The Specter of Fear
March 12, 2020
In the next 30 days, we as a nation will be confronted with a new reality. Our way of life will be temporarily changed, and in some ways perhaps, permanently changed. We will be telecommuting, compulsively washing our hands, and thinking about the welfare of each other. Our children will be home from school. Our parents will be staying out of public. The specter of fear will cast a long shadow.
Obviously, demand for travel and leisure services will collapse to nil. Restaurants will be empty and sporting events will be played in front of empty stadiums. People will get sick. Most will recover, though some will not. Our task at this time is to suppress the spread of the virus so that our capacity to administer health care is not overwhelmed, preserving our ability to support the most vulnerable among us.
None of this supports the speculative component of financial markets. It’s no surprise that liquidity is receding, and prices of financial assets are falling. Prices could fall further as the virus spreads. The beautiful math of compounding upon which the practice of investing is built is now being deployed against us by COV-19. Some rational observers believe that price stability will not occur until we have successfully “bent the curve” of the rate of infection, and even when we achieve that milestone, there will be some question regarding the new normal, the new price equilibrium in a world of apprehensive social interaction. How much lower will it be?
At the time of this writing, all of last year’s market gains have been erased. The 11-year bull run is over. The VIX index, which measures market volatility has spiked above 65, levels not seen since the Great Financial Crisis, when it approached 90. We are already in rare territory. Accordingly, the market’s recent decline is as fast as any since the crash of 1987. This is, in short, a panic.
By definition, most of the trading volume in any market occurs because active traders are doing their jobs—they’re trading. In a market such as this, when volatility spikes and active traders no longer believe they can responsibly manage risk, they stop trading. So, naturally, prices fall. When prices fall, some market participants conclude they cannot accept further losses and they begin selling, which of course then creates a cascading effect of selling, precisely at the time when liquidity-providing speculators have, like Elvis, left the building. This becomes a panic, which is what we have today.
In a panic, the tail begins to wag the dog. When this happens, investors lose the single most important advantage they have, which is to let the market (Warren Buffett calls it Mr. Market) work for them, not the other way around. It’s during times like these when the difference between price and value—intrinsic value—becomes more evident, though usually in hindsight.
Our economy is about to go into a temporarily state of suspended animation. Corporate earnings are going to suffer. There’s nothing to like about what’s happening, except perhaps furious innovation in the health care industry. As terrible as this all is, it does seem like something that will seem a lot less scary by Memorial Day. Flu season will be over, and while we will certainly still have the coronavirus, we will then be co-existing with it, perhaps not fearing it as we fear it today. We will at least know more about it.
Here’s the key point. As that happens, as we learn and familiarize ourselves with our foe, the market will begin to discount it. The moment the future is more clear, almost no matter what that future is, the discounting will begin with breathtaking force.
Investing is one giant exercise in approximating discounted cash flows. Whether you spend much time on it or not, that’s what you’re doing. A stock is nothing more than a right to a stream of future cash flows. Same as a bond. The coronavirus has blown up everyone’s ability to forecast cash flows for this year, the one that’s supposed to be the easiest one to forecast. Perhaps next year’s cash flows will also be disrupted. Beyond that, the case that COV-19 will permanently impair corporate cash flows doesn’t seem as compelling. China and South Korea already appear to have slowed the spread of contagion to manageable levels. The medical community will have had that much more time to develop treatments, perhaps a vaccine.
Buffett is famous for saying that in the near-term, the market is a voting machine, but in the long term, it’s a weighing machine. It seems likely to me that the value of the earnings power of global business will not be severely diminished by the events of this spring, as terrible as they may seem at this ephemeral moment. The terrible compounding that is powering the spread of the virus is about to collide with the compounding of knowledge that serves human ingenuity.
In 2001, I was a young analyst working in Lower Manhattan when the planes hit the Twin Towers, just a few hundred feet from my little cubicle on the 20th floor of a tower in the World Financial Center. Aside from the obvious terrible loss of life and property, there was reasonable case to be made that the airline industry would not survive, nor the cruise lines, nor commercial activity in lower Manhattan. Financial markets temporarily closed. The specter of fear was among us but we prevailed.
In 2009, I was an analyst covering banks and insurance companies. Clearly, that was awful, and terrible losses were sustained, and there was a reasonable case to be made that we were headed into a global depression. The specter of fear was among us but we prevailed.
In the year 2020, we have been struck by a terrible viral outbreak that will threaten the lives of millions of people. The specter of fear is among us.
I believe we will prevail.
Any opinions are those of Burke Koonce and not necessarily those of Raymond James. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Past performance may not be indicative of future results. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete; it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation.