was well aware that it was going on and concerned about impact here, but initially thought we could ride it out. What really rang the bell for me was the day I saw reports about the oil price war between Saudi Arabia and Russia. The alarms went off in my head as it seemed that a heavily leveraged US oil industry was the canary in the coal mine and the first of many dominos I was afraid would start to fall. So the combination of oil price drop shock and the virus shutting down every sports league, was enough for me to part ways to many of my beloved and, up to that point, profitable holdings.
When I write about it, I realize this sounds like panic, and seems to be exactly the wrong thing to do according to every investing guru out there. The right thing to do is to ride it out, buy the dip, it will come back, it’s just a matter of time, they say. In my short investment career, I’ve done exactly as prescribed twice. Once during the financial crisis in 2008/2009, and once during the almost 20% dip at the end of 2018. The first time it was a disaster, the second it worked like a charm. This COVID-19 induced crisis reminded me so much more of the great recession of 2008 that it was an easy decision for me to liquidate everything and exit the market.
In this writeup I will discuss specifically why I believe more pain is likely ahead and why it looks to me that the stock market is likely priced for an overly optimistic scenario about to unfold.
Fighting the COVID-19
One particularly bothersome and, in my view, inaccurate line of thinking was that many so-called experts were calling for a simple parallel to how China did it, and just assumed the US would get out of this problem the same way in a few months’ time.
Let’s get something straight first. The initial Chinese response to the virus was a disaster because by the time they locked down Wuhan and other cities in late January, possibly millions of people were able to get out due to the Lunar New Year travel. So the Chinese didn’t quite trap it, far from it. If they did, the world would not have the problem we are having now. However, once Chinese government realized how bad this could be, they went into overdrive to shut things down, and track down the impacted individuals, using all means necessary, from cell phone locations, to limiting people’s movement, aggressively placing people in isolation, color coding their locations, expanding hospital capacity, and other rather drastic measures. Although I am skeptical of their overly low numbers of infections and deaths, it is undeniable that they are on the other side of it because their businesses have mostly come back online.
The US Approach
Many of the tactics China used were simply not possible to be applied in our society, at least not early on in the outbreak. The political backlash would have been too great and some of the measures would have violated many laws here in the US. However, there were many blunders made on the federal level that exasperated the situation.
First, this was a health crisis, not a banking crisis or economic crisis. The Federal Reserve and US Treasury got involved in a formidable way and seemed to have been doing most of the things in their power to lessen the blow. But the issue is not with them. The issue is that monetary or fiscal policies are not treating the root cause.
The US federal government needed to do much more to deal with the health aspects here. If early estimates were in the hundreds of thousands of dead, it was quite surprising that our government didn’t treat this as a war type scenario. After all, WWII killed some 400 thousand Americans, and the entire country was mobilized to fight it. But with COVID-19, there seemed a lack of coordination and urgency early on, in spite of the fact that we had at least some advance notice from the situation in China and parts of Europe. I’m afraid we are now paying a much higher price. In my opinion, if the government immediately started to muster the might of the US resources and ingenuity, such as building ventilators, masks and other protective equipment, mandating hospitals to greatly expand capacity, massive testing plans, etc., and basically go into this war with full military type readiness, this would have demonstrated in a tremendous way that the US government was serious about attacking the root cause and prepared to protect American lives at all costs necessary. Could people have been more willing to take the risk of going to work and resuming somewhat normal daily life if they had faith that there would be a hospital bed, a ventilator, and a doctor available to help them, regardless of their income, insurance, or location? And how much would that cost, a few hundred billion? Instead, the economy is stopped in its tracks and trillions are needed for the rescue. I don’t know the answers here, but certainly these could be interesting questions to be examined as we prepare for some other pandemic.
