ost of the time we go about our business not
thinking very much about dangers lurking in nature, beyond those that
can be controlled by normal sanitation, hygiene, and a decent respect
for our fellow creatures. But in the space of less than three months an
amoral and lethal natural force that knows no boundaries of any kind has
swept across the globe rendering even the most normal human interactions
potentially dangerous. At the time of this writing fully 30% of the
world’s population is subject to lockdowns because of the Covid-19
pandemic, and some governments have forbidden their citizens to venture
forth from their homes in groups larger than two, and then only for
essential purposes.
Since businesses are people, commercial activity
began to decline rapidly as individuals en masse avoided contact, put
off vacations, and postponed dental appointments. As the extent of the
infection became better understood, governments began to shut down
non-essential activity, bringing about the economic equivalent of an
induced coma designed to put business infrastructure into a stasis mode
until the disease is brought under control. These drastic but necessary
measures mean that economic statistics will soon look ghastly — already
unemployment claims in the U.S. skyrocketed to over six million in the
latest report, a record number. Some projections call for unemployment
rates in the U.S. to reach as high as 30%, meaning fifty million people
without work, very quickly. The global economy appears set to suffer its
biggest setback since the Great Depression, with growth almost certainly
turning negative for the year.
In the face of such dreadful prospects,
countries are also taking steps to preserve their citizens’ well-being,
providing support for employees, small business owners, and contractors
who suddenly find themselves without incomes or hope of finding
alternative jobs. Large businesses as well, such as the airlines, in
dire straits due to the shutdowns, will also receive public support.
Fortunately for sovereign borrowers, interest rates remain quite low, in
some cases even negative, so the financial resources necessary to cover
the enormous expenditure that is required (the U.S. has so far approved
over two trillion dollars in assistance of various kinds), appears to be
readily available. And even in usually fiscally conservative
countries such as Germany, the health and economic emergency has
motivated all political factions to join in supporting measures totaling
about 20% of GDP (the American program comes to about 10% of our annual
domestic product.
At the forefront of efforts to contain the
worldwide economic fallout from the pandemic have been the world’s
central banks. The banks in the U.S. and European Union moved
aggressively to lower interest rates, and both have pledged unlimited
support for their respective economies and financial infrastructure. But
the banks have long stressed the limits of their power to reinvigorate
economies. Although it has taken a monumental crisis to incentivize
action, fiscal stimulus measures to promote recovery after the crisis
passes may also be in store in the form of massive government spending
on long-needed infrastructure projects. With interest rates being what
they currently are, almost any investment in public goods can be
profitable to societies in the long run. That such measures are being
seriously discussed at this time proves that, in a crisis, we are truly
all Keynesians.
The sheer magnitude and uncertainty of the
current situation, the realization that this is a different kind of
menace perhaps not readily amenable to the usual ameliorative efforts,
convulsed the financial markets. Investors raced to the safety of
sovereign bonds and fled riskier paper, such as “high yield,” or junk
bonds. In the US, stocks fell by about a third in the space of a month. Similar routs occurred worldwide, and behind the scenes far from the
public eye, financial strains began to appear, necessitating massive
central bank intervention in money markets. The stresses have not, so
far, been as severe as in 2008, but they serve as a stark reminder of
how quickly confidence in the core systems of finance can erode in the
face of fear and uncertainty.
After what has happened it is hard to believe
that in mid-February the U.S. equity market averages peaked at all-time
highs. The subsequent collapse was epic: the Dow Jones Industrial
Average had its worst first quarter ever; in March the S&P 500 suffered
its worst month since 2008; foreign markets fell over 20%. The Dow also
suffered its sharpest single-day decline, off nearly 3000 points on
March 16. This is the stuff of market lore that will be talked about for
years. It is testimony to the viciousness of the panic that the S&P fell
34% between February 19 and March 23, the quickest selloff of that
magnitude in history. Subsequently, however, the Dow Jones Industrial
Average rose
over 11% in one day, the best one-day rise since 1933; the S&P gained
9.4% in one trading session, its best daily gain since 2008. Such steep
moves, though bewildering to the casual observer, are not unusual when
markets are shaken by fear. Also typical of emotional market situations
are those sudden shifts that defy the prevailing market sentiment. As
Jillian Tett of the Financial Times
reported in a well-timed piece on February 20 (in other words, at the
market top), two-thirds of those responding to a survey had expected
stocks to continue their climb to more new highs. Such bullishness
exceeded that of early 2007 and corresponded to equity valuations that
were at their highest level since the dotcom bubble. We have no doubt
that at the bottom of this cycle (at a date to be determined in
hindsight), expectations will be just as determinately
negative as
they were confidently positive at the top.
