April 7, 2020
We are entering what has been called a pivotal time by health officials, as the number of new COVID-19 cases jumps worldwide—one-third of which are here, in the United States. Meanwhile, state shutdowns have cut off as much as one-third of the economy, shuttering industries like hospitality.
There are scant silver linings—antivirals and antibody therapies are promising, as is quick testing. The workforce that is still in business has adapted and is leveraging technology to work remotely to the best of their ability. And, from a health care perspective, our system will be better prepared to manage coronavirus and other pandemics in the future. We are witnessing bipartisan efforts in congress that were absent two months ago.
But we think things could get worse before they get better. This reality could sum up the recent stream of news stories related to COVID-19, the economy and the markets. But when? How long will it take for a come-back? How badly will we suffer in the meantime?
These are questions we would all like the answers to right now.
In an Oaketree report from renowned investor Howard Marks, who authored numerous books including Mastering the Market Cycle, he noted how during the last six weeks, the markets have seen the best of times and the worst of times. Of the 21 trading days between February 27 and March 27, we saw moves in the S&P of 50 of more than 2% for 18 days—11 were down and 7 were up. That includes the biggest daily percentage gain since 1933 and the second-biggest percentage loss since 1940, exceeded only by Black Monday in 1987. This was the fastest drop ever in one quarter, in the history of the market.
Which will take over in the short and immediate term—COVID-19, economic stress or Fed/Treasury actions?
Some forecasts show that the virus will eventually be brought under control within about three months—others are saying six months to one year, and who really knows. Richard Bernstein told Barron’s Advisor last week that bear markets have three phases: the first is when investors view it as temporary; the second is that it’s worse than anyone could’ve expected; and the third is that it will never end. He thinks that because investors are still searching for the bottom that we are in phase one. I hope this is not the case—but no one knows for sure. Many believe we will have a slower recovery than people think.
That said, the “life support” the government is providing will help bolster the economy. Also, banks are much less vulnerable than they were during the economic crisis. As Mill Creek Capital Advisors noted in a recent update, “just as epidemiologists and the healthcare sector are diligently seeking to flatten the curve of virus case growth, recently implemented government spending policies to offset some portion of the collateral damage of widespread business shutdowns should also serve to flatten (make less worse) the depth and length of the contraction.”
Still, while government intervention is crucial, we are also creating another set of challenges as individuals and corporations continue to take on tremendous debt.
Meanwhile, we are seeing a spike in COVID-19 cases across the country. Our major metropolitan centers look like ghost towns. (We could look at this as a positive since so many are heeding the advice to practice social distancing.) The headlines are ugly, and it creates a great amount of fear and worry. Can we really expect a V-shaped recovery where the economy will pop back to life?
What will next week look like—and what about next month or a year from now?
No one can really answer that question. And, it feels risky to make a prediction. As Mark Twain famously said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
Like many of you, I’ve been reading a significant volume of updates and news articles, analyses from investors and business professionals, and listening to insight from advisors and colleagues I know and trust. I am fortunate to have a knowledgeable network of friends in the public, private and non-profit sectors who share their insights with me, and whom I turn to for guidance. We can learn many lessons from history, which I shared in the last email update, Investing and Doing Business During Times of Great Uncertainty.
Now, I’d like to share some lessons I’ve learned from my own mistakes that I hope will serve you well as you consider how to manage personally and financially during this unprecedented time. I hope they are helpful. We are all feeling incredibly uncomfortable in this great unknown. This week, we saw the markets lift by 7 and 9 percent. Is this a temporary bear market bump, or are we on the road to financial and economic recovery? Markets drop faster than they rise—but they go up for longer than they go down. And, markets tend to rebound before the economy.
Perhaps now there is no better time to reflect on how we can sharpen our strategies and personally grow from this experience. After all, we are all in this together.
Lesson #1 A Sense of Urgency is Great for Business—but Dangerous for Investing
Don’t waste time. Better jump in now—there’s a window of opportunity. For many of us, our human nature is to act during times of crisis. There’s a fear of missing out. As Mill Creek Capital Advisors notes, investors are facing two divergent fears: the fear that equity markets will re-test their March 23rd lows and fall further; and a fear of missing opportunities for strong gains if markets move higher.
I admit, when it comes to investing, I struggle with that fear and it has led to some significant mistakes, such as in 2008 when I was heavily invested in bank stocks during a time when financial institutions collapsed. My mistake: I bought too much too soon after the crash. I also underestimated how far the market would fall before it turned around.
How many of you are facing this fear now? You’re not alone. I have incredibly intelligent, experienced advisors I turn to for market insight and direction. I’ve been told, don’t buy until the stock is down by 40%. I’m resisting the urge. How do I know that we’ll fall that far? What if a stock I am after goes down 25% or 30% and I miss an opportunity to buy at a lower price? I remind myself of the mistake I made in 2008 when I bought too soon—still, we don’t know what today’s markets will do. And, if you’re fully invested and too leveraged, it doesn’t matter how low the market goes, you’re not prepared to buy now. Also, there is a whole group of people who struggle with fear to the extent they never get into the market and they miss the ride back up. Some got out of the market in 2008 after suffering serious losses and never got back in.
