Readings For The Week (18/4)

Posted on By offpisteblog

This week’s readings/links include an interview with Stephen Diggle, Charlie Munger on why the phone is not ringing off the hook, a follow-up discussion with Harris Kupperman on oil tankers, Gerard Minack on how the coronavirus crisis will change investment strategy, a Tim Ferriss conversation with Jane Goodall and Marc Andreessen on why it’s time to build.

Notes from the interview with Stephen Diggle:
These are for personal reference only, some parts are paraphrased and any mistakes are my own.

Psychological state in the time of coronavirus:
Impossible to have a completely objective mental state, but understanding the strains and biases you are under allows you to intelligently offset the way your fears, hopes and greed are going to affect the way you see things.

He recommends David Robson’s article on how the coronavirus is changing our psychology. His quick summary is that we are still tribal beings and our fear of disease is ancient. When you expose people to the fear of disease, they have a change of psychological state – more fearful about outsiders, more obedient, more respectful of authority, more questioning of anyone outside their tribe etc.

The more you read on the coronavirus, more extreme your psychology is going to be. The most important thing to accept is you are not in a normal state, need to address it to try and think clearly.

The way he tries to address it is by not reading the mainstream press coverage. “Could” and “may” have appeared way too many times in the headlines. Less news, more speculation. The more alarmist and scary the headline, the more clicks you are going to get.

He is trying to focus instead on collecting data and putting context around the numbers. Looking at mortality rates, for example – how many people normally die? Reporting that X people died is a meaningless number without establishing the baseline. Of course, one could argue (perhaps correctly) that if we weren’t doing these lockdowns, the rates would be much higher.

Opportunities for both traders and investors:
In trading, you are trying to predict where the market psychology is going to go; there are definitely opportunities in the current environment because there is a huge amount of volatility.

But there are also good investment opportunities – his family office is buying blue chip stocks where they like the yield and locking them up forever. He doesn’t care if the stock prices go lower, he is focused more on whether the business is going to return to normality. His psychology is I will pay X for Y and the future returns from that will be good enough for me. Even if the company goes private and never trades again, should be happy with your decision.

Finding opportunities everywhere, but probably fewer in the US. Mentioned Royal Dutch Shell. Also DBS. Yielding 6% in an environment where Singapore bonds are yielding 1%. Well run yet not terribly ambitious bank (which is a good thing). Quasi-government guarantee. You can put your money in the bank and they will pay you 0% or own part of the bank and they will pay you 6%.  

The current crisis versus the 2008 financial crisis:
Coronavirus had been in the world for a few months, but volatility was still very cheap. We were coming off so many years where things had gone so well. All of sudden, when it spread to Europe, people got very scared very quickly. The market went into this crisis with way too much complacency and leverage. In that sense it’s like 2008.

But also not as big a pyramid of leverage as 2008 because it doesn’t involve the banks. Banks have mostly missed this crisis. This is more of a demand shock in the real economy. 2008 was a debt crisis centered on the banks, which were incredibly leveraged, much more systemic risk. Here the leverage is more specific – things like retail traders in ETFs etc.

VIX – gauge of fear, topped out in Oct 2008, but the market didn’t bottom until Mar 2009. 5-6 months after the VIX reached its highest, the market bottomed out. So just because the VIX is coming off now, doesn’t mean the market has bottomed.

The solution is also different this time. 2008 was a banking crisis. Hank Paulson was able to get 12 people together in a room -> take the TARP money, no questions asked. That meeting was probably the start of the recovery. This is an economy-wide demand problem, you can’t get 12 people in a room and start to solve the problem. The solution to this is much harder, much broader.

We are seeing a huge market bounce, but a lot of that is down to the Fed. The actual speed that money gets into people’s pockets is much slower. Big businesses have an advantage over small businesses right now. The Fed is out buying US$30, 40, 50bn in treasuries and you can see real money selling into that all across the curve. Almost every day, big businesses are coming up with US$1bn+ bond deals to sell to those people who are selling their treasuries. Not even thinking about what they are going to do with the money. But for the small cafe owner now shut who is thinking of how to get through to June, where is the money?

Timeline for recovery:
Totally uncertain, you just need to work with various scenarios. In general, however, economists are terrible at predicting even the short-term future. Gave the example of how, in December 1973, the British national union of mineworkers went on strike. Went to a 3-day week, from January 1 to March 7 of 1974. Industry was only able to have power 3 days a week, people had power on different days. Economists’ consensus was that GDP would be down 40% for Q1. Came in at -2.4%.

Possibility for a positive surprise? Not a complete shutdown. Lot of people are working. Lot of stuff gets done when it needs to get done. The unusual thing here is that people have been sent home. But we regularly have periods of time with very little economic activity.

The comparison with war he finds laughable. War is a catastrophe, on both a moral and human scale. 4 economic effects – stop productive capacity, build destructive capacity. Young men (historically speaking) stop work and go somewhere else, not productive. Focus on destroying other people’s productive capacity. Nations borrow enormous amounts of money, go into debt. When survivors return, there is much less infrastructure, fewer people in workforce, a mountain of debt. In this case, every productive person has gone home – some can get work done, some can’t. But the infrastructure is there. We will, however, have the mountain of debt. Perhaps just another example of how antifragile we are these days, that nothing bad can ever happen to us.

The much more interesting question to him is not when do we go back to work, but what are people going to do differently, use more/less of? For an investor, that’s an exciting range of opportunities.

Conflicts and tensions being exacerbated by the current crisis:
One is possibly intergenerational. Based on the data, this virus overwhelmingly kills retirees. We are crashing the global economy and putting millions of people out of work to protect retirees. Many young people are forced to suffer economic catastrophe as they have little in the form of savings. 

Two is the tangible increase in hostility between the US and China. Could have been an opportunity for cooperation, but seems to have turned into a clash of systems.

Third is the tensions in the EU – broadly speaking, between the southern indebted nations and the northern savings nations. The coronavirus has significantly exacerbated tensions to the point where the chance that this is the beginning of the end for the EU has gone up a lot. We are now seeing a surge of nationalism everywhere – US, UK, China, Europe. The EU is effectively sitting out this crisis, they are not being listened to. If this crisis doesn’t abate quickly, hard to see how we go back to an EU as it was before.

Inflation worries:
He felt that inflation was going to be a problem after 2008/09, but got it completely wrong. Now we are seeing an even bigger intervention than in 2008. All the infrastructure and capacity is still there, much of the workforce is furloughed for now, but more money in the system. When it all comes back, could have too much money chasing too few goods. All the reasons they had in 2008/09 are back and better and purer. If you are not making a provision for inflation, you are being very complacent.

Finding alternative sources of income even more important – bond yields will stay longer for lower. Real estate one option, but want to consider what happens to retail real estate, maybe even office real estate. Farm assets – don’t necessarily get coupons every year, because climate change is causing an increasing in volatility of returns in agriculture. Returns from agriculture are decent across the asset class, much better than government bonds, with an in-built inflation hedge. But not easy and you will get large amounts of volatility. Need a very long term horizon, can’t change your mind. Once you own it, you own it forever. 

What else could change:
This has been a very severe, sharp and rapid lesson in fragility for both businesses and individuals. Need to revisit the strength of your supply chain, how much inventory you are holding in your business, the capital buffer in your business as well as personal finances (changes in savings rate), how much you stock up on ammunition, canned foods and so on. The most important thing is working with a range of outcomes. The doomsday preppers have been laughed at for a long time, but are perhaps now in a good position. Also reinforced the degree to which we have been dependent on an international supply chain. What happens if we can’t rely on international trade?  

Gold:
The interesting thing is gold didn’t work in 2008, but it worked like a charm after (perhaps too well). He just views gold as cash. But it is cash that is inflation-resistant and difficult to produce. If you are going to be raising cash levels and your antifragility trade is that you need more cash, why wouldn’t you have gold as a significant part of that holding?  They view themselves as perpetual buyers of gold. If gold falls, they will buy it. The way they do it is by selling short-dated (e.g. 3 month) out of the money puts and using that income to buy out of the money calls.

In terms of the portfolio, thinks dollars will do well in the short-term. The world has borrowed too many dollars, needs to pay some of those back. But you want to buy today what will be scarce tomorrow – and that isn’t going to be the dollar. If had to make a bet on the best performing currency over the next 5 years, will probably be gold. But also remember that gold is only as good as cash. You have to go out and spend it on something productive. It is a preserver of value, not a builder of value.

Counterparty risk:
The problem in 2008 was that every counterparty was suspect for about 48 hours. Then that problem was solved. Much bigger problem now, more widespread and outside of the banks. Only thing you can do with counterparty risk right now is to hug those who have access to government money. The biggest banks and corporates will get bailed out. Small is bad right now. Also want to go with counterparties where the government is more interventionist. Might not necessarily be good for the equity holders (e.g. the BoE has stopped HSBC, Stan Chart from paying out dividends), but the solvency of them as a counterparty is likely to be good. There is a real risk that people stop paying each other, so making sure you can get paid (and on time) is going to be incredibly important.