NAVIGATING A PANDEMIC – PART 6

WHERE COVID-19 GOES, SO GOES THE MARKETS

It’s been a dizzying 10 weeks or so and one thing has not changed: COVID-19 (and where it goes from here) will dictate much of what happens with all markets in all countries. Nothing can escape it.

WHAT IS IT GOING TO TAKE FOR A RECOVERY?

People will need to feel safe getting back to normal. Not some people, but the vast majority of people will need to feel safe. This leads businesses to fully open, to resume hiring, to sell things and then make money. The making money part is earnings, and expected future earnings are what drive all investment prices, whether it be stocks, real estate or anything else.

WHAT IS IT GOING TO TAKE FOR PEOPLE TO FEEL SAFE?

Quite simply, people need to feel that if they return to their normal routines, there is an exceptionally low probability they will get seriously ill or die. There are three potential paths to this:

1. COVID-19 runs its course (the easy way or the hard way),
2. There is a treatment that substantially improves the mortality rate or
3. There is a vaccine.

Let’s take a look at where we stand with these three scenarios.[1]

CAN COVID-19 RUN ITS COURSE?

There are over 500 mutations of COVID-19. It is unknown thus far if COVID-19 will mutate into something far more aggressive and deadlier or more benign. Could it perhaps ease up in the summer and return stronger than ever in the fall? Possibly. Could it subside in the summer and social distancing measures keep it at bay until a treatment or vaccine develops? Possibly. Could it relentlessly spread until 60% or so of the population has had it and we establish herd immunity? Possibly. Could it turn out that those who have antibodies simply get it again? Possibly. More on what this means later.[2]

What is the outlook for a treatment to substantially improve the mortality rate?  According to the U.S. Food and Drug Administration, there are currently 144 active trials of therapeutic agents and another 457 development programs in the planning stages. Gilead’s remdesivir is on track to be approved for use in the European Union (even faster than in the U.S.) and could be prescribed all over the world inside a month. It is likely not the silver bullet everyone is looking for, but it demonstrates the speed with which a treatment that shows promise can be approved. The world is attacking this disease in ways that are unprecedented. Could we get an effective treatment soon? Possibly.

WHAT IS THE LIKELIHOOD OF A VACCINE?

One does not have to look far to find wildly different points of view here. Many epidemiologists argue that a vaccine may never happen. And one need look no further than Dr. Anthony Fauci himself to hear a grim assessment: “We will have coronavirus in the fall. I am convinced of that” and that the “ultimate game changer” would be a vaccine, but that will likely take “12 to 18 months”. Some scientists believe we may never get a vaccine. The United Kingdom’s Chief Medical Officer, Christopher Whitty, told a Parliamentary committee he was concerned a vaccine would be impossible to develop. For those looking to add to the doom and gloom, no coronavirus vaccine has ever been approved in the U.S. or U.K.

Others are far more optimistic, pointing out that while a vaccine being discovered, tested and approved in less than a year sounds impossible, one must also acknowledge that never before have so many resources, so much brainpower and so much money been thrown at a disease in such a short amount of time. Moderna’s phase 1 vaccine trial appears to have yielded very positive results. Do we already have the silver bullet and it is just a matter of speeding through the other phases? It is too early to tell. What we do know is the world is throwing everything, including the kitchen sink, at this.

Now, have I told you anything you don’t know already? Of course not, we all know this. I can hear you right now: “I’ve already wasted 3 minutes, Captain Obvious. Get to the point!”

Here’s the deal, though. We know all of this is obvious. We know that no one knows with certainty how this virus will unfold in the coming months, no one has certainty on when a treatment that improves the mortality rate will be discovered, and no one has any certainty around if and when a vaccine will come to market. So, what is the point?[3]

Without any certainty on any of these issues, no one can have any certainty as to the near-future performance of the market.

For example, if we knew with certainty that the coronavirus would die out in the next 30 days, the market would almost certainly jump 20% today. If we had conviction that a highly effective medication or vaccine would come out next month, the market would rocket today. Likewise, if everyone had conviction that the coronavirus will simply resume its spread exponentially, just as it did prior to the quarantine, the market would likely drop 20% or more today. If we had near certainty that there would be no compelling treatment and no vaccine any time in the next 12 months, the market would crater and the economy would likely take a run at matching the Great Depression.

To make a prediction, one starts by putting together probabilities then factoring the likelihood of the most likely scenario. Here is basically what we have going into our “prediction machine” today: maybe the coronavirus will retreat, maybe it will spread quickly; maybe the coronavirus will mutate into a less harmful disease, maybe it will get deadlier; possibly we will get an impactful treatment that will improve the mortality rate, but possibly it will take a year or more; potentially we will get a vaccine within months, or potentially it will take 12 months, 18 months or more.

When we put “maybe” and “possibly” and “potentially” into the prediction machine this many times, we can only get “maybe” and “possibly” and “potentially” coming out of it. In other words, predictions about where we are headed over the next year or two are worth less than my expansive childhood baseball card collection.[4]

Yet, despite all the variables going into our prediction machine, people still make predictions and do so with great conviction. Let’s take a look at half a dozen recent predictions from some of the most prominent figures in the investment world.