Regardless, we all want to know: Are we there yet? How much farther will the market fall? How much lower will Stock ABC drop? Is now the time to hold—or buy?
There are no answers for these questions. But I have learned to remember this: It’s hard to quiet a fear of missing out, but it’s much harder to rebound if you buy based on an emotional response. And, we can’t control what happens, but we can control how we react.
We are all emotional now. We are worried about the health of our loved ones, our colleagues and our communities. We are concerned about the economy and jobs—about financial stability and the future. We inherently have a sense of urgency to make it all better. Sometimes, all we can do is wait and see. And, we can trust our resiliency as an economy and a country. The crash that happened in 2008 generally happens only two or three times in a person’s life. In a December 2008 interview, the late financial investor Martin J. Whitman said he saw the opportunity of a lifetime. Rarely is there a chance to buy great businesses at attractive prices.
Sir John Templeton in 16 Rules for Investment Success, said this: The only way to avoid mistakes is not to invest—which is the biggest mistake of all. So, forgive yourself for your errors. Don’t become discouraged, and certainly don’t try to recoup your losses by taking bigger risks. Instead, turn each mistake into a learning experience. Determine exactly what went wrong and how you can avoid the same mistake in the future.
Lesson #2 This Time is Different—But Some Things Never Change
We’ve never seen a situation like coronavirus, though we compare it to other historical events like the Spanish Flu and The Great Depression. The other week, the index dropped 23.2% since the start of the year—the worst three-month stretch since December 1987 when it fell 25.3%, the worst quarter ever. But as investor Kenneth Rogoff shared with Barron’s last week, “a bad quarter is usually followed by some solid gains. The index rose by an average of 5.4% in the three months following its worst quarters. It was an average of 10.5% higher a year later.”
There are days when I think to myself, “This will pass.” And, there are days when I think, “This is so different—we are shut down.” One-quarter to one-third of our economy is “closed for business.” Which businesses will survive this? How will they deal with staffing?
We all want the answers now. Not knowing exactly when COVID-19 will peak, exactly how long we will stay shut down, and how far the markets will fall is unsettling. It’s the fear of the unknown—which is one of the first fears and why so many of us fear death.
Rogoff says this COVID-19 war will be won or lost on the health front.
Walter Russell Mead in a March 30 WSJ article, U.S. Leadership Will Survive Coronavirus, writes that “comebacks are America’s specialty.” We’ve done far more to fight the pandemic and its consequences than other countries. He says, “The American response to date, flawed as it is, suggests that the strengths that brought the U.S. through even the worst crises in the past have not yet faded away.”
We are a come-back country. This time is different—but our strengths as innovators, our world-class healthcare system, and individuals’ efforts to contain the spread of the virus will contribute toward the comeback. We are incredibly fortunate to have Ohio Gov. Mike DeWine, who was ranked No. 1 by Politico, which stated: “Perhaps there is no single governor who has done more to put the nation on a war footing in the fight against coronavirus than DeWine, whose actions have contributed to Ohio’s relatively modest number of cases, with a per capital infection rate, currently ranked 27th out of 50 states.”
We are grateful for the leadership of Gov. DeWine and Sen. Rob Portman, along with a team of public officials focused on managing this crisis. Their quick responses to this epidemic have been invaluable to our state.
When we are healthy, we are strong. By managing the healthcare crisis and focusing on caring for the people through vehicles like the stimulus, our economy will eventually gain strength, as well.
The problem is, there is no timeframe. We can compare COVID-19 to historical crises and their impacts on the economy and market, but no one is quite sure how far we’ll fall and how fast we’ll rebound.
There is a lot different about COVID-19—again, parts of our economy are literally shutting down. But what is the same is how fear and uncertainty drives emotional decisions in terms of investing. We are afraid of loss. But we must remember that we can come back. In a paper published in Liberty Street Economics, “Fight the Pandemic, Save the Economy: Lessons from the 1918 Flu,” by Sergio Correia, Stephan Luck and Emil Verner, they acknowledged that areas more severely affected by the 1918 flu saw a sharp, persistent decline in real economic activity. Second, cities that implemented early and extensive NPIs suffered no adverse economic effects over the medium term. However, cities that intervened earlier and more aggressively experienced a relative increase in real economic activity after the pandemic subsided.
The bottom line: Pandemics can have substantial economic costs, and assertive action can lead to better economic outcomes and lower mortality rates.
Lesson #3 Not Every ‘Turnaround’ Situation is Designed to Turn Around
The one thing I’ve learned about buying turnaround businesses is it always takes longer, there are always more problems and more risks—much like trying to turn around a bad relationship or a struggling household. Under the “big problems” are many more problems. An actual turn-around is not always possible. However, when you focus on quality, you can recover from challenging situations. With quality investments in quality businesses with quality management, a turnaround is not only possible, it’s likely.
When will COVID-19 turn around? When will it stem, and when will we return to work? We all want answers to those questions, and we are pummeled with a constant stream of news updates that suggest a range of outcomes.