Since the Financial Crisis twelve years ago,
investors have been spoiled by long periods of calm markets, rising
stock prices, and falling interest rates (or rising bond prices), so the
recent market action should serve as an important reminder that
disturbing declines and sudden reversals of attitude are nothing new — we
have all been here before. As difficult as it may be at these times, it
is critical that investors keep matters in perspective. While down
significantly from their highs, U.S. stocks are still above the lows
reached relatively recently at the end of 2018 — such has been the
strength of the advance over the past year — and valuations are nowhere
near as compressed as they were in the early 1930s, or during any of the
major downturns since. While it is tempting to think that with the
selloff, stocks are attractive — and in some individual cases they are — on
average they are not especially compelling. After markets have
stabilized somewhat, as they did toward quarter’s end, it is also
tempting to pronounce the market crisis over. In late 1929, after the
October crash that year, stocks began to recover toward previous highs,
leading some to conclude that the turning point had been reached, and
that sentiment would return to its prior bullishness. Immediately
thereafter began a sickening decline that took the averages down to
total losses of about 85% by mid-1932.
At
this point no serious observer, including ourselves, expects a
1930s-style calamity; the massive fiscal and monetary programs now
underway should mitigate against a contraction of that magnitude.
Nevertheless, it is wise to be mindful and respectful of what markets
are capable of doing. Used with care they can be the source of
great benefit, but like the corona virus, they are impersonal, amoral,
and apolitical, and certainly not your friend. It is also very important
not to let them do your thinking for you. At the extremes, people are
inclined to make the worst decisions — to buy when markets are bullish and
sell when bears are prowling, out of fear of missing out on more gains,
or of losing more after declines. All things being equal, the
appropriate response is to do just the opposite. When skies are blue,
the road ahead clear, all around the world is in bloom and markets are
rocketing higher, that is the time to sell if you wish to do so; buy
when no one sees hope for the future and prices are heading down. It is
best, however, for investors to ignore the markets entirely and buy
businesses that they want to own (such businesses are seldom sold),
when the numbers are attractive. Acting rationally, you will have
fewer regrets; the market will go on its merry way regardless of what
you do, and securities will invariably rise in price after you have sold
them and continue to fall after your purchases. “Shoulda, woulda,
coulda” is an occupational hazard in investing.
A final
word from our perspective: people do recover from the corona virus. It
will not wipe out the human race. Markets will recover in due course, as
they always have. Whether a pandemic or a bear market, in the midst of a
crisis it feels like things will never get better. But it is unwise to
let the current darkness cloud your judgement, as many in our
grandparents’ generation did after the Great Crash, when, by shunning
equity investments out of fear, they failed to participate in the
stunning growth in wealth that followed. At such times it’s wise to
recall an overlooked aspect of the 1930s experience: after that
devastating 85% loss, U.S. stock prices multiplied by about five times
in the middle years of that decade. Not all is lost.
No one,
including us, knows what the financial markets will do going forward,
but that is not a subject for productive inquiry in any case. It is far
better to concentrate on acting rationally in a manner that current
circumstances require, and in accordance with basic principles, the
chief of which is one of attitude: we own businesses and do not
trade stocks. We believe this gives our efforts an advantage in the face
of panic — stock prices may fluctuate wildly, but good businesses endure.
If the
present market instability continues it is likely that we will have new
opportunities to deploy our capital, in both the equity and fixed-income
spheres. Mistakes will be made, especially in an environment as unusual
as the one we are now living through. But buying assets from distressed
sellers, at sharply lower prices, and offering higher expected returns,
has worked well for us in the aggregate in the past. We believe the
future will be no different in this regard.
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