Why we remain bullish
Note this blog post was written on 16th April, the news changes quickly so some of what we say below might be outdated or obvious in hindsight. So when going through this letter, pretend It’s Thursday the 16th of April 2020.
During the last few weeks we’ve seen a strange dichotomy between Wall Street and Main Street, with a large rally in asset prices but stories of doom and gloom in the real world. Just opening up LinkedIn we see a slew of people posting about job losses, Bloomberg posts about countries extending lockdowns, and WhatsApp forwards about more people succumbing to the virus (typically we avoid the news like the plague, but we find we can’t really operate without LinkedIn, Bloomberg, and Whatsapp).
The question becomes – who is correct? Does the market in all its wisdom know something the average person doesn’t? Or has the market been pumped up due to central bank liquidity and short-term speculators?
In the short-term, honestly we don’t know – we can see the market going either way. But in the long-term we remain bullish. We’re often questioned on this by those skeptical (perhaps, rightly) of the market rally – but here is our reasoning:
Why we remain bullish:
It hasn’t paid to be bearish: Despite several world and regional wars, oil crises, financial crises, disease outbreaks over decades, global equity markets have continued to grow at 5.25% over the last 120 years[1]. Imagine if you were bearish throughout that whole period and kept your money in cash – you would have given up $438 for every dollar you had.
Human ingenuity: While how the coronavirus issue will conclude is very unclear (Will it disappear this summer? How many subsequent waves will we see? When can we go back to normal life?), we are confident that at some time, in the near future, it will conclude. Currently there are over 70 firms working on a vaccine (several more working on anti-virals), and eventually we will have this virus beat.
Governments have acted swiftly: While there is plenty of finger-pointing across aisles, in general we feel globally governments have acted swiftly. Within 1-2 weeks of the virus going global, most of the world shut-down, a few weeks later stimulus packages were passed, and central governments provided liquidity to financial markets. During the 2008 financial markets it was months before any such action was taken. The swift action we’ve seen this time around should save several businesses from bankruptcy.
Virus Growth Slowing: Every day, for the last 8 weeks, our first task of the day is to track global numbers on Active Case and Total Case growth. We have seen a rapid decline in those growth numbers. If there are 3 stages of an outbreak; the rapid expansion, the slowing growth, and then the decline, the data shows we are clearly in the second stage. Now, there are lots of good arguments about how this data is under-reported, but even when data is impure, if it points to a clear trend, it can’t be completely discounted.
Demand is pent-up: From data from cruise lines showing an uptick of bookings in 2021, anecdotal evidence from our friends in China illustrating lines at restaurants/cafe’s we do believe that as soon as people feel safe (either case numbers go negative or a solid treatment is rolled out) they will be back to consuming in force. After this global lock down we find it hard to imagine people aren’t raring to get out there, as even the most introverted among us are dreaming of weekends out.
We’ve sacrificed to save the most vulnerable among us: While there is a lot unclear about how this virus affects people, what is clear is that it affects the elderly and those with underlying conditions worse than others. In order to not overwhelm global medical services and to give the vulnerable a fighting chance, humanity has and will pay a high economic cost. Be as cynical as you want, but this is a world we would want to invest in.
Thus far, being bullish has worked out well for us and our clients, as we’ve been net buyers throughout the decline. But we are well aware of our confirmation bias. What do we mean? Well, we are naturally bullish, and always have been thus we will discount negative information (or information that goes against our steady state). So the next question is what if we’re wrong and our confirmation bias has led us astray? Well this is what we’re doing.
How we control our confirmation bias:
Keeping some money in cash: As mentioned, along with our clients, we have been net buyers throughout the decline and subsequent rise. However we’re not out of the woods yet. While the market will never give you an all-clear signal, at this point we think it’s more prudent to have some liquidity rather than no liquidity. Most of our clients are 15-20% in cash.
Value still matters: Buying anything and everything just because you’re bullish in general is the height of stupidity. Value (and valuation) still matters. The rally over the last week has pushed most large blue ships back to early- or mid-2019 levels. Since we weren’t buyers then of those assets when the outlook is positive, we aren’t going to be buyers when the price is the same but earnings power has significantly reduced. Even the S&P 500 doesn’t seem obviously cheap anymore.
Tracking Thesis and Pre-mortems: Whenever we invest in an asset (usually stocks) we find it’s very useful to write down all the reasons why we are buying that business (our thesis), and then we track the progress of the company using this benchmark. A thesis breaking isn’t necessarily a reason to buy/sell but a signal that you need to go back to the drawing board. Simultaneously we do a pre-mortem where we imagine the investment has failed, and we think about all the reasons why that might have occurred and see if we can get comfortable with the risk. While this is usual practice for us, we have now added the element of the virus to stress test our assumptions.
Reducing Leverage: We cut leverage completely for most of our clients either before or during the virus outbreak and subsequent market impact. For the clients that still want to maintain a certain amount of leverage, we’ve recommended cutting to ratios around 0.1-0.2x equity. Although if the market really tanks (i.e. falls further than the recent lows) we might consider (emphasis on might) actually increase leverage as its perversely safer to lever when the market has dropped significantly than when it’s at its all-time high.
Watching the pendulum: When the market was ~30% down we definitely felt the market pendulum swing to extreme bearishness when Mr. Market was in an all-out panic. We noted 3 events that could signal somewhat of a bottom (obviously the fact that the market did indeed temporarily bottom was luck – the market could have fallen another 10-15% easily if the Fed hadn’t stepped up). The first indication was 1) Italy started showing a flattening curve on a log basis 2) General growth rates in cases started to slow 3) Our friends who know next to nothing about investing were buying puts on the index. These signals gave us a sense that this was a reasonable time to start buying more heavily than we had been (note it was a reasonable time, we couldn’t tell you that it was the time). However, now the pendulum seems to be swinging the other way, and while it is not in total euphoria given the push/pull between Wall and Main Street, it’s less obvious to us that this is a great time to deploy money.
If you’re like us and are bullish on the current situation we hope that the above helps you keep your confirmation bias in control. If you’re bearish, it would be helpful to do your own version of a bias check.
Happy investing all!