Ides of March
The Ides of March is the 74th day in the Roman calendar that corresponds to 15 March. It was marked by several religious observances and was notable for the Romans as a deadline for settling debts.
The world’s economy has been disrupted by the Corona Virus. One third of the entire population in the United States has been told they have to stay home. Businesses are ordered shut. Travel is essentially eliminated, along with related lodging and food services. Realizing the dramatic reduction of economic activity, investors have reacted by selling everything. Every asset class is included, meaning stocks, bonds, gold, silver, oil, other commodities. Painful. Very painful. In fact, the drop is the quickest and most severe for the market since the Depression. If one remembers our economic history, the Depression was caused by too much leverage of those participating in the stock market. Interestingly, the same may be taking place with the current selloff.
In looking at the situation, the obvious root of the problem is the elimination of any possibility of a functioning society in some of the largest segments of our twenty five trillion dollar economy. You can see from some of the videos of New York, Seattle, and my hometown of Las Vegas, the streets are empty. In Manhattan. The Strip. Until people can go back to work, investors are going to find it difficult to take the risk of owning a financial asset that is not tied to something which generates income. Instead, they look to bonds. However, the bond market has long been dominated by our friends at central banks across the world. Yields have been anchored near 0, or in some countries, they have been negative. Owning bonds with these interest rates rates leaves the owner with little compensation relative to the risk of owning something risk free, like a Treasury bond issued by the government. So, bond fund managers decided to be really clever, and leverage what they own by borrowing lots of money as a way to create more return. Remember, bond yields only go down, and bond prices only go up. That is of course, until investors see more risk of owning a government issued bond. Clearly, the U.S. economy, it’s citizens and businesses, need help from it’s long dysfunctional government. With the leaders of the United States now talking about a stimulus package in the neighborhood of one trillion dollars or more (some analysts thinks that will not be near enough), the US financial position will be adding to it’s current deficit of over a trillion per year. Without mentioning our unfunded liabilities (let’s conservatively estimate them at $50 trillion), the pertinent question is how can bond yields stay at near zero? The answer, quite obviously, is they couldn’t.
As such, I suspect those very intelligent and creative bond fund managers who borrowed against their holdings had the trade go against them. The same could be said for any entity that used leverage against their assets. Many custodians offer equity loans for those individuals who want to borrow against the positions they own in their portfolios. So, as has historically been the case in prior selloffs, leverage is exacerbating what is already a tough trading climate. How long will this last? Nobody knows, and anyone who thinks they can accurately tell you is just guessing. We know that markets look ahead, maybe six to nine months. We know the selloff has been fierce and difficult for those who own assets, especially equities. Leveraged sellers get rid of what they must, regardless of the quality. Nothing is spared, including owners of quality stocks. In fact, those assets are the hardest hit because they are liquid and able to be traded. Punishment does not begin to accurately represent how difficult the last week was. The numbers behind the week are difficult to look at as the market was down 17%. In five days. Every day has huge trading swings which clearly don’t give any kind of accurate representation to economic fundamentals. The obvious question I keep getting asked is when do you step in to buy? The answer is based on the specific circumstances of the client (risk tolerance, financial situation, liquidity needs, dependents, beneficiaries). We know that tax requirements are being pushed out at least four months, so that should be considered as well. You don’t need to buy everything, or anything. You should buy what you want to own and know why you want to own it, and be prepared to own it if it goes down plenty more. The most important idea here is the quote from Mr. Munger,
” This is the third time Warren and I have seen our holdings go down, top tick to bottom tick, by 50%.
I think it’s in the nature of long term shareholding of the normal vicissitudes, of worldly outcomes, of markets that the long term holder has his quoted value of his stocks go down by say 50%. In fact, you can argue that if your not willing to react with equanimity to a market decline of 50% two or three times in a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.”
Finally, the country’s current dilemma shows there are structural problems in both health care and the market which have become quite glaring. On the health care side, the lack of beds and hospitals is related to outdated laws which haven’t been modernized in many states. Too much reliance on China for critical ingredients or inputs in important products like drugs, masks, gowns, ventilators, and respirators. In our markets, we have stocks of hundreds or thousands of companies trading which currently aren’t allowed to do business. In most instances, the prudent course would be to suspend trading in that company. Investors won’t have any luck with that as you pays your money, you take your chances. The last month has been tough for any equity owner, myself included. I understand it’s a difficult time, and might get more so. However, as this month proves yet again that March is when debts get settled, if you stay calm and focused on what opportunities may be popping up, many years from now you may have fond memories of this legendary time.
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Yale Bock, Y H & C Investments, its clients, and the family of Yale Bock have positions in the securities mentioned in the blog, Investing in securities involves risk and the potential loss of ones principal. Past performance is no guarantee of future results. All investment decisions should be considered with respect to ones risk tolerance, return objectives, liquidity needs, tax considerations, and one’s overall financial situation. The fact that Yale Bock has earned the right to use the CFA designation does not mean Y H & C Investments will outperform broad market indexes.