The big news this morning, timed perfectly with the open of our stock market, is that the US Federal Reserve will cut interest rates to a 0% – 0.25% range, and embark on significant quantitative easing.
While this may be a boon for markets (because lower discount rates increase net present value of future cash flows), central banks can’t fix a health crisis. Rather, you need to enact measures like they have in Singapore, South Korea and China. For a start:
- Free provision of face masks
- Free testing for Covid-19 and government funded contact tracing and testing of contacts
- Ban on entry
- Temperature testing to enter in any location
- Massive government funded cleaning and sterilisation of public infrastructure.
So far, those who have argued that the virus will have a different impact in Western countries than it has in China have been repeatedly and completely wrong. It is not just a flu and it is an insidious invisible killer. There’s a good reason China is sterilising their cities.
In fact, John Hempton muses in this excellent podcast with David Clark (Inside the Rope) that rate cuts may exacerbate the issue since they encourage economic activity. What is needed to deal with this crisis is dampening economic activity, for a time.
I thoroughly recommend every investor listen to the above podcast which discusses the way an astute hedge fund has navigated this disaster and (more importantly) looks at how governments can deal with the emerging crisis. John is understandably very concerned about the potential loss of life. As he points out, our primary priority should be protect our health and the health of our loved ones.
On top of that, he makes the argument that ultimately markets will price for outcomes of the pandemic, which are uncertain, unknown, and (in my opinion) looking worse by the day. This is the key fact I think many investors are missing. They are anchoring to past prices in a pre-pandemic world or they are looking at unprecedented charts that are technically oversold. But I think ultimately markets will reflect the range of real-world outcomes arising from the pandemic.
However, that wasn’t the most important part of the podcast. Rather I think the most important bit of advice was when John said at the end:
“If you think that the winner at the end is the guy that holds the biggest pile of cash… you’re tempted to do silly things in order to be the winner… If you think that the winner at the end is the person that has the good stable family relationships and the happy children… then you’re not tempted to risk what you have and need for what you don’t have and don’t need. And that remains my advice always: don’t risk what you have and need for what you don’t have and don’t need.“
Whether or not markets continue Friday’s pop today, I will likely take the opportunity to raise more cash by selling shares. For me, the policy responses that will make me feel more confident are the responses that will actually reduce death, suffering and economic impact from the virus, rather than simply pumping up markets with ever lower rates.
Increasingly, I believe we are going to suffer a recession or depression as a result of this pandemic. For the sake of my family I want to make sure I am in a strong position to be buying as much stock in good quality companies during the darkest days. If I’m wrong, and equity markets have already bottomed, then I will still benefit as stocks rise (although my gains will be less than otherwise). If I’m right I will benefit greatly as I am able to buy good quality businesses of distressed sellers in the darkest of days.
And I do not believe that we are in the darkest of days; the data tells me this is the (relative) calm before the storm. As I write, ASIC has announced that certain institutions must limit the volume of shares they trade. That means that there will be less liquidity and less efficient markets.
Does that sound like something that happens at the bottom of the market?
I am increasingly concerned that regulators are acting like communists and am scared that they will either ban short selling or actually just start buying equities like “team China” does. Therefore, I will also likely reduce my short positions (and gain more cash that way). Of course the flip side is I will also lose downside “protection”.