A framework for handling uncertainty
Howard Marks, a brilliant financial mind, said, “In the real world things generally fluctuate between ‘pretty good’ and ‘not so hot’.” But in the world of investing, perception often swings from ‘flawless’ to ‘hopeless’.” Only a month ago, the consensus for the global economic outlook was uniformly positive, and in a mere month an unimaginable and unknowable event is here and it is putting fear into investors.
At the most basic level, what does any investor’s composition of equities, mutual funds, and fixed income instruments actually represent? For equity - stocks and equity mutual funds - the answer is business ownership. On the fixed income side, your investments essentially represent loans to governments and businesses.
Viewing investment portfolios in this context can help simplify difficult market events because it reframes our investments. They are not simply random quotes on a computer screen or numbers on monthly statements. They represent real ownership in high-quality businesses.
With that as background, a critical question in our minds is this - with all we know (and don’t know) about coronavirus - have the long-term earnings and cash flow streams from companies like Apple, McDonalds, CN Rail, Fortis etc. forever changed?
The S&P 500 is currently 19% off of its February peak, one of the largest and quickest corrections on record. But are the long-term cash flows from corporate America worth 19% less today than they were a mere two and a half weeks ago? We don’t think so.
How can we be so sure?
There is still much we do not know about COVID-19, but the majority of experts agree this is not the Spanish Flu reincarnated. The COVID-19 virus itself has now infected 105,586 people globally, with 3,613 new cases confirmed outside of China on March 8. This rate of spread is nearly as high as China’s peak of 3,892 new cases on February 5.
On a positive note, RBC Global Asset Management points out that within China the improvement is truly remarkable. Rates of new infections have plunged, and tens of thousands have been declared virus-free. The number of those currently infected has receded to less than 19,000 of the almost 81,000 originally infected. At this point, China – responsible for 77% of the world’s cases – has managed to control the disease and is now in the process of restarting its economy. This must surely bode well for the rest of the world.
Outside of Asia, infection rates are accelerating, which is a concern to us. Containment and quarantine efforts have ramped up meaningfully in Italy, which should help to arrest the spread of the virus going forward in this country. Infection rates may continue to accelerate in other nations, including in North America, as reporting and testing improves.
The market now finds itself in bear market territory following the most recent sell-off, with global markets pricing in lower growth going forward at this point. It makes little sense to us to pivot off our asset allocation and sell equities into a market that is paying roughly 20% less for businesses than it was last month.
Similarly, it does not seem like an attractive proposition to then take those proceeds and lend them to the U.S. or Canadian government for 30 years at 0.7% interest rate. There is no doubt that times like these can rattle investor confidence, but we continue to remind ourselves of the sage advice from the legendary investor, Warren Buffett – “Be fearful when others are greedy and greedy when others are fearful.”
Some Thoughts on Oil
Crude oil prices are down 50% year-to-date. The last time oil fell 30% in a day we were invading Iraq in a literal war (1991 Gulf War), not a figurative one between the Saudis and Russia.
Why is this happening?
Last week, OPEC members had a meeting, to respond to the slowing in global oil demand as a result of the Coronavirus outbreak. But the group failed to agree to deeper cuts on Friday after Russia (not even a member of OPEC) resisted a proposed 1.5 million barrels per day cut to oil supplies.
The result is a far weaker supply/demand backdrop. In response, Saudi Arabia engaged in a price war over the weekend - slashing pricing for its crude by the most in more than 30 years, while also promising to ramp output.
In the near-term, we expect most oil producers around the world will have to significantly scale back production and capital expenditure plans in the face of lower energy prices.
We appreciate that these are difficult times, and we are there with you. If you have any questions or concerns, please feel free to call Tim Corney (tim.corney@rbc.com).
Tim Corney, CFA I Portfolio Manager & Vice-President
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