Currently, the stock market is in a weird situation where most stocks have exposure to the systemic risk of COVID-19. As it is highly likely that social distancing will become the new norm, a long list of businesses will be badly hurt: airlines, restaurants, movie theatres, music events, conventions, lenders, etc.
If the COVID-19 situation drags on for 3+ years, you don’t want your portfolio to blow up because of it. It would make sense to put a good portion of your portfolio into less risky investments that will survive. Because individual stocks can blow up, it is a good idea to diversify (e.g. 10-30+ stocks). It’s also a good idea to avoid owning too many stocks with similar risks (e.g. stocks in the same industry, too much COVID-19 risk, etc.).
Stocks discussed: CNC, UNH, CHTR / LBRDA, TSN, HRL, COST, PGR, V, MA, MCO, SPGI, FB, GOOGL, IAC / MTCH, VRSN.
In this blog post, I’ll give my thoughts on industries that will almost certainly see many bankruptcies. In general, the stocks with the most bankruptcy risk have some combination of the following:
- A fall in revenues because consumers don’t want to go out in public and possibly die. Some industries will continue to be impacted even after a vaccine is developed (if it is developed).
- Fixed cost leverage. Some businesses such as restaurants are locked into leases that will cause them to burn a substantial amount of cash.
These situations may be very difficult to analyze. However, there may be opportunities in the mispricings such as going long restaurant franchises and shorting airlines, E&Ps, and the lowest quality lenders. If an industry such as airlines has high bankruptcy risk, I will also talk about related industries even if they do not have high bankruptcy risk.
I was naive for believing that governments around the world would implement country-wide lockdowns once the bodies start piling up. Now that people are dying, it is clear that many countries are not particularly interested in mounting an effective response against the coronavirus. Countries are still being dragged down by their internal politics. Given the rapidly changing situation, some of the current stock market valuations will be unsustainable. Here’s what many investors haven’t yet figured out:
- Social distancing is the new normal. Mass testing and contact tracing are less effective against SARS-Cov-2 than other viruses. We cannot rely on contact tracing alone.
- Premature re-opening is a dangerous experiment that will end in body bags and bankrupt businesses.
I don’t mean to be a permabear or to be alarmist. However, most investors are blissfully unaware about how difficult it is to fight this virus. A segment of the stock market will be hit hard by the virus and you need to make sure that your portfolio will hold up.
While this manufacturer of nitrogen fertilizers has sold off in the recent stock market crash, it is largely unaffected by COVID-19 and is positioned to see a small benefit from it. Regardless of how well COVID-19 treats CF (or not), the company will continue to be the lucky beneficiary of the shale revolution. CF is a low-cost operator simply because most of its manufacturing plants have access to cheap natural gas. Further advances in shale technology will improve CF’s profitability.
Keep in mind that CF is in a cyclical industry. I believe that the industry is set for another bull market run as there is very little new capacity being brought online.
Monroe Capital reports profits on their loans even after the borrower declares bankruptcy. The company has highly unconventional ideas about when impairments should be taken.
Market cap $141M, borrow about 3%. *Disclosure: I do not currently have a short position in this company but you should expect me to try to short this company.
While there are many people who don’t take the coronavirus pandemic seriously, there are some people who want to see the government take quick and decisive action on COVID-19. But here’s the problem with the decisive action camp: the people who believe in decisive action don’t realize how bad their healthcare system is. Everybody is assuming that the coronavirus will somehow magically go away because developed countries are supposed to have first-class healthcare systems. The reality is that most developed countries are far, far behind China and South Korea. That idea may be difficult to accept. But the stock market is not going to reward investors for making the same mistakes that everybody else is making.
I apologize for repeatedly writing about COVID-19. But, it’s worth writing about because people aren’t getting it.
China is the country in the world that has been the most aggressive in combating COVID-19. But even China is disallowing large gatherings such as their education system’s most important examinations. Why? One of their medical experts, Dr. Zhong Nanshan, has the opinion that the virus can be suppressed but not eradicated. There’s something about the virus that makes it incredibly difficult to eradicate at the moment.
What China looks like right now will be the new normal until a better solution for the virus emerges.
- Far less people eating at restaurants.
- Airlines are operating at a very small fraction of their full capacity.
- There are no large gatherings- sports, movie theatres, cruise ships, etc.
- Factories are running and most people are back to work.