What a big week the past week has been! A quick overview of the major indices to the close of markets on Friday Feb 28: a) X% week on week, b) Y% since Jan 20, 2020 (start of virus fears):
Dow Jones Industrial (DJI): -13.6%, -13.4%
S&P500 (SPX): -12.6%, -11.3%
Nasdaq (NQ): -12%, -8.8%
FTSE100 (FTSE): -11.5%, -14%
Shanghai Composite (SSE): -3.5%, -7%
Shenzhen Composite (SZSE): -2.3%, -8%
Hang Sen (HSI): -6.5%, -9.3%
It's clear that last week was catchup for Western markets. The SH and SZ composites troughed Feb 3 at -11.3% and -12.1% respectively (from Jan 20). They had actually recovered to only -3.4% and -5.8% by Thursday Feb 27 before taking a dump on the Friday!
The news flow has been thick, fast and very negative with reports of spiking infection outbreaks in South Korea, Italy, Iran, US, WHO raising the global risk rating to VERY HIGH, a dog in Hong Kong testing positive... Meanwhile high profile experts have come out with warnings such as Roubini (expect markets could fall 30-40% from a global recession), Bill Gates (this could be a once-in-a-century pathogen) among them.
Firstly let's review the (relative) knowns of this outbreak:
The Virus: the base understanding today is it's highly contagious with a relatively low mortality rate (0.5-4%) which increases with age. It doesn't tolerate heat well (though temperature in Iran is teens so who knows). There are potential treatments and vaccines but probably not enough to make any major impact until 3-12months later
The Cases: as at Feb 28 according to WHO globally there were 83,652 cumulative cases of which 78,961 cases were in China and 4,691 outside. Ex China, South Korea has the most cases with 2,337 followed by Italy: 650, Iran: 245, Japan: 210, Singapore: 96. The US had 59. Globally there has been 2,971 deaths in China and 67 outside China. The incidence of new cases on Friday was: 331 in China (though China NHC reported 427) and 1,027 globally. Given suspicion of China's reporting and the sudden spike in global cases (previously only 3,664 cases) both the real number of infected and new cases is probably much higher. Within China there have been 39,002 recoveries and 2,835 deaths. On Friday China's recovery number was 2,885, deaths 47 which is far greater than the incidence of new cases (if one believes these numbers)
Market valuations (12m Trailing PE, Div Yield): DJI: 17.8x, 2.6%; SPX: 20.6x, 2.5%; NQ: 24.6x, -%; FTSE: 15.1x, 5%; SSE: 11.4x, 2.7%; SZSE: 25.1x, 1%; HSI: 11.1x, 3.7%
Cost of Capital (2yr, 10yr benchmark rate): USA: 0.93%, 1.16%; UK: 0.31%, 0.45%; China: 2.36%, 2.79%; Hong Kong: 1.09%, 1.05%
If China's numbers are to be believed and the current recovery vs new cases trend continues, then its active case number should be minimal within 2-3weeks. We should be able to see if China's numbers are accurate very soon! Given China's high population density and relatively basic medical facilities, it would be a good indication that the coronavirus can be resolved in the rest of the world with relatively limited damage. A more grim possible scenario is: 50% of the world gets infected with a mortality rate of 2% = ~77m deaths. Given the various drugs on trial and vaccines in development, the likely time-frame of impact is 2months to 2years.
Given the imperfect information and large number of variables and possibilities, I don't believe it's possible to make a better assessment than this today.
What else do I know?
Most of the things I'm highly sure about relate to myself.
I have no debt, minimal cash flow needs and my current capital stands at 50% net Equity exposure (includes cumulative impact of derivatives assuming full exercise), 7% Bonds and 43% Cash.
I know I don't have an information collection, interpretation or trading Edge when it comes to this virus. So it's highly unlikely I can time and optimise my near term investment outcome during this outbreak.
What do I believe?
