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.
Mass testing is not enough
The problem with testing is that most people infected by SARS-Cov-2 will not test positive. For every confirmed case, there will be at least several other cases that go undetected. There are two main reasons for this:
- 40% or more of the infected are asymptomatic and don’t know that they have the disease. This truly makes the virus an invisible enemy because it spreads undetected. This undetected transmission makes the SARS-Cov-2 pandemic more damaging than what I originally anticipated.
- At the early stages of the disease, the PCR test generates many false negatives for the virus. Sensitivity may be in the 30-70% range at the beginning stages of an infection (see the paper referenced in my earlier blog post). One way to improve the detection rate is to perform a PCR test several days after the first test. This is one area where China is being meticulous in ways that other countries aren’t. For returning travellers, Chinese healthcare workers perform a PCR test on arrival, quarantine travellers for 14 days in a government-run facility (rather than home quarantine), and then they perform another PCR test days later.
In the US, one scientist guesses that there are 10 to 20 cases of infection for every confirmed case (*limited testing capacity in the US leads to a very low detection rate). Some coronavirus denial scientists put the number even higher at 50-85X the number of infected per confirmed case. Regardless of the true number, most sources would agree that there are many undetected cases for each confirmed case.
The large number of undetected cases limits the effectiveness of contact tracing as it means that most carriers aren’t being quarantined. Iceland and Germany demonstrate that testing alone is not enough to keep the virus suppressed despite very high testing capacity in both countries. Both countries are implementing restrictions on their citizens.
While China and South Korea are leading the world in suppressing the coronavirus, they have not been able to eradicate it. Community transmission is still ongoing in those countries. The best that we can do right now is to use contact tracing alongside other tools to suppress the virus:
- Travel restrictions.
- Mask wearing. See my post on aerosol transmission for a more detailed discussion about the mask debate.
- Restrictions/bans on large events.
- Social distancing.
Tools that are less obvious include:
- Better infection control at testing sites. South Korea for example has drive-thru testing centers where patients are segregated from each other and do not touch common surfaces such as door handles to an indoor building.
- Better infection control at hospitals. Hospitals can perform more testing to make better guesses about a patient’s status such as using CT scans, follow-up PCR tests, contact history, etc. Many developed countries lag behind because doctors aren’t being educated about the specificity and sensitivity of PCR tests; those words generally do not appear on government websites. Developed countries need to educate their healthcare workers and to re-arrange hospitals for better infection control.
Currently, China is hanging onto restrictions on large events while Singapore is seeing infections increase (see Worldometers for Singapore new cases data). Like it or not, restrictions on daily life are here to stay until a better solution for the coronavirus emerges.
The new normal will lead to bankruptcies and financial distress
Airlines, large events, hotels, and movie theatres will all see their revenues decimated by restrictions that slow the spread of the virus. They will receive the heaviest restrictions as they are not critical to the economy and they put their customers into high-risk situations. Even if there are no government restrictions, customers will stay away from these businesses due to fear. In Sweden and Korea, movie theatres have close to zero customers despite being open to the public. Public data from America’s TSA shows that air travel is roughly 5% of what it once was despite the government bribing the airlines into flying empty planes around the country.
What I’m saying may be unpleasant. You may have entered the current situation with stocks that were previously reasonably safe: REITs, retailers, restaurants, banks, hotels, movie theatres, mortgage servicers, etc. etc. Now I’m telling you that you need to manage risk and to reduce your exposure if necessary. On individual stocks, levels of leverage that were previously safe may now be dangerous. You should re-analyze companies in your portfolio to see if they will make it through a highly unusual recession.
The businesses that will likely be hit the hardest are airlines, movie theatres and large events/gatherings (e.g. Gildan, Informa, Live Nation) because those businesses will see the most restrictions and/or the greatest loss of customers. There may also be bankruptcies due to lower oil demand (e.g. shale E&Ps) and unemployment (e.g. leveraged lenders like banks, subprime auto, and mortgage REITs). Companies in hard-hit industries with low amounts of leverage should have a good chance of surviving, so I wouldn’t necessarily be bearish on all of the stocks within industries hit the hardest by COVID-19.
Government inaction will take economies into uncharted waters
The pandemic is disrupting certain essential businesses. It turns out that infection spreads rapidly at meat processing plants as many employees in these plants work within a few feet of each other over their entire shift. One Smithfield plant has over 640 infected workers (!!!). Other meat processing facilities around the US and Canada are also closing temporarily; this may soon cause a shortage of meat processing capacity that will force farmers to kill livestock. Many businesses have been forced into paying their workers an additional $2/hr due to workers not showing up for their shifts; I would presume that the absenteeism is a combination of staying home while sick and workers being afraid of dying.
This is not what a normal economy looks like.
Worse than Italy?
Italy did not see disruptions in its essential businesses while America has been experiencing them. If the ongoing disruptions in developed countries result in food shortages, consumers may start hoarding food when their country’s media runs news stories on shortages; developed countries have already seen irrational shortages in toilet paper due to media attention. Food shortages would teach citizens to fear the virus and, indirectly, to fear their workplace. In the end, America would have to go through a hard national lockdown like Italy and deal with additional problems that Italy did not face:
- Labour shortages from workers not showing up to work.
- A lack of consumer confidence once stores re-open.
- An extended period of low oil prices, potentially causing more bankruptcy in oil stocks.
- A longer period of economic disruption. This means more bankruptcies and defaulted debt rippling through a highly-leveraged financial system.
If American politicians decide to forgo a national lockdown, I don’t know what will happen. Perhaps the country would remain in a de facto lockdown where most citizens decide to stay home. At the same time, another portion of the population will go out and do their shopping and attend church, spreading infection. It is likely that such a situation would cause the most economic damage as the country would experience the economic damage of a lockdown over a long period of time.
The duration of a nation-wide lockdown is uncertain
Italy’s lockdown has been far less effective than the lockdown that China implemented on Hebei province. The level of new cases remains stubbornly high and has not shown signs of rapid decline like in China.
Like Italy, developed countries may have cultural elements and subpar pandemic expertise that would make their lockdowns only mildly effective.
While Donald Trump is a polarizing figure and I really don’t like him, I would have to point out his political genius:
- He makes his supporters feel like they are under attack. When a group of people feel like they are attacked, they will band together and feel a strong sense of kinship (e.g. sports fans, sports riots, the social bonds that form among soldiers, etc.). The September 11 terrorist attacks brought America together and caused its president’s approval ratings to skyrocket. Trump is doing something similar with his followers.
- Trump creates scapegoats. Human beings want to go along with scapegoating because they don’t want to end up on the wrong side of it.
These dynamics are causing Trump supporters to take an anti-lockdown stance and to engage in coronavirus denial (e.g. it’s not that deadly, the lockdowns are more harmful than the virus, etc.). Instead of Americans uniting against their common enemy, instead Americans are in a conflict with each other. Trump is intentionally trying to scapegoat left-leaning state governors who have implemented lockdowns. His supporters are even staging protests in the streets and chanting “Fire Fauci”.
There are also some non-conservatives in the US who also oppose lockdowns. The scientism crowd (e.g. John Ioannidis) has taken the stance that the mainstream media has been engaging in fear mongering instead of looking at “scientific evidence”.
Among liberals, there is a tendency to elevate Dr. Fauci to hero status because (A) he supports lockdowns and (B) most liberals perpetuate the worship of scientism (bullshit that sounds scientific). This is not necessarily in America’s best interests because other experts in the world are sharper than Dr. Fauci. To some degree, Dr. Fauci pushes the pharmaceutical industry’s agenda. The pharma industry wants the coronavirus solution to involve products that the pharma industry sells: off label drugs, treatment drugs, vaccines, antibody tests, etc. The pharma industry does not sell contact tracing or aerosol protection.
Overall, the political divisions and corruption in America will hinder its ability to effectively suppress the virus. If Americans want their country to burn then I don’t want to be on the wrong side of that.
Antibody/serology tests are a fantasy
The antibody tests provide a guess as to whether or not somebody has been infected by SARS-Cov-2 in the past. These tests are helpful for researchers. However, they will not allow for the economy to re-open.
Suppose that 5% of the population has been infected and that the tests generate false positives in 10% of people. In a population of one million people, 50,000 will be true positives and 95,000 will be false positives. This means that only 34.5% of people who test positive have actually been infected in their life. A re-opening based on antibody testing will not work because most of the people who test positive are still in danger of being infected. In practice, there are other issues with these tests as a re-opening strategy:
- If only 2% of the population has been infected, then 2% of the workforce returning to work isn’t particularly exciting.
- Some patients are re-testing positive after they leave the hospital. There are 2 main theories at the moment. The first theory is that the virus remains latent/dormant in the patient and somehow re-activates (like the herpes virus). The other theory is that some people don’t have lasting immunity against the disease and have become re-infected. If the re-infection theory is true, then the antibody plan may be fundamentally flawed.
- The sensitivity and specificity of the antibody tests are likely below 90%.
Now is the time to be greedy… about the right situations
The large dislocations in the stock market have created many situations where the risk/reward is more favourable than normal. This is obvious in the various arbitrage trades out there such as the IAC/MTCH spinoff special situation, A/B share arbitrage in the John Malone empire, LSXMA/SIRI, merger arb, etc. etc. (*Note: I do not currently have any arbitrage trades as I do not believe their risk/return is attractive.) The mispricings in the stock market are clearly much bigger than normal. Now is the time to put capital to work.
To manage risk:
- Avoid excessive exposure to COVID-19. The combination of leverage and negative cash flow will lead to bankruptcies. Do not allocate too much of your portfolio into buying stocks beaten down by COVID-19 fears.
- You don’t have to play the game of figuring out how long the economy will be disrupted and whether or not a company will go bankrupt. You can simply stick to businesses that will largely be unaffected by the coronavirus.
I own some risky beaten-down stocks: Gildan, MTY Food Group, Boston Pizza Royalties Income Fund, Great Canadian Gaming, Simon Property Group (call option), and Cimpress PLC. I am fine if all of them go to 0. I also have a number of hedges, though hedges don’t always work. The hedges consist of shorting airlines, shorting oil and E&Ps, OZK puts, PSEC puts, AMC puts, short CPSS, short CONN, short MFIN, short MRCC, short EQB.TO and HCG.TO, and going long CF. (I am also short LYV / Live Nation but it may be a bad short.) While I am shorting common stock in tiny amounts, I would be very wary about doing so because the risk/reward is not good (as explained in my post about short selling).
Don’t worry about what other people will think of you
What I’ve been saying may be difficult to accept. I am telling you that many experts are full of bullshit and that health authorities haven’t been telling you the full truth. Nobody is explaining to you that most infected cases will go un-quarantined. Nobody is telling you that SARS-Cov-2 is mainly transmitted through aerosols and that some aerosols will pass through a N95 respirator. (*Don’t panic because viral infections are mild when the dose is low. It is highly likely that a N95 respirator will give you some level of protection, more so if the seal is good.) Understandably, you don’t want to be seen as somebody who believes in ‘bro science’ or ‘woo’ from some investing blog on the Internet. Human beings are wired to seek safety from their in-group/tribe so that they don’t end up on the wrong side of bullying, ostracization, discrimination, etc. It would be socially convenient to have shared beliefs with the coronavirus denial camps or the group of people who are in favour of decisive action. However, your personal and financial safety are more important than that. Most investors are too optimistic about the coronavirus’ impact.
You should also figure out which group of experts to trust. The Chinese take precautions against aerosols (even if they are officially wishy-washy about it) and are very meticulous in their efforts to contain the virus. What they do looks extremely paranoid. But they are generating results. I am inclined to side with medical figures such as Zhong Nanshan of China and Kim Woo Joo of South Korea (they have interviews available on Youtube). There are also the agricultural scientists who perform randomized controlled trials on animals to gather scientific evidence about the respiratory coronaviruses that affect livestock.
Currently, I am optimistic about making money in the stock market (perhaps in a naive and dangerous way). There is opportunity in front running other investors who have not figured out how economically dangerous the coronavirus is. Think for yourself and you may be rewarded with money… and loneliness.
Coronavirus at Smithfield pork plant: The untold story of America’s biggest outbreak – This BBC article describes the questionable management of a Smithfield meat processing plant with 644 confirmed cases. I wonder if the company will face legal liability- the situation will not look good to a judge because Smithfield was dishonest and unnecessarily endangered its workers.
Google Scholar and Sci-Hub.tw can be used to read academic papers. Use Google Scholar to find papers on a topic (e.g. “coronavirus aerosol”) with the most citations. A high number of citations is usually a sign of an important paper. If Google Scholar does not have a link to the full paper, copy the DOI into Sci Hub.