Gotta make that change–Charles Bradley
We gotta all make that change
My brothers and my sisters
It’s time to make this world a private place
For the generation to come
Can find love and peace
What for the last of it
It has been barely 4 or 5 weeks since the Age of the Covid-19 began in earnest here in the United States, and yet it seems so much longer. The double-barrel challenge of dealing with both a health crisis and a financial crisis has made the month of March extremely treacherous for many. The vast quantities of information being thrown at us in hourly barrages make it even more difficult to process.
At times when it is hard to filter noise from data, I revert to keeping things simple. I have written before about the benefits of using the old Don Rumsfeld rubric when assessing markets. If you don’t remember the reference, it simply states that in any complex situation there are always known/knowns, known/unknowns and unknown/unknowns.
In market terms, known/knowns are, by definition, dominant in a low-volatility environment. The known/unknowns are prevalent when volatility is elevated. Then there are the unknown/unknowns that mark extreme volatility and make it virtually impossible to invest in the equity markets.
Four weeks ago, Covid-19 was an unknown/unknown. We had no idea what this new infection was, how it would impact our health, how it would affect our economy, and how bad things would get. Around March 20, as we closed in on the enormity of the situation and the suggested policy responses from the government, the situation began to evolve.
Today I would argue that the virus is more of a known/unknown.
- We all know a lot more about this virus and how it spreads than we did just a few weeks ago. Every day we learn a lot more.
- We know that it is going to have a material impact on the economy for the foreseeable future.
- We know that drastic steps have been taken by governmental authorities to help stop the spread of the virus—and also that we should prepare for an onslaught of cases that will tax the healthcare system.
- We know that the fiscal and monetary policy responses were approved and implemented in record time focused on helping critical elements of the economy. Monetary actions have begun to aid many of the non-equity marketplaces function, albeit with more stress than normal. In other words, the Fed has told us not to worry about liquidity. And the Congress and Treasury have told us they will do whatever it takes to help bridge companies and individuals economically until we can begin to restart the economy.
In broad terms that is basically what we know.
What we don’t know is:
- How long it will take to flatten the curve.
- How far and wide the epidemic will spread.
- How long it will take for the US and Global economies to begin switching back on after the curve has flattened
- What the new economic paradigm will be going forward – how much activity there will be, what kind of activity it will be, whether or not there will be a permanent impairment to the companies in which we invest, or if there will be a whole new series of opportunities.
Over the upcoming weeks, while the news continues to ebb and flow along the spectrum of hopeful to dire, we will likely have at least the beginnings of a basis on how to begin an analysis of equity valuations. When fundamental players rebuild their models, most will look beyond 2020 for the vast majority of their companies. 2020 will largely be a year of lost growth – even as the consensus base case suggests that the economy will begin to rebound at some point during the third or fourth quarter.
That should help keep a lid on extreme moves in volatility, but it doesn’t mean that we won’t try to retest the lows in equity markets. During the wave of selling, we saw in the first 2 weeks of March, it felt like there was no bottom because there was no time to do the analysis. A lack of liquidity in non-equity products and the unwinding of large positions in leveraged quantitative funds and factor-based investment strategies exacerbated moves to the downside. Simply put, when investors of all types need liquidity, they sell equities because they can. Equity markets are, by far, the most liquid of any asset class.
I have been impressed by the alacrity of the Fed and Congress to address key underpinnings that will allow us to get to the other side and assess the damage. The moves to allow funds to flow freely to short duration markets will hopefully cause banks to hold off on draining liquidity from borrowers at the very moment when borrowers need cash the most. Most of the monetary programs being used by the Fed were developed in the wake of the last crisis and, over the past week, have shown signs of bringing some stability to non-equity markets.
The CARES Act, which took less than one week to get passed (which is a record!) is a giant fiscal bridge meant to give Americans cash to live on until the economy restarts—whenever that happens. There is no certainty when that will occur so lawmakers have made it clear that they will come back with more stimulus if needed. There are some big questions about how much the American government can do, but honestly, those are questions to be answered over a much longer time frame. For today, we know that we have liquidity and a plan to bridge economic activity for the next 4-6 weeks.
So where do we go from here? IMHO, volatility will remain elevated compared to what we experienced during the last decade. And therein lies the opportunity – especially as we migrate from index volatility to single name volatility, and from correlation to dispersion. That is arguably better for active managers who can help their clients to outperform in this tricky time. The real question is how to plan for that environment.
Here are some thoughts:
- Pay attention to the virus spread numbers. Pick the data source or two that you think are most valuable and monitor them consistently—every day. Regardless of flaws (and all sources have flaws) over the next few weeks, we are going to get directionally better data on the size and shape of the contagion curve. I look primarily at the Johns Hopkins data. And in New York, I look at the Westchester County data – not just because I live there, but also because it has a 1-week lead time on the rest of the state. Governor Cuomo’s information on NY State by county is among the most consistent. Click here for The New York Times interactive model.
- Build three cases into your models V, U and L recovery patterns. Run bottoming sensitivities somewhere between Q320, Q420 and Q121 for economic activity. Keep in mind that, just as the rolling shutdown occurred, we are likely to have a rolling start-up with those areas hit less hard getting back to work more quickly. Sadly, for many of us in urban centers like New York, Boston, San Francisco, and London, it probably will take longer than in other cities. But it is better to be safe than sorry.
- Be nimble. We all know that markets overreact to both the upside and the downside. Trade around your core positions more than you normally would. This is the number one tool that active managers have to outperform their passive brethren.
- Do your best to slow things down. Time is compressed. We are all experiencing data in amounts that the human mind cannot effectively process. That’s why every day feels like a month, and every week feels a quarter or a year. But you have the unique ability to keep it simple. Filter the noise as best you can to allow yourself to get as much clarity of thought as possible. These skills are uniquely human and play to your best traits—so use them.
Wishing you all continued good health and good fortune. We really are all in this together. And at Cowen, we are thrilled to be in a position where we can be helpful.
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