• March 3rd, 2020 – Mohamed El-Erian: “market chart will look like a U or an L and not a V.”
• March 27th, 2020 – Dubravko Lakos-Bujas, JP Morgan Chief US equity strategist: “Stock market can recover from sell off to hit record highs early next year.”
• April 4th, 2020 – Gary Shilling: “The stock market is probably far away from the bottom.”[5]
• April 8th, 2020 – Ray Dalio: “We’re heading into a Great Depression.”[6]
• April 21st, 2020 – Bill Miller: “This is one of the 5 greatest buying opportunities of my life.”[7]
• April 28th, 2020 – Jeff Gundlach: “Shorts S&P, says retest of low very plausible.” [8]

Anyone who makes a prediction with any certainty as to how the market will perform over the next 3 to 12 months is guessing. Nothing more, nothing less.

The highly scientific prediction machine works like this:  Garbage In = Garbage Out.

Yes, over the long run, the market is fairly predictable. Over the short run, it is never predictable, especially in times like this when everything going into the prediction machine is unknown. Of course, someone will be right. Someone is predicting the market will rocket this year. If an effective treatment comes out soon, they will be right. But were they right for the right reasons, or lucky? Likewise, many are predicting a market collapse. If we return to the exponential spreading of the coronavirus and treatments and vaccines don’t deliver, they will be right. But because no one knows what will happen with the mutations, treatments or a potential vaccine, no one honest and competent can predict with conviction. That is why you don’t see people like Warren Buffett making predictions. Yes, he says things like, “Don’t bet against America” and so on, but he is referencing over years not over the next year.

We have before us four general scenarios that can play out:

1. We return to work, the new cases stay manageable and we have some hotspots that we handle. We dig our way out of this over time despite a spike in the fall and winter, with a treatment improving things sometime in the next year and a vaccine or herd immunity coming sometime in the next 6 to 18 months. This is the scenario (or something similar to this) that the market has priced in right now. Any surprises to the upside, and the market goes up. Any surprises to the downside, and the market goes down.
2. We return to work and the coronavirus picks up where it left off, spreading quickly. A treatment reducing the mortality rate substantially does not come along this year and a vaccine is, at best, in late 2021. Schools close again, our health care system gets overwhelmed, businesses that are hanging on close their doors for good, unemployment rockets and the economy goes into a very deep recession or depression. If this scenario plays out, the market is likely to drop very sharply from these levels.
3. Any of the following happening in the next 30 days would likely result in a rubber band effect that would cause an economic explosion (the good kind): an effective treatment is announced with an imminent release, a vaccine is pushed through with a date for public use set inside a few months or, for whatever reason, the coronavirus ceases to spread significantly.
4. And, of course, there is this: Something we are not thinking about comes out of nowhere and changes the calculation of everything: a terrorist strike, cybersecurity attack, a war, a new tariff conflict,[9] a completely separate economic or political event, the death of a major political figure and on and on and on.

BOTTOM LINE: NO ONE KNOWS.

When there is conviction, one places bets. For example, we have strong conviction that interest rates will stay low for some time but that the yield from long term bonds is not high enough to justify the risk to move away from shorter term bonds. For this reason, we are not recommending long term bonds to clients and are considering other changes in this space.

When there is no conviction, the wise investor makes sure the money they need in the coming years is invested conservatively and the money they need more than five years out is invested for growth. For investors that need money this year, bonds are doing what they are supposed to for you. And for those who need money years down the road, stocks will very likely do what they do over time: rise to the occasion.

In the meantime, be on the lookout for the pundits and talking heads, making convicted short-term predictions that deserve the same credibility you would bestow to a card reader.[10]

Footnotes:

1. Note that I am not an epidemiologist, nor do I play one on TV, so we are sticking with data from the medical field.
2. I know, I know: ‘Thanks for nothing, Peter’. Stay with me.
3. There is one, I promise.
4. Which is to say they are basically worth zero. As a kid, I saved up all my money buying rare baseball cards. I spent thousands of dollars building a huge collection. Then the internet came out and everyone found out the baseball card companies had been printing far more cards than they advertised. I lost a lot of lawn mowing money, but I can tell you the batting average of most players from the 1980s. That’s worth something right? Oh shoot, that’s actually worth nothing, too.
5. To be fair, this is his predication basically every year, so at least he’s consistent.
6. Later, Dalio clarified that there could be a correction, not necessarily that there would be one.
7. Bill Miller is the only mutual fund manager to have outperformed the S&P 500 15 years in a row. The last time he thought the market was one of the greatest buying opportunities of his lifetime was during the 2008 crisis. He went heavily into Fannie Mae, which went bankrupt, destroying his track record and even pulling him into the bottom 10% of managers for the year and over the previous 10 years.
8. Gundlach is quite frequently bearish on stocks. It could have something to do with the fact he is a bond manager, and bonds tend to be more attractive when stocks perform poorly. Possibly.
9. You may have noticed the U.S. and China aren’t getting along so well.
10. My apologies to card readers.

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This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed