Positioning Into Reopening
Summary
- I don't agree with what I believe to be a cheerful consensus view of what the reopening is going to look like.
- There is an edge in positioning better into the reopening.
- Forming your own opinion on the battle between the virus and humanity can help with that.
- Unfortunately, I think we're going to face a challenging environment for a while longer.
- Looking for a helping hand in the market? Members of Special Situation Report get exclusive ideas and guidance to navigate any climate. Get started today »
I did not want to spend time anymore on the following COVID-19's exact development after obsessing over the outbreak, and potential implications, since the end of January. Well, that didn't work out.
Increasingly, I get the sense that I need to stay up to date on developments because these are informing government/central bank actions, psychology and have a huge practical impact on many businesses.
Because I've been closely following Gilead (GILD) and the remdesivir story (first FDA-approved treatment for COVID-19), recommending it publicly for the first time on February 17, I'm sometimes surprised how even professional money managers with billions on the line think about reopening and about cures and vaccines. More about that in a minute.
My general impression is that the market is interpreting the flattening curves of infection and the antibody data way too optimistically. This year of earnings has more or less been written off (at least H1), and "the market" believes we'll see a strong recovery when lockdowns are loosened with stimulus surging in.
To its credit, the market is perceiving balance sheet risk and has adjusted for it. Small businesses and businesses with constrained access to low-cost capital are marked down strongly. Meanwhile, the dominant forces in the market over the past 10 years, highly exposed to the passive investment trend, have recovered most of their losses.
The market treats this as a temporary headwind (which it ultimately is; it may just take an awfully long time to deal with it). I fear that the market is not adequately provisioning for negative second-order effects that will cascade through the economy.
Companies and governments were already fairly vulnerable (due to excessive debt) prior to the pandemic. Odds are that many companies (including high-flying software companies) will struggle in H2 and possibly beyond. Odds are governments will struggle to finance the required stimulus to stave off an extended recession. The Nasdaq (QQQ) is up year to date and the S&P 500 (SPY) only down modestly:
As I said, it surprises that a great percentage of professional (as well as private) investors writing or talking about the current investment environment seem to be taking one of several flawed approaches:
a) Talk their book (putting too much stock into future scenarios that don't destroy their portfolios).
b) Disregard the "short-term" pandemic impact and focus on their expertise; i.e., valuing companies for the long term based on "normalized earnings."
c) Do work on COVID-19 and find that there's a reasonable path to recovery. Then put too high a probability on that path, or worse, subscribe to a one-scenario view.
d) Bargain-hunt in the hard-hit travel and hospitality sectors too aggressively counting on the Fed put or just direct government bailouts or a quick rebound to pre-COVID-19 business as usual.
Because 1) a lot of the approaches followed by investors do not make sense to me or 2) seem at least naive, 3) professionally traded markets are generally down a lot.
Combined with the way the market has been running up, I'm getting the sense that there's still likely an edge in interpreting COVID-19 development.
As evidenced by copper futures for September:
Oil futures September:
10-year treasury future September:
In my opinion, the market is too positive, and I think the right approach is to 1) snap up unkillable long-term bargains 2) find modest but safe returns that can provide liquidity on a second leg down 3) hold some combination of liquidity/hedges that can be used to buy more as the market gives up some of its overoptimistic gains.
I still want to position in a way that if I'm wrong I'm coming out OK too. In other words, I'm confident, but not so certain that I'm betting everything on the above view.
Views on COVID-19 development
I'll try to lay out how I'm thinking about the way we're going to open the economy and deal with this thing. Another warning: I'm not an MD or virologist. Just putting my head down and doing my best to understand what's going on because it seems paramount to investing.
Reported growth is really leveling off (probably a lot of undetected infections going on everywhere, but most certainly in emerging markets):
This graph clearly shows that things are improving:
It would be really something if we locked up half the world and an infectious disease spread did not level off...
The key problem is the way out
Clearly, lockdowns are strangling the economy. It seems as if the market thinks that once you get the growth rate down, you can resume life and the virus has been dealt with. Sometimes, investors think in waves because of the Spanish flu.
