The Black Swan, Part Deux

A few weeks ago, we focused on what the potential impacts of the Coronavirus could be, and as the outbreak has spread globally and intensified, the economic fallout is greater than we could have ever imagined. This morning, Italy leapt into second place (a dubious position that no nation wants) becoming the country with the second-highest number of recorded infections outside of China (South Korea is number one). Even the famed “Venice Carnival” (the birthplace of the Mardi Gras festival) couldn’t survive COVID-19, and was cancelled this morning for the first time in 41 years, as Italy took extraordinary steps to contain the virus’s spread. This celebration began in the year 1162 in San Marco Square, and has been a showcase of art and culture in Venice for close to 900 years, and couldn’t have been an easy decision to cancel. 

The economic impact of this virus is real, as for the past month, the second-largest economy in the world, China, has been at a complete standstill. In focusing on real numbers, here are just a couple of staggering figures from the People’s Republic of China: Real estate sales down 90% month-over-month (M/O/M); auto sales down 89% M/O/M; demand for oil and other natural resources down 20% M/O/M. With over a billion people stuck inside their homes, with no end in sight, a major economic catastrophe is brewing, and has put millions of Chinese companies on the brink of bankruptcy. It’s apparent that the data out of China is being managed carefully by the Communist Party, and it’s highly probable that the real numbers, both of the victims and economic activity, are actually much worse than what we are being told. Much like the “Great Famine” where over 20 million people starved to death in the country from 1959-1961 - the central government maintained that it was result of three natural disasters until the 1980’s, and not from a series of poorly thought-out centralist policies that were its actual cause - it may be many years before we know the true human costs of the virus. One thing we know is that over 190 major Chinese companies announced that they will delay releasing their earnings reports, as these numbers can only be, in a few words, an unmitigated disaster.

China is also the world’s manufacturing hub, which has greatly affected the course of business for companies across the globe. Over the past week, a number of giant U.S. companies have posted profit warnings, as their factories in China are either shut down or operating at minimal output. I’d theorized in my original article that Apple would feel this very quickly, and they actually were the first major company to warn of a huge hit to their revenues this past Tuesday - Qualcomm, Samsung, and Reebok have quickly followed suit. What wasn’t as easy to see initially, was the effect it would have on companies that make consumer products, as many of the world’s companies get a large amount of their packaging materials from China. On Thursday, Proctor & Gamble issued a warning that their global supply chain has been totally interrupted, which will affect their ability to produce over 17,800 of their products. Additionally, the $41 billion cruise industry is starting to wobble, as the world’s eyes have been on several Princess cruise ships that are quarantined off the coast of Japan, and become mini-outbreaks in their own right. I’ve never been a fan of “cruising”, and I’m hard-pressed to imagine how anyone who’s been watching this news, would get on a boat anytime soon. Just like the Chipotle food-poisoning debacle of several years ago, the hit its business took, and then its eventual rebound today, these industries will all eventually recover, but the impact they are feeling is real and will be reflected in short-order in their stock prices. As I heard 23 years ago when I started in the investment business, “Only a fool tries to catch falling knives”, so when it comes to your money, don’t lose your fingers. Let these knives hit the ground on their own, as there’s no stopping this freight train now that it has left the station.

How far and how wide this virus spreads is anyone’s guess, but the numbers are already pretty staggering. The virus has now been confirmed in over 30 countries, infecting close to 80,000 people, with over 2,000 dead, which is ten times the number of cases, and three times more deaths, than those that were stricken over the entire course of the SARS outbreak in 2003. We will survive this disease, as will many of the companies whose profits will suffer in the near-term, but remember this: your investment dollars are like soldiers. Commit them to battle when your odds of winning are great, and pull them out of battle when the chances of a slaughter (a Stock Market drop) is highly probable. Since the short-term results of investment markets are driven almost entirely by two emotions, fear and greed, it’s important to ask yourself which is more likely to dominate the inflection point that we’re currently at. It’s this author’s humble opinion that the time of greed has ended (which resulted in an 11 year Bull Market), and that fear will dominate the landscape for the next six to nine months. We’ve put our money where our mouth is, and have reduced stock exposure for clients to less than 10%, and placed the proceeds into investments that are entirely defensive in nature which have historically surged upward when the stock market falls. The timing of a stock market drop is always up for debate as no one has a crystal ball, but a storm in the investment markets is building, and getting hit by lightning is one of the least pleasant experiences in life, at least from what I’ve heard.

Follow this link to the original "Black Swan" article: https://www.dhirubhai.net/pulse/black-swan-michael-m-knittel/

Michael Knittel is the lead portfolio manager and Chief Investment Officer at Lagunitas Asset Management. He carries the series 7, 63, and 66 securities licenses, and his firm is an independent Registered Investment Advisory firm that holds client assets at TD Ameritrade and Charles Schwab. The opinions above are his own and should not be construed as investment advice. For more on Michael and Lagunitas visit the link below.

www.LagunitasFinancialPlanning.com