Time to buy?
MOST countries around the world are in lockdown, with much of economic activities suspended. The modern economy needs money to flow in order to function. Without the flow, large swathes of companies are in danger of going bankrupt.
To avert that, governments are opening their coffers in ways and magnitude unseen before. The word "unprecedented" is used almost every single day by journalists all over the world to describe the situation we are all going through. Large economies in the West are looking at 20 to 30 per cent contraction in GDP in the second quarter this year. Unemployment is skyrocketing. Infections are still climbing globally. We have not seen the peak, neither are we seeing light at the end of the tunnel yet.
Still, since the markets' violent lurch downward between mid-February and the fourth week of March, when the S&P 500 Index lost a third of its value, relative calm seemed to have returned. As of Thursday, the S&P 500 has clawed back about 25 per cent from its low on March 23. However, compared with Feb 19, it is still down by 17.4 per cent.
The trigger of the February/March sell off was, of course, concerns over the impact of the new Coronavirus on the global economy. But the unwinding of positions in volatility-targeting and risk-parity funds contributed significantly to the volatility. Such funds use volatility as a measurement of risk. As volatility increases, sell decisions are triggered in order to reduce "risk", exacerbating the market declines. Another contributor to the market decline has been the sellers of options, especially put options, who are moved to sell in order to hedge their losses.
But well-conditioned by the market's inexorable march upwards for the longest time, the mom-and-pop investors seemed to be not selling, at least data from the US showed.
According to Yahoo Finance, Vanguard, the second largest provider of exchange traded funds (ETFs), reported that despite the market tumble, it's seeing massive inflows of money in its equity ETFs. Even on March 9, when markets fell on the oil shock, Vanguard's S&P 500 ETF had net inflows.Vanguard's data is at odds with its competitors BlackRock and State Street which have both seen outflows on the bad days in recent weeks. One reason could be that their products are more popular with traders rather than long-term investors, who often prefer Vanguard. State Street's S&P 500 ETF (SPY), for example, is used by short-term traders.
Meanwhile, Yahoo Finance reported Matt Sommer of Janus Henderson as saying that respondents in their survey, which was conducted on retail investors and savers, are, in fact, still calm and very bullish on the market. That's the sentiment too among long-only equity funds. Mandy Xu of Credit Suisse was quoted as saying "if you look at the equity long short, the long-only institution community, we're not seeing widespread de-leveraging from that community yet". Supposedly many of them have large long equity positions with borrowed money.
Meanwhile, the recent market corrections have brought many value investors back into the markets. While some say they think markets will still have some way down to go, they are buying now.
Howard Marks, co-founder and co-chairman of Oaktree Capital Management - one of the most celebrated investors in the world - said in a letter to his investors this week that: "a) markets may well be considerably lower sometime in the coming months and b) we're buying today when we find good value. I don't find these statements inconsistent." Up till recently, Mr Marks has been complaining that markets have been expensive for quite some time now.
Carl Icahn said similar things during a recent appearance on CNBC. Mr Icahn said the markets may still have a long way to go down, but he is buying.
Seeing the very stretched valuations in the US, another highly regarded investor Seth Klarman of Baupost Group hedged his portfolio against declines earlier this year. He made US$1 billion betting against stocks and corporate credit. But that wasn't enough to make up for losses in his long portfolio, resulting in an 8 per cent decline in March for his portfolio, Bloomberg quoted a person familiar with the firm as saying. But he has turned bullish since. Since Feb 24, Baupost has deployed a net US$2.3 billion of cash. Not only that. Last month, he reopened the Boston-based firm to new capital for the first time since 2011. In a conference call with clients on March 27, Mr Klarman was said to disclose plans to raise as much as US$1 billion from existing investors. Bill Ackman, who made US$2.6 billion hedging his portfolio with credit protection on investment-grade and high-yield credit indexes, used the money to increase wagers in companies including Lowe's Cos and Warren Buffett's Berkshire Hathaway Inc.
Berkshire Hathaway's sales
But one legendary value investor has been conspicuous in his absence in the recent market rout. Last month, Warren Buffett was quoted as saying he won't be selling. Yet early this month, investors learned through US regulatory filings that his firm Berkshire Hathaway had sold some of its stakes in Delta Air Lines and Southwest Airlines bought in end 2016. The sales brought Berkshire's holdings in these two airlines below 10 per cent, the threshold for mandatory transaction disclosure. Berkshire also has stakes in United Airlines and American Airlines. Investors will only know in May if Berkshire has pared its holdings in these two stocks as well.
Meanwhile, in January Mr Buffett sold Berkshire's entire holdings in newspapers business for US$140 million, at a loss of some US$200 million compared with his purchase prices in 2012. Berkshire's recent sales could well just be housekeeping. But Mr Buffett's reticence thus far is a stark contrast to the last crisis. In mid-October of 2008, he penned an op-ed for The New York Times entitled, "Buy American. I am." At that point the S&P 500 was nearly 40 per cent off its highs and in the midst of the worst financial crisis since the Great Depression. Stocks would fall a further 30 per cent or so from the day Buffett said he was buying stocks. Still, had an investor bought into the S&P 500 on the day his op-ed was published, he/she would be sitting on gains of close to 300 per cent, despite the recent sell off.
Is Mr Buffett seeing something that many are wilfully ignoring right now? Or is he waiting for real panic to grip the markets and the figurative blood on the street before he deploys Berkshire's close to US$130 billion cash hoard?
Given that we are not seeing any meaningful slowdown in the infection rates, there may well be another leg down in the markets. But as value investors, we look at valuations to guide our actions. The accompanying table shows valuation for the Asian markets on March 19. It was lower than all the crisis we had gone through, except for February 2009 at the height of the Global Financial Crisis.
So if you believe in the ingenuity of the human race - many top brains are working on treatment and vaccines - then we should be able to overcome this. In which case, now is not a bad time to ease into the market, bearing in mind, the stance of many value investors above that markets may go down further, but they are buying anyway.
Yet if we are in unprecedented territory, as many journalists around the world said, then history is not a good guide. In which case, one would have to imagine the various possible scenarios, eg a world which has to live with the virus, resulting in permanently increased demand for certain products and services, and reduced demand for others. In this scenario, there's still a case to be made for staying invested. We just have to be more selective.
Being an optimist, I'd like to believe that life can return to "normal", but with some adjustments like better care for the environment and other co-occupiers of our planet. That means some adjustments to existing supply and demand will take place.
The key question now is when, and how much pain we will have to endure, before we reach there.