It seems more logical to me that if you were to open up in a business-as-usual fashion, the virus will immediately spread as it did before. Perhaps mitigated somewhat by spring/summer (if that is a factor at all) and more virus proof behavior.
Here's what I learned about the virus
By reading and listening to experts, I've developed an understanding of the COVID-19 threat. I'm laying out what I think I know so it is clear to you under what assumptions I'm operating.
*The mortality rate in North America and Europe, when the healthcare system is not overloaded, should be below 1% and possibly slightly below 0.5% of those infected.
*About 10-20% (more likely closer to 10%) of infected people need hospitalization.
*5% of infected people get into intensive care units, or ICUs.
*Mortality is very heavily skewed towards underlying conditions and the elderly. More heavily even than I've previously assumed.
*COVID-19 looks like it is extremely contagious when people mill about in close quarters indoors.
*Because of the asymptomatic spread, it is extremely hard to contain spreads without at least semi-lockdowns (hence, global policies).
*Mortality rates are extremely low among sub-20-year-olds and even sub-30-year-olds. They are likely lower than the case fatality rates, because I'm guessing that the younger cohort is overrepresented among the asymptomatic. See graph:
*It is my impression that comorbidities are a crucial factor. Age increases the odds of comorbidities and it indirectly influences that statistic.
*There is a worldwide phenomenon where many more people are dying compared to a "normalized" baseline, but these deaths, for administrative reasons, don't get chalked up to COVID-19.
*It is quite possible that <12-year-olds can be asymptomatic carriers but do not efficiently spread it, whether symptomatic or not. This is a graph from the Dutch RIVM - equivalent of the U.S. CDC. It shows percentages of infected people sorted by the age of the person that infected them. In other words, children and young adults were never the sources of infection in this dataset.
I do think the dataset is rather limited, but it is encouraging news and fits the fact that children seem to suffer fewer negative effects from COVID-19 in general.
(Source: RIVM)
*I'm under the impression that North American and European standard of care (when hospitals are not overwhelmed) brings the mortality rate down from what it could be without healthcare.
*When healthcare systems become overwhelmed, the mortality rate rockets upwards to potentially as much as around ~5%.
*Aside from the ethics, I believe it is not the right economic choice to allow this to happen.
*It still seems very possible there are different "strains" going around that have characteristics that result in mortality statistics to be noticeably different from the baseline I've sketched above.
*Finally, there is still a lot that is not known, not proven or partially wrong about what we think we know about this disease, as it is still so new. That means I should operate as if the above information can change. Because it can.
The way forward
Most countries facing COVID-19 engage in some form of lockdown when it becomes evident their healthcare system will get overrun. Countries immediately start talking about opening up as it becomes clear the pressure on the healthcare system is stable.
On balance, I expect societies will implement steps to unlock until the pressure on the healthcare system is no longer stable and then take a step back.
This is probably going to be an iterative and very dynamic process. Local circumstances can make a big difference in what is possible, and the more decentralized the execution, the better results I'd expect. Whether there are distinct "strains" will also have a major impact on the speed of reopening.
The unlocking plan is likely to include one or more of the following tactics:
- Continued social distancing
- Contact tracing (technologically or manually)
- Testing (ideally; widespread, practically tactically)
- Continued isolation
- Improvements in treatment (even progress like getting time spent in ICU down is a win)
Sometimes you see the approach contemplated to just let the virus rip through society with vulnerable subsets of the population isolating. I believe that would have disastrous consequences, both from a humanitarian and an economic perspective. It is highly likely to be a bad strategy, and the vast majority of countries are not going that route.
Here's what reopening could look like
*Most countries will rationally prioritize high-value economic activities that are at relatively low risk of accelerating spread.
*It also seems a wise strategy to reopen schools and probably even universities. There are several advantages. Lots of people are hampered in their ability to contribute to the economy by being forced into childcare. This frees them up. Children are probably relatively inefficient spreaders of the disease.