Next, from the very beginning it was the states and localities calling the shots which resulted in a tapestry of different approaches to the crisis. I live in California, and my state and city have been fairly progressive with the shelter at home policies, with people understanding and supporting it from the get-go. This was done by the Governor and the Mayor locally, and they made some tough decisions early on to attempt to get ahead of this problem. But while I and millions of Californians were sheltering at home, we watched on TV kids in Florida on spring break, socializing and partying as if everything was completely normal! Almost every state in the country was on a different schedule, some completely dismissive about the crisis, and most missing the main point: if you don’t do the lockdowns before things get out of control, you will pay a much higher price later. Shelter in place only works if everyone does it, or if travel from places that don’t have shelter in place is banned. It is beyond me why this wasn’t in the government pandemic 101 playbook.
These shortcomings stood out early on and I never considered that following the same curve as China was the most likely scenario for the US. And if every state is on its own individual schedule, while the federal government is constantly in a reactive mode, how could we possibly restart the economy in just a few weeks? A prolonged country-wide shutdown makes the whole calamity an order of magnitude more serious and an already difficult problem quickly grows into a disaster.
COVID-19 Market Commentary
As the market was climbing highs in 2019 and 2020, an investor could probably choose their own market valuation measure and conclude that equity markets were not cheap before the virus came along. In fact, it was historically quite expensive. For example, Buffett Indicator (Market Cap to GDP), at over 150%, was flashing red. Shiller’s Cyclically Adjusted P/E (CAPE) was also in the top 20%.
My point is not that someone should have been selling because of these various valuations. I certainly did not, and the economy was humming along just fine, as far as the eye could see. But what this tells us now, after the virus hit, is that a 20% discount from an already overheated market, is well, not that much of a discount.
December 2018 vs. Today’s Valuations
I’m a bottom-up investor, not a macro buff, and mostly just use the market to roughly gauge where things are. But one area where I’m a lot more comfortable operating is understanding where my holdings were when I thought they were cheap. For example, I wrote extensively about Ferrari and Facebook in the past. I owned RACE since before the Fiat Chrysler (NYSE:FCAU) spinoff but then purchased more at the time when I thought the company was dirt cheap. Similar for FB. In fact, these were no-brainer purchases. I even remember going to the holiday parties in 2018 and probably annoying anyone who would listen telling them that getting into a RACE stock around a $100, or FB at around $130, would likely to do very well over an extended period of time.
Let’s quickly take a look at these securities today, but more importantly where their businesses are today. On March 18, Ferrari stopped making cars in Italy as their factories as well as their suppliers are effectively shut down with no clarity as to when they will open. Yet, RACE has been trading in the range of $140 to $150 per share, some 20% off its $180 high. Not bad you may say, it is holding up pretty good. But if you could have gotten it for $100 or $115/share some 1.5 years ago, when the factory was cranking out cars and selling them into a robust world economy to anyone who had money to buy one, how is it reasonable to buy it at $150 now? What will happen with their sales, profits, and even 5-year projections? Does anyone even have a scant idea of a forward P/E or any other valuation ratio to hang some conclusion on? I certainly don’t.
How about FB? Yes, this business is an incredible money-making machine, and you’re likely to do okay if you buy it at any price, just give it time. But in December of 2018 you could have bought it for $125/share. Even with all the regulatory overhang, if you adjusted for net cash, that would have been a ridiculously low P/E for such a high-growth and high-quality business. When I analyzed FB, one of the main thesis points was that FB was providing an incredible advertising venue for a small guy, for mom-and-pop businesses that cannot afford to get on ESPN or a national network. In fact, at current count, FB has more than 7 million advertisers and a huge majority of these is from small and medium businesses worldwide. Here is a year+ old article that delves into some numbers and impacts on FB during recessions. So now, as small businesses are being wiped off the face of the earth and shattering their doors, I just cannot see that advertising is anywhere on their must-have list. These folks, even if they wanted, simply won’t be able to spend money on FB ads. And when will it all come back? I certainly wouldn’t dare to guess. Will any of this kill FB? Absolutely not. But should the company still be worth more today (around $160/share) than when none of the virus headwinds existed? In my opinion, no.