For example, Dr. Larry Brilliant, who has been on the frontlines of fighting disease as an epidemiologist who helped eradicate smallpox and was involved in the battle against polio, spoke to Boston’s NPR News (wbur) and said he expects COVID-19 to potentially infect more than a billion people. It’s disruptive. But, he adds, “I’m absolutely confident that we will have an antiviral that works, but it’ll take us a little while to know which ones will work and which ones don’t work….I’m optimistic that we will find an antiviral that not only is curative but is also preventative.”
We think this number is very high, and especially what we are learning in the last few days regarding infection and mortality rates, particularly in Ohio right now.
Now, what about investments? How can we stage a turnaround in our own portfolios when the time comes?
When people ask me for investment advice, I usually tell them what not to do based on my past mistakes. I am not an investment professional, and I am not in the investment business—but I am a passionate, curious investor and I love studying the correlation between life lessons and investment lessons. I have learned this the hard way: Start with what you know. Add to the best positioned companies that have proven to be successful. Focus on those high-quality, higher-growth, high-value companies that will thrive in the future. You do not need to start from scratch. Add to the good positions you already own and look at opportunities that have been on your watch list but were previously too expensive. Add to the best things first.
Lesson #4 You Can Get a Deal on a Bargain Business, or Pay a Fair Price for a Great Business
I’ve learned a lot of hard lessons related to buying value traps—businesses that seem like a great deal because they are cheap, but in reality, they are priced low for a reason. Even last week, I got tempted by a stock that was paying a 22% dividend—and it was down by about two-thirds. “Even if the stock doesn’t go up again, you’re still getting 22%.” But, stepping back and resisting a natural tendency to act with urgency, I realized—what if that company is out of business next year? Sure, you get that 22% dividend for a little while, but you may lose every penny you invested in that stock.
Another mistake I’ve made: If a stock was $100 per share and lowered to $50 per share, I thought, “This is a bargain!” But just because a stock is way overpriced to begin with doesn’t mean that it’s a good value. We always have to evaluate the factors of a good investment, and valuation must be determined vs. comparing a price today with what it cost yesterday.
With the steep market decline, there are lots of “deals” if you are positioned to invest during the coronavirus crisis. There are companies that might seem attractive because they were trading high during a record bull market. But what about tomorrow—and next year?
Focus on quality. Quality costs more even during tough times, but quality businesses can turn around after a recession and rebound following economic falls. This leads to the next lesson, and probably the most important.
Lesson #5 Remember, Quality Rules—Look for Businesses with a Durable, Sustainable, Competitive Advantage
Speaking of things that don’t change, regardless of the economic landscape or whether we’re in a bull market or a recession, quality rules. Buy quality before anything. Look for businesses with a durable, sustainable, competitive advantage with quality management that knows how to allocate capital, is shareholder friendly and makes sound decisions.
I have made many mistakes and I have learned the hard way. I’ve bought low-quality stocks that were cheap and never turned around. In good times and bad, quality companies hold strong. Quality management makes decisions that help businesses come back following market declines and even unprecedented pandemics like COVID-19. There are three components to quality management: 1) They make quality decisions; 2) they are good allocators of capital; and 3) they have proven to be shareholder friendly.
Avoid the temptation to invest in bargains—unless it’s a bargain for a quality company.
Beware of value traps and, instead, be willing to pay a fair price for a company that has a durable, sustainable advantage.
What does that mean in today’s world? Our behaviors are changing amid COVID-19. In some cases, what was durable and sustainable prior to the pandemic might not be so after the virus stems and we, with all hopes, continue living a new normal. For example, this country had a glut of retail and our buying habits have evolved over the years. Those already vulnerable stocks might not get healthy again as our way of life continues to change.
So, look at durable and sustainable through a new lens.
Consider what competitive advantage companies have that are sustaining them through hardship and will position them for growth in the future. Of course, we’d all like a crystal ball that shows us which companies/stocks will bounce back and which ones will become a statistic of COVID-19 and the resulting economic downfall. There are no clear answers, but we can look to the past and consider how innovative, quality companies have evolved to stay relevant. For example, American Express didn’t start out as a credit card company. It was in the delivery business. Developers/shopping centers have moved to creating experiences as lifestyle centers. Focus on quality companies that are finding ways to create a durable, sustainable advantage that will make them relevant in our new economy. This is what Buffet refers to as a moat.
Truly, we are in this together. And, I have great faith in our talented medical community, our innovative researchers and our responsive, entrepreneurial business community that are all stepping up to consider ways to quell the COVID-19 crisis. I feel so fortunate to serve as a member of the board of directors of Cleveland Clinic, where CEO Dr.Tomislav Mihaljevic, M.D., Dr. Robert Wyllie, and their entire team of caregivers have done a tremendous job. I would also like to send thanks to all of the unsung heroes; the first responders, front-line healthcare workers, nurses, doctors, EMS, police and fire.
We are in a new world and how we live after the COVID-19 crisis will probably be different, from how we work to how we approach healthcare. We are also preparing for other possible future pandemics, by design or by accident. Through all of this, we are finding new ways to come together—for this, we should be proud. Be well, stay safe and rest assured that the all-hands-on-deck approach we’re taking will pay off in dividends.
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