Why I Drastically Increased Cash Holdings Because Of The Coronavirus

This article focuses on the economic and investing impacts of coronavirus but in no way intends to minimize the very real and tragic human cost.

I wish I could say that I had started to reduce my portfolio holdings drastically on Friday 21, 2020 — before the meltdown — but I can’t.

Annoyingly, the signs to sell were there Friday. In the morning the ABC reported that an Italian man had died in Italy, a surefire sign that there was community infection. Meanwhile, it was already clear the virus was going rampant thanks to a ‘shadowy’ church in South Korea. And worst of all, we’d learnt the day before we’d seen that Japan was allowing (statistically certainly) infected patients on the Corona Princess (a better name) to mingle with the population.

Painfully, I was simply too distracted processing actual financial results to piece it all together and see — finally — that the pandemic was so much more likely than I had previously thought. In the periodical update sent out on Friday 21, after market, I wrote: “I should note here that I have now taken the view that people are underestimating the threat from the coronavirus. This is a 180 reversal of my previous view.”

By Saturday morning I articulated my thoughts, arguing why the world should start pricing a coronavirus pandemic soon.

Clearly, to me, the markets were not pricing this threat to future returns, so on Monday, 24 February, I started selling and on the morning of Tuesday the 25th, before market, I wrote about what I was selling and what I was planning to sell further. And of course, by Wednesday I was holding more cash than ever before.

The question is why?

As a few may recall, I make investment decisions based on a “latticework of frameworks” that I use to try to predict long term and medium term stock price movements. The most important of these frameworks is valuation.

Many of my major holdings had reasonably optimisitic valuations due to strong past share price performance. Pro Medicus was up over 100% in a year. Audinate had gained over 60%. EML had done more like 200% in a year (but 80% since I bought). McPhersons was up over 60% since I decided to buy it in August. The list goes on.

Now I had already taken plenty of profits out of the market (and subsequently deployed into renovating our investment property) as shares flew high, but I had also kept holdings in these businesses because I think they have really good long term prospects, even if I wasn’t that comfortable with the price. Part of the reason I held on was because the sociological framework told me that there would continue to be strong demand for high quality growth stocks in a low interest rate environment with a reasonably healthy global economic outlook.

Of course, that all changes when a pandemic strikes. While interest rates may remain low, a lot of companies will see their growth interrupted, and the suddenly negative outlook will see many investors pull money out of the market. The selling of passive ETFs would then see the wonton selling of their constituent stocks. The pandemic was sure to break the sociological phenomena that saw people view equities as the only option for a large part of their capital. Suddenly, the optionality of cash and the glitter of gold were relatively appealing. A huge amount of hot money, chasing price and nothing else, was clearly likely to flow out of equities.

On top of that, the virus may actually interrupt or cause genuine difficulties in the business cycle. Large scale efforts to save lives — and reduce pressure on health systems — mean a reduction in business activity generally. Except for a few winners, the impact is going to be negative on most businesses.

As an aside, the kind of ‘winner’ I am interested in is a company that will see people use their services more, but this behavioural change will be permanent: think Teledoc (NYSE: TDOC) (a telemedicine provider which I hold) over Zoonoo (ASX: ZNO) (an ASX listed business with more red flags than revenue and an astronomical valuation, selling hand sanitisers).

So basically, I see this as a potentially cycle-ending event; far more so than the sell-off in October 2018. As a result, I decided to move from around 5% cash to around 33% cash in my portfolio. I did it quickly as detailed here.

Now many people say things such as “if you liked the business at $5 you should like it even more at $4”. However, this forgets that valuation is relative.

Imagine there are two companies:

Company A I hold at $5, and drops to $4.50.

Company B I do not hold, because it was too expensive at $8 for me, but I think its shares are worth more than Company A shares.

Well, if I suddenly I see Company B shares are cratering. They are $7, then $6. Meanwhile, Company A has only gotten a little less expensive. I’m probably better off selling Company A at $4.50 rather than waiting, if I’m fairly certain that other, better, opportunities have been created by the panic.

And — because I think this is a potentially large disruption — I think there probably will be better opportunities. Will markets really trade higher if US schools are closed, and the Australian Prime Minister is in hospital? Will they trade higher if there’s a global shortage of certain antibiotics? Will they trade higher if we are sick, mourning, and panicking for basic supplies or unable to do any non-emergency surgery because our hospitals are crushed?

I don’t think so. But of course, I do not know, and none of this is advice or a recommendation, it is simply an investment diary.

And more importantly, do you really think we’re at the bottom after ~10% falls from the top, and epidemics getting started (or playing out) in just 4 or 5 countries. Will it not be worse if Europe, America and others are hit?

As I write this an Italian in Nigeria is sick. Clearly, the disease is spreading in France. Countries simply have not restricted travel from Italy, Japan or South Korea in the same way they did from China. As I write Qatar Airways offers cheap flights from Milan to Sydney, with just one short stopover. If we haven’t already got community infection here, it’s probably just a matter of time.

My bet is that this gets worse before it gets better, and I get better bargains offered to me along the way. Now, that’s not guaranteed to happen, and I did not sell 100% of my portfolio.

One thing I will not do is blindly hold all my stocks — and refuse to move to cash — simply because I’m anchored to the price they were before this sell-off. I’m not selling some of my stocks because I think worse of them as companies — I’m selling some of my stocks because I want to be able to redeploy the capital later, at lower prices, and own more of good companies.

This is not a guaranteed outcome, and if it was, I would have sold a lot more!