3/25/2020

COVID-19 update #2, 3/25/2020:

As of 3/5/2020, the COVID-19 virus was primarily a Chinese phenomenon with a limited global presence. China’s solution was to implement draconian physical isolation measures that seems to have slowed successfully this virus’s proliferation.

The below graph of officially-confirmed COVID-19 cases in China —via Johns Hopkins University—illustrates coronavirus’s plateau in China. Although it is often difficult to trust Chinese data, today that country does appear to be returning (little by little) to business as usual.

With respect to financial markets—Long Game Financial’s (“LGF”) purview—we noted on 3/5/2020 that China’s strict quarantine measures had the short-term side effect of dramatically contracting China’s economy. Because China is the world’s second-largest economy, this, in turn, impacted negatively the global economy and global markets.

Now, less than three weeks later, the unfortunate reality is that COVID-19 (along with its negative economic effects) is spreading rapidly worldwide, per the exhibits below.

Because few countries can control their citizenry like China, at this point LGF believes is likely that this global outbreak will continue until (1) each country develops herd immunity (that is, the majority contract COVID-19) or (2) we have a COVID-19 vaccine.

Until either or both (1) and (2) come to pass, we believe it is likely that many countries’ physical isolation policies, which are aimed at slowing COVID-19’s spread, will continue. And, to state the obvious, every additional day of physical isolation is quite economically negative. Our working assumption presently is that the COVID-19 crisis will last 12-18 months.

We also believe, however, that a lot of this bad news is priced into financial markets right now given how panicked sentiment has been this month; look no further than the $135 billion of net redemptions from mutual funds for the week ending 3/18/2020. When it comes to COVID-19, we sense that there is a dominant, fear-driven narrative among many investors—something along the lines of: “COVID-19 is a global economic disaster. You either understand this or you do not. If you have anything positive to say with respect to financial markets and COVID-19, you do not ‘get it.’”

In our view economic reality is more nuanced than this. Without question, COVID-19 is a terrible human and economic disaster—but, as we wrote on 3/5/2020, it affects certain industries (e.g., airlines and oil) far more than others (e.g., e-commerce). There are also countervailing factors to consider, including market price adjustments (again, the stock market’s dramatic decline this month priced in much COVID-19 negativity and lower interest rates, all else equal, help stock prices) and government action (election-year Trump has an incentive to stimulate and support the economy as much as he can).

More broadly, we remind clients that most of a typical company’s theoretical value is attributable to its long-term earnings power, whereas the COVID-19 outbreak is a temporary phenomenon. (Academically, we would say that terminal value generally constitutes well over 60% of the value of a stock in a discounted cash flow analysis.) To LGF this suggests that, top-down, there should be a greater number of attractive multi-year investments available today than at the beginning of the year given our -23.9% year-to-date S&P 500, all-time low interest rates, and, in our view, the fact that there are many companies whose long-term earnings power should remain intact beyond COVID-19. 

Someday we can look back together and judge whether this line of reasoning was correct. In the meantime, at LGF we think it makes sense and rings true based on our work analyzing companies one-by-one—though, to be clear, we are not through this in the least and there are many sectors and industries that we continue to consider uninvestable (e.g., energy).

Although LGF is as concerned and proactive about COVID-19 as anybody (recall our investment reallocation earlier this month), we believe it is more important than ever to maintain an open mind, remembering that it is possible to over-react to risks—even pandemics—and that it tends to be wrong to have a stubbornly one-sided viewpoint when it comes to something as vast and heterogenous as the global economy. As the COVID-19 crisis continues, we will continue our work of using experience and reason to analyze evenhandedly the positives and negatives of specific investments, one-by-one, for the benefit of our investors.

© 2020 Long Game Financial, LLC