The Digest #13

Published on March 18, 2020

Coronavirus: The Perilous Road Ahead

The weekend of March 14-15 will go down in the history books as the point at which the Coronavirus pandemic finally became real to most Americans.  In rapid succession, state and local jurisdictions throughout the country began to implement visible measures that were impossible for the general population to ignore. For those of us who have been following the unfolding pandemic for weeks, many of the steps were not surprising but a large segment of the population remained seemingly oblivious until the last minute. 

I wrote about this surreal weekend in an article published on Sunday afternoon. Immediately after the article was published, the weekend became even more surreal as I read about the Federal Reserve’s emergency action to cut the Federal Funds rate by 100 basis points to 0-0.25%. Financial markets were in chaos from the opening on Monday morning with the S&P 500 immediately falling 7% which triggered a fifteen minute halt.  The Monday carnage ended with the S&P 500 down 12% which was its third worst day in its history. The losses were partially reversed on Tuesday with the S&P 500 rising 6%. At this point, a day when the index moves just 1-2% will seem downright placid.

The current news cycle is developing rapidly and rendering any attempt to provide a summary immediately obsolete. What is obvious at this point is that we are currently living through a historic period without modern precedent. Large segments of the private sector economy in the United States are simply shutting down and demobilizing for an indeterminate period of time. The most dramatic move so far has been the shelter-in-place order for 7 million people living in six counties in the San Francisco Bay Area. It is likely that other jurisdictions will implement similar orders that will halt many sectors of economic activity for at least several weeks. 

We are in the midst of experiencing an exogenous shock that is shaking our capitalist system to the core. The airlines are seeking more than $50 billion in federal aid and many other large corporations, such as Boeing, will surely follow. However, the many small businesses that operate on thin margins and with small cash reserves face imminent financial ruin, particularly restaurants and bars. Employees of such businesses will also face financial distress almost immediately. Various proposals have been made to provide emergency financial aid to individuals and small business. The Trump Administration has proposed a $1 trillion stimulus bill which includes $250 billion of direct payments.

I wrote The Coronavirus Correction two weeks ago in an effort to point out that a disruption to earnings in 2020 need not be catastrophic in terms of the hit to the intrinsic value of a business as long as earnings power is not permanently diminished. However, an even more important caveat is that to enjoy a recovery, one must first survive. Businesses that cannot survive the coming weeks and months due to insufficient resources to meet fixed expenses without much (or any) revenue could very well expire before any recovery. 

The path ahead is going to be perilous for all Americans, particularly those who have limited financial ability to weather any storms, let alone one of this magnitude. Last year, a Federal Reserve study found that 40% of Americans do not have $400 in the bank to cover an unexpected emergency. It is politically impossible for the government to bail out the current equity holders of the airlines while the owner of the corner bar goes bankrupt and millions of Americans face financial ruin. 

In Coping With Market Meltdowns, published last week, I tried to provide some principles that could help investors assess the unfolding situation in light of the securities they hold. Clearly, the most important assessment to make at this point is whether companies in which one owns equity positions are likely to survive a prolonged period of little or no revenue. The resiliency of a business will depend on the strength of its balance sheet as well as the degree to which management has employed operating and financial leverage. It is a useful exercise to “stress test” each investment to understand what would happen if revenues dried up for a period of several months. 

Chaos and noise is not conducive to intelligent decision making and dubious or outright false information is distressingly prevalent. Like most people, I am more concerned about the health implications of Coronavirus than the financial fallout. Farnam Street’s recent interview with Balaji Srinivasan was particularly valuable. Srinivasan is not a medical doctor but he does have a diverse multidisciplinary background and explains the situation clearly. The links provided with the podcast are also very useful. 

Another recent podcast that was more technical but still interesting was a discussion between Peter Attia and Paul Grewal, both medical doctors, who cover the COVID-19 outbreak in much more detail. While I did not understand all of the technical details presented, there was much that I was able to grasp on topics such as the problem of hospital capacity, and the nature of how this virus transmits. 

Many have compared Coronavirus to the 2008-09 financial crisis and while there are some parallels in terms of the actions the Federal Reserve has taken and the stimulus and bailout proposals under discussion in Washington, this period of history seems fundamentally different. In 2008-09, the crisis was financial, not related to matters of life and death. I worried about my investments but not about the impact of the crisis on my health or the health of friends and family. 

The current crisis feels more like the period after September 11, 2001 when many of us either lost loved ones or, for periods of time, could not contact them. Additionally, after 9/11, there was a period of many weeks and months when Americans did not know when or if the next attack would take place. The prospect of a “dirty bomb” was ever present in our minds. Many businesses did shut down but activity came back to life over the following weeks and normalcy slowly returned. 

September 11, 2001 was an exogenous shock to the system resulting from the actions of known and visible enemies. The enemy in the Coronavirus pandemic is known but invisible — a malign force that threatens to sicken and kill the most vulnerable among us, but has the potential to severely affect anyone. Even worse, human interactions are curtailed as we worry about being asymptomatic carriers who could infect those who are particularly vulnerable. It’s a cruel irony that interactions between family members are often not possible despite the fact that many of us suddenly have more free time to spare due to the closure of offices and schools. The possibility of contagion can sometimes make the risk of interaction too high.

The 1918 flu epidemic is often referred to as a comparable event so I have ordered The Great Influenza: The Story of the Deadliest Pandemic in Historyand plan to review it on The Rational Walk. History can provide some clues regarding what to expect but there simply is no modern precedent we can fully rely on.

We are in uncharted territory.

A number of topics planned for this week’s newsletter have been deferred to next week to make room for the preceding essay. In particular, I plan to examine prospects for Berkshire Hathaway in this unfolding crisis, with particular focus on the repurchase program, the potential impacts to Berkshire’s operating companies, and the decline in the equity portfolio.

To read last week’s newsletter covering coping with market meltdowns, Berkshire’s Occidental Petroleum investment, Markel’s 2019 annual letter, and Thomas Jefferson on enduring hardship, please click here.

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Copyright and Disclosures

Nothing in this newsletter constitutes investment advice and all content is subject to the copyright and disclaimer policy of The Rational Walk LLC. 

The Digest #13