*We will see lockdowns loosened and constrained in starts and stops. The more we learn, or more conservative a region acts, the fewer steps back will be necessary. But that's not necessarily better.
*I expect that businesses with high operating leverage that are likely to run on sub-optimal utilization will have an extremely high default rate.
*Rush time in public transport needs to be avoided. Can this be avoided in metro areas like New York and London that heavily rely on that same network? (Zoom (ZM) and Slack (WORK) etc. will likely continue to experience tailwinds.)
*Travel is likely to continue to be down severely for quite some time.
*Masks are likely to become a necessity until a vaccine is found.
*At-risk groups would be wise to continue isolating.
*Contact tracing apps would allow for broader and faster reopening.
*As healthcare systems (especially IC units) become crowded, freedom will be restrained again.
*If Remdesivir or a (hydro)chloroquinine-combination/variant turns out to be effective, this will allow for much faster reopening by relieving pressure from IC units and decreasing mortality rates (these are very important, but likely no economic game changers).
Remdesivir was just approved as an emergency treatment for COVID-19 by the FDA. For now, its main benefit appears to be that some people get out of the hospital sooner. This is still very helpful, because it decreases the burden on the healthcare system per patient. By combining drugs or using it in different ways, further improvements are possible. The main reason I don't think this drug will drive a grand reopening is because it is very hard to manufacture at scale. Gilead has been working on scaling up capacity for months, but manufacturing projections look like this:
(Source: Gilead earnings)
Around October, Gilead can produce 600k treatments per month. That is great until you realize that we are currently adding about 100k cases per day:
That's 3 million cases per month, and that's only those that actually get identified and with large parts of the world sheltering at home. If you look at those numbers, it is clear that remdesivir is not the silver bullet that allows us to get back into the cinemas.
Conclusion
Reopening is going to be an arduous trial with starts and stops. Companies may recover after disastrous Q1 and Q2 levels of earnings. At the same time, it may not be enough to be cash flow-positive for quite a while. Every quarter, companies are burning through historically low reserves. Expect loads and loads of bankruptcies with a ripple-through effect in the economy. Fed and government stimulus will be thrown at the economy to offset the negative effects. I don't think it will be effective enough in most regions to offset, at a minimum, an initial awful deflationary bust. Positioning-wise, I like gold (GLD), silver (SLV), select short positions, cash and various special situations. In the second part of this note I'll go over some specific things I'm buying.
I'm not bullish on the general stock market. However, market turmoil and chaos creates opportunities to pick stocks that can shine in this hyper challenging environment. In part II of this article exclusively available to subscribers, I discuss several specific stocks that I'm buying.
This article was written by
Bram de Haas brings 15 years of investing experience to the table and has over 5 years of experience managing a Euro hedge fund. He is also a former professional poker player and utilizes his bundle of risk management skills to uncover lucrative investments based on special situations.
He is the leader of the investing group Special Situation Report where he offers his community several features, including: a portfolio of actionable special situations, weekly updates on current ideas, ideas across sectors for diversification, select foreign investment ideas in addition to the majority of US market ideas. Learn more.Analyst’s Disclosure: I am/we are long GLD, SLV, GILD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Short SPY, QQQ.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (26)
US Death rates are still spiking
US Infection rates are still spiking
There are not enough FDA approved test kits
There is no FDA approved treatment
There is no FDA approved vaccinePro's
Don't fight the Federal Reserve
Hope for a vaccine to treatment soonest
There will be waves of infection but i believe the first wave we have been through was the worse for a few reasons.
1 we were completely unlrepared and no measures were set in place.
2 More and faster testing
3. some partial immunity has been achieved and with time
Anw deathrate is not relevant. There is peaking of deaths also, which only shows that no lockdown is required.
Mark the words of the future, there will be other waves but not so serious in nature as what we have experienced, there will be no second lockdown, and life will get on as usual except with social distancing until vaccine.
Most of the businesses except those affected by social distancing will get back to normal. So for those stocks who are still lagging in price expect i 2 years to reach previous levels.
My guide to picking stocks as long as there are still some bargains there.
