Markets in the Time of Coronavirus

The global outbreak of COVID-19 began more than 3 months ago, yet 3 months in, the world is still uncertain about what exactly humanity is up against.

How infectious is this disease? How widespread is it? How deadly is it? What do you and I need to do to survive?

The lack of answers has taken a toll on the markets, and despite having fallen ~15% already, it is still very hard to say whether the markets will be up or down tomorrow, next week, next month…

Can the market continue to fall another 10% from here? Absolutely.

Can the market continue to fall another 15% from here? Absolutely.

Can the market continue to fall another 20% from here? Absolutely.

Although I wish I have the answers, too, I think it’s more important to recognize that not having those answers is very unlikely to matter over a long term (1 year+) investment horizon.

As with all things, perspective is important, and 2008 is probably useful perspective: The worst economic hurricane to ever batter human kind in the last 50 years was certainly the 2008 financial crisis. The global financial system teetered on the brink of collapse in a world where everything had become financialized and deeply integrated. While rational minds can rationally disagree about what would have been the best course of action, there should be no disagreement that Central Bankers/authorities needed to act in order to prevent systemic, global collapse of society as we knew it.

What did the markets do then? Everyone talks about the 2008 financial crisis, but the markets actually peaked in late 2007. From peak in October 2007 to the bottom in March 2009, the markets declined 56%.

If we only look at the depths of the panic in 2008, the markets declined 41% over a 5 month period.

And this was the worst economic hurricane to hit the global economy in 50 years.

But what is most interesting is that despite the uncertainty of the situation and the gravity of the situation, the S&P500 was only down 4% by the end of 2009 (vs the acceleration of the panic in October of 2008).

Was 2008 very nearly a disaster? Absolutely.

Did it matter much for the long-term investor? No (caveat – this answer would be very different if Central Bankers were not successful in arresting the collapse of the global financial system).

Was 2008 a phenomenal buying opportunity? Unequivocally, yes.

In perspective, 2008 was the worst crisis of the last 50 years and the market declined 41% in a panic and 56% over 1.5 years.

Where should COVID-19 stack up?

Well you might say it depends on how many people die, how dangerous this situation is, and how disruptive it might be to society.

Currently, the data we have suggest that the death rate is potentially as high as 2-3% of those infected. However, there is also a lot of circumstantial evidence in countries that have already experienced outbreaks to suggest that a lot of people that had coronavirus did not know it and were not tested. As a result, the death rate could be much lower (e.g. perhaps 0.5-1%).

The US has a population of ~300 million. Assuming we all get it, then that means 6-9 million deaths is potentially possible if the death rate is 2-3%. If the death rate is 0.5-1%, then it would still be a whopping 1.5-3 million.

Would this be a humanitarian disaster? Absolutely.

Would this be a challenging psychological human moment? Absolutely.

But in all likelihood, these types of numbers are highly unlikely to matter to the long-term investor with respect to potential investment returns.

Consider – While millions of deaths is absolutely a humanitarian disaster, the lasting impact on capital markets would be the loss of economic participation from these millions of individuals.

How would millions of deaths compare against the economic impact of 2008? I would argue that 2008 would still rank as a far more serious economic disaster. The unemployment rate went from <5% to ~10%. The number of unemployed individuals in the US rose from ~6.8 million in early 2007 to ~15.5 million by the end of 2009. That is ~9 million individuals that no longer had income, and effectively became non-participants in the economy.

Disease and death are very visceral subjects. It is understandably very hard to think rationally about what it means. Making the right investment decisions requires thinking rationally about economic outcomes both at a macro and micro level. But because disease and death are visceral subjects, investors are being forced to think about things emotionally. That would very likely lead to the wrong decisions. But this is very likely an opportunity for those that can think rationally.

Can the market still go down tomorrow, next week, next month? Yes.

Is the market likely to be lower 1 year from now? I think the probability is low.

Is the market likely to be lower 2 years form now? I think highly unlikely, and if so, it is more likely to be a result of something else in the future that strikes fear into the hearts and minds of investors, long after COVID-19 has been forgotten.

Lastly, while I think COVID-19 is a serious issue but is not likely the pandemic that ends all of human society and that the current sell-off is a good investment opportunity, investors can only reap the rewards from this opportunity if we physically survive. Please stay safe (wash your hands, stay away from obviously sick people) and take necessary precautions to at least minimize the risk of contracting the virus.

Most of the time, to make money investors need to be smarter than others. That is a hard task to do consistently…But this time, investors don’t need to be smarter than others. Investors just need to have calculated courage and to survive.

As long as we invest in the highest quality companies that have strong balance sheets, is there any doubt that they will emerge from this even stronger than before? I have no doubts that regardless of what happens with COVID-19, human society is likely to accelerate adoption of secular trends that were already well under way – More digital payments, more digital commerce, more software, more technology, more medical technology. An acceleration of any/all of these things will benefit the Paper Portfolio in the long run.