I realize that using the above two companies as examples to extrapolate the entire market is far from being wise. There are probably some businesses that can be analyzed with some level of confidence. But there are dozens of well-known companies out there whose outlook range is just too wide to call it a great deal at today’s price. An investor should ask a very simple question: why would this XYZ stock sell for more today when the world economy stopped than only a little more than a year ago when everything was normal?
COVID-19 Current Market Assumptions
Which brings me to the final point of my discussion – the market is looking at COVID-19 through rose-colored glasses and is only willing to accept the best-case scenario. That would involve the following:
- Virus gets under control within a few short weeks, either by a medical remedy, social distancing, or some miracle mutation that makes it far less impacting.
- Everyone is hired back as before, people go back to their jobs, spending, traveling, buying cars, iPhones, etc., as if nothing happened.
- Corporate earnings just drop a bit for 2020.
- Market assigns the same high multiples to the earnings as they existed before the virus.
I hope I am wrong and I get egg on my face for it. For I would rather miss the upside opportunity if that means we get rid of the virus and the world is back exactly to where it was before. But if I’m right, and any one of the above 4 bullets does not pan out for the foreseeable future, then there is a very low probability that the stock market will be shooting up anytime soon. In fact, it is more likely that it will continue to head down.
Market Talking Heads
I find it interesting that market commentators, in unison, still believe that there will be a quick run-up, and that there are some incredible values out there. When I hear them or read their reasoning, it often makes me doubt at the assumptions I just described above. But how can they be saying that, when almost no company right now can predict with any accuracy what the rest of the year or beyond will look like, or to what extent will customer behavior change?
In fact, even when the virus gets under control, two things that drive market performance are almost certain to be impacted: earnings will be meaningfully lower, while at the same time, market multiples will contract.
Also, let’s not forget the elephant in the room. Corporate buybacks were a critical pillar of the stock market advance in the last decade and they kept accelerating over time. With the current crisis and possible political and PR implications, buybacks will be greatly curtailed, even for companies that don’t take a dime of government help.
It is particularly appalling that many of the popular media market commentators or money managers are on the air giving “expert advice” and parroting to buy the dip, while at the same time having massive and undisclosed conflicts of interest. For example, on March 18, billionaire investor Bill Ackman, in an emotional interview on CNBC, pleaded for the US to perform immediate economic shutdown for 30 days that “hell is coming” and that he was taking money out of ATM, but still buying stocks. That day the market had a significant down day, which only got worse after his impassioned pleas, even if no one can prove he caused a deeper low. Turns out that he had a massive short position on the market that netted his fund some $2.6b in profits, a 100-fold gain on a $27m short bet. Only a few days later, after he closed the short, he revealed that he had these various credit default swaps.
Many of these so-called experts are not unbiased observers who dole out free advice out of the abundance of goodness. These people are well aware that their own words can make a difference and influence enough of their clients or other market participants to do something that may ultimately benefit the so-called expert. In fact, they are not required to disclose their positions, and could very well be hedging with options or other under-the-radar contracts that nobody but their firm knows about. So, unless there are some facts that can be verified, hearing a billionaire giving advice while holding back his tears should be taken with a grain (or pound) of salt.
Where is the Oracle?
As commentators and overrated money managers are incessantly in the media spotlight, one man that actually counts is curiously missing. You guessed it, Warren Buffett, and he is nowhere to be found. As in the famous Sherlock Holmes mystery, the dog that didn’t bark was also a clue. Could it be that he has nothing positive to say?
Buffett has been criticized for sitting on a $128b of cash with no plan to spend it or return to Berkshire (NYSE:BRK.A) (NYSE:BRK.B) shareholders. We don’t know, he could be buying hand over fist at this very moment, or maybe he thinks the time is not right yet. Meanwhile, Berkshire is raising even more cash by registering for issuing low interest bonds in various denominations, while lightening up on some of his airline holdings. Once Buffett pipes up, it probably will mean that his main purchases are over and that a chunk of $128b has been put to work. In the meantime, I choose to sit on the sidelines, and accept that I could be wrong and miss some incredible rally that may take place.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.