As a global pandemic I don't believe there is any geographic or asset class that will necessarily rise in value over this period. Traditional safe havens like Treasuries, Gold, Yen may preserve or even rise in value in the near term but even then there is no guarantee (and minimal yield). Furthermore I don't believe we'll see a mass movement in capital from the main wealth storage areas of: Bonds, Equities and Property. So even if the coronavirus is a once in a lifetime virus, all major asset prices should fall which relatively speaking, means everyone remains the same.
Without the coronavirus, the current monetary conditions is very supportive of equity asset prices.
The Equity Indices' offer of 5-10% Real yield + dividends and some possible growth (in some sectors) is attractive relative to negative to low single digit % yields on Fixed Income. Property offers low single digit free-cashflow yield but risk that valuation over a >1yr time frame will fall due to rising interest rates. Private Equity and VC funds benefit from the low cost of borrowing but with abundant capital they need to fight with peers and Industry buyers for opportunities and it's not clear what their returns will be 5yrs out (especially for Equity market dependent exits). Also the lack of liquidity is a huge negative in high volatility times like today.
As far as the most attractive place for capital to flow, Equities still seems the best. And given my belief that the main linchpin of Asset values today is the Discount Rate, I'm less worried about a recessionary impact to earnings than I am about Interest Rates rising. The later risk seems highly unlikely given messages of support from all the major Central Banks. Some analysts on the Street are now pricing in 1 or more rate cuts in the US this year... That is a clear positive to valuations. Liquidity and the low cost of capital will quickly drive up markets once fears abate.
Lastly, I believe the investments I have and plan for my portfolio are significantly more attractive than the averages presented by the Indices. I have opportunities that include:
Growth companies priced on mid to high teens PE with >20% growth rates
Value/Yield companies priced on high single digit to teens PE paying mid to high single digit dividends and growing earnings in the low single digits to low teens
Binomial outcome bets with 5->10x upside
What have I done?
Equity prices will probably remain volatile but I'm more concerned about protecting and growing the real value of my capital at least 5yrs out. There is a lot of fear today but I don't believe we should extrapolate this indefinitely into the Future.
A week or two ago my net Equity exposure was a bit over 40% but since the market decline I've added another 10% of my AUM to Equities to reach ~50% net Equity. I've accumulated shares in existing companies I like e.g. JD.com, Maoyan, the tobacco majors; and started new positions in other names e.g. Oil & Gas majors (like CNOOC), Lexinfintech. Also some of my stop losses on companies took down most of my exposure before the turmoil e.g. Goldman Sachs, Galaxy Entertainment, Sands China; which I've started or am looking to rebuild in the coming weeks. My oil rigs investments have come down considerably over the past few weeks. I'd hit the pause button as they've fallen but in reality the coronavirus impact on oil demand has little impact on the long nature capex decisions of offshore oil drilling. They remain binomial in nature and with additional Central Bank liquidity their deadline for reaching positive free-cashflows has probably increased. The payoff structure is more attractive so I may add further to them in the coming weeks (though admitted the technicals do not support this). Interestingly they rallied hard on Friday (RIG: 11%, VAL: 21%, DO: 18%). I'm not sure if this was related to the wider market perception on risk or something else.
I also want to add that I've chosen to execute more of my long trades via shorting Puts with expiry dates in late May or further. The benefits are obvious:
Option premiums have gone up with the increase in volatility
If China's numbers are real then the markets should calm by April
I want to own these companies either way. So I consider either buying them at discount or the options paying off a Win (though I'm likely to close out the options early and buy the underlying stock if markets are clearly over the virus fears).
I have plenty of dry powder and I plan to continue adding until at least 55-60% net Equity exposure. If markets tank I'll happily increase the allocation further (if Roubini is right and markets falls 40% then double digit yields would truly be once in a lifetime opportunity!).
Final word
Dear Reader, whoever you are, you should invest according to your circumstances and objectives. Some diversification is warranted whether by Asset class or with Asset class. I have a concentrated portfolio of Ideas but even then my investments cover a wide range of Drivers, Industries, Geographies, Objectives. Lastly don't get greedy and especially don't chase returns using excessive Leverage. We should always be mindful of the little we know, are certain about or able to understand, and that the Market is never sympathetic to Individuals with egos.
Peace
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