Investors Are Still Badly Positioned For Pandemic — Here’s What I’m Doing This Week

This article focuses on the impact of the coronavirus on stock markets but in no way intends to minimise the very real human cost. Flatten the curve!

In order to make excess returns over the market for a sustained period of time you have to be doing something differently and you have to be doing something better. This is the first time I’ve had to invest through a global pandemic and I have two main observations so far.

First, people (including myself) have a bias to inertia because a good long term investor develops a huge bias to inertia. And that makes sense: 95% of the time inertia, which results in doing nothing when in doubt, is beneficial for returns.

However, business and markets are reflexive, investing is about the relative merit of different investments and valuations are constantly changing. When a huge disruption looms, reflexivity goes haywire, valuations change greatly, and the relative merit of investments is completely rearranged.

Second, a large group of people don’t seem to realise that investing is about finding the most attractive investments, not just finding any investment with a positive expected return. Historic global price volatility, combined with historic global disruption and likely recession have already massively changed the chess board. It is hard to keep up with the ever-changing opportunity set, but the chances that optimal positioning in December looks even vaguely similar to optimal positioning in February are a precisely zero.

So what does bad positioning for a pandemic look like?

  • Low levels of cash going into a likely recession, made lower by “buying the dip” too early.
    • It’s extra bad if you bought an overexposed company like Webjet, Corporate Travel Management or Flight Centre in late February or March.
  • No cash coming if the market keeps falling. If you’re ballsy and meditate effectively you can just ride down a crash like a zen master, but you sure as hell better have good cash and/or cash flow to fund the opportunistic investments available on the other side of the crash. I don’t have good cash flow. Cash reserves give me the ability to strike when the time is right. Short positions generate gains as the market falls.
  • Very long overvalued stocks.
    • If you haven’t been revising your valuations downwards in the last two weeks, you’re not really a value investor. Two months ago, the chances of business disruption and recession were a whole lot lower than they are now. That changes value.
    • I am seeing a lot of anchoring. To use myself as an example, I might think “Pro Medicus was $30 just a few months ago, how could the value have halved since then?” This ignores the fact it was overvalued a few months ago. While Pro Medicus will not be overly impacted by the virus, it will of course be impacted, and must now compete against alternative investments that have seen massive price changes.

Tell me where I’m going to die so I don’t go there

Of course, through the process of describing bad positioning I have seen some of my own bad positioning. At the time of writing I am still overwhelmingly long and about 33% cash. I don’t have good cashflow going out of a recession to play offence, so I need to hedge effectively. I first disclosed some of my short selling in the last portfolio update and I will continue to do so while my short exposure is having a significant impact on my overall returns.

You should not be deceived by the fact that I will remain long many of my favourite businesses throughout the coming tumult. I will be moving aggressively towards a “market neutral” position, which I aim to maintain until I have more visibility to when the pandemic will end. My best guess at this point is that markets have only fallen about half what they are going to, as a result of this global pandemic.

If a market is going to fall 40% overall, and we have already had a 20% fall, then there is still another fall of 25% to come. I do not know exactly what that will look like but I think that the second half of the fall will be slower, and punctuated by lots of ‘up days’ where lemmings try to pick the bottom based on market price action rather than real world data.

When Will I Start Deploying My Cash Aggressively?

As a fundamental investor I will make my portfolio positioning reflect what is going on in the world. Therefore, I will be looking for an overall slowing in the rate of coronavirus case growth outside of China, and within a variety of individual countries. In particular, I will want to see that the disease has relented in the USA, and that we have a good degree of certainty it will not flare up again. The best thing that could happen would be for humans to gain access on a large scale to an effective vaccine, and I believe that would probably signal the bottom.