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Large Risks, Large Opportunities

Posted on March 10, 2020

“Periods of turbulence provide both large risks and large opportunities…” – Ray Dalio, Bridgewater

2020-03-10_market_chart.jpgTwo weeks ago, in Well That Escalated Quickly, Elliott described how the global reaction to the coronavirus (COVID-19) had begun sending shockwaves through financial markets. The situation has continued to evolve rapidly since then, and although the continued spread of the virus was more or less expected the fallout in financial markets has been more severe than anyone could have anticipated. Yesterday, in particular, was unlike anything we’ve seen outside of Lehman’s collapse in the 2008 financial crisis. In this week’s post we’ll provide a brief update on what’s been happening and how we’re positioned from an investment standpoint.

While we’ll try not to regurgitate news that everyone is already aware of, we did want to start with a brief update on the virus itself. Since our post two weeks ago new cases outside China have continued to expand, with major outbreaks in Italy, Iran and South Korea. Below we’re reposting a chart from worldometers showing the daily number of new cases outside China. I’ve indicated in red where the chart stood as of our last post. As you can see, the efforts to contain the spread of the virus outside China have not been successful.

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The virus has obviously been popping up all over the world, but thus far the growth of confirmed cases has been relatively muted for all other countries compared to the three outbreaks mentioned above. Interestingly, the Chinese are reporting a marked slowdown in new cases, indicating that their containment efforts have been effective. The big grain of salt with all this is that no one actually knows how many active cases there are. Not all the reported data is to be trusted, and active testing in many of these areas has simply not kept pace. Not to mention the fact that many carriers of COVID-19 might not exhibit symptoms for weeks, and even then might not experience symptoms severe enough to suspect they have the virus. All things considered, it seems reasonable to expect that the current statistics dramatically understate the actual number of active cases, which we will continue to see grow for the foreseeable future.

There are a wide range of opinions in regards to how seriously to take all of this. The reality is that there are multiple layers to the discussion. In regards to the actual health risk, it seems that for the vast majority of the population catching the virus should not be a major concern. The exceptions to this would obviously be the elderly and/or those with secondary conditions that might exacerbate the impact of the virus. That said, hopes of containment have all but vanished, and the focus has now shifted to taking measures to mitigate the speed and breadth at which it spreads. This all begs the question, to what extremes will everyone be going to avoid infection (regardless of how warranted or unwarranted they are)? And what will the economic impact be of these communal behavior changes? Indeed, a very real economic impact is already being felt, especially by certain industries.

Which brings us to how the financial markets have responded.

It’s hard to know where to even start here, because the severity of the recent moves has led to a dizzying number of headlines, stats and anecdotes putting the recent market action into historical context. Volatility has returned in a big way; just look at the chart below showing the daily returns for the Dow Jones Industrial Average since the market set an all-time high on February 19th.

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We have now given up over a year’s worth of gains through yesterday, with over $5 trillion in market capitalization being wiped out in the global stock market.

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Meanwhile, investors have flocked to the perceived safe haven of US Treasuries. The 10-year Treasury yield fell to an all-time low of 0.32% intraday yesterday before settling in around 0.50%. The idea that the entire US Treasury yield curve is trading below 1% is hard to believe, especially given how strong the economy and financial markets have been for so many years now. (By the way, you might want to look into refinancing your mortgage if you haven’t already done so!)

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Policy makers around the globe are responding to both the spread of the virus and the reaction in financial markets in a variety of ways. Many are implementing travel restrictions and mandatory quarantines, the most dramatic of which includes Italy shutting down all non-essential gatherings for the entire country through at least the end of this month. We don’t envy the position governing authorities find themselves in. It’s an old quote, but something Health and Human Services Secretary Mike Leavitt said back in June 2007 rings true today, “Everything we do before a pandemic will seem alarmist. Everything we do after a pandemic will seem inadequate.”

Here in the US the Fed held an emergency session to announce a 0.50% interest rate cut. While this was primarily an effort to stem the tide of panic, we think it’s unlikely to have any immediate impact on the real economy. The New York Time’s Peter Goodman described the move as, “handing coupons to shoppers and sending them to a store that is closed.” Additionally, Congress passed an $8.3 billion supplemental spending bill intended to provide aid where needed, and over the past couple of days President Trump has been floating more options for how the government can step in to provide support. We think any stimulus measures should be highly targeted if they are to directly address the underlying issues in the economy, and hopefully political considerations will be left out of it (yeah right).

So how has all of this been impacting us and our clients? As Elliott mentioned in our last post, one of the primary ways we manage risk is through a dedicated focus on broad, meaningful diversification in our client portfolios. This approach, along with the fact that we entered the recent period tactically underweight our long term targets in equities, has helped our client portfolios remain relatively resilient in the face of the increased volatility. In regards to our trend following models, another one of our risk management tools, they have prompted only a marginal use of cash thus far. The correction simply occurred far too quickly for cash signals to be triggered prior to the major selling pressure (more on this in a future post). That said, we will continue to monitor our models and remain open to the strategic use of cash in the weeks ahead if it’s warranted.

Yesterday Barry Ritholz stated that he thought, “It may be too late to sell and too early to buy.” This sentiment resonates with us. Realizing that times like these present us with both Large Risks and Large Opportunities, we expect to be faced with decisions in the coming weeks to either reduce risk further or to take advantage of dislocations in the market if the selling intensifies. But we’re not sure either of those moves makes much sense at the moment. It never pays to panic or let emotions drive decision making, especially when it comes to investing. So for the time being our plan is to stick to our process, continue monitoring the situation as it unfolds…and just to be safe, wash our hands every chance we get.


david_headshot_bw.jpgAuthor David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.


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