Our firms has spent a lot of time researching coronavirus and COVID-19, and now, with confidence, we can tell you that we don’t know how this will play out. Nobody does. The virus may get contained relatively quickly, as has happened in both China and South Korea. Social distancing and lots of hand washing are key to slowing the spread of the virus.
My biggest hope is that capitalism will win — that pharmaceutical companies will find a cure or a vaccine for COVID-19. I’d bet on capitalism — our selfish perpetual engine with the power to do seemingly impossible things. Or the virus may get killed by sunlight and warmer weather — something that happens every year with the common flu.
The realist in me believes COVID-19 may linger longer than a few months (especially after seeing the damaging and embarrassing U.S. response to date). How much longer? We don’t know. From today’s perch a global recession looks unavoidable; in fact we are most likely already in recession. At my firm, we’re positioning our portfolio and our strategy as if the virus is here to stay for a considerable time.
We had not been positioning our portfolio for a virus but for a recession; and since this virus will cause a recession, we find ourselves owning a lot of recession-proof “anti-viral” stocks (a lot of them are in healthcare). Also, we have plenty of cash and hedges (where we are allowed).
“Life can only be understood backwards, but it must be lived forwards,” the Danish philosopher Søren Kierkegaard observed. To that point, I was discussing the Great Recession with a client, and he was reminiscing about how it would have been nice to buy stocks in March 2009. I spent a lot of time thinking about that lately, and here is the reality of it: It is only “nice” from today’s rear-view mirror perspective.
If you bought stocks six months, a month, and or even a day before March 9, 2009, Mr. Market would have schooled you: “Don’t buy, just sell.” Just as during bull markets every sell decision stirs subsequent regret, and every buy decision brings instant confirmation of your brilliance.
The lessons Mr. Market teaches during one of his manic-depressive moods are usually the wrong lessons — opposite from what you should be learning. It is now clear as rain that you should have pawned your treasures and bought the market in March 2009, but it sure as heck wasn’t clear then. If you turned on your TV or read the newspaper back then, every single headline raised your blood pressure. The news was depressing — even worse than it had been six months before.
I promise you that at some point in the future we’ll know that on this or that day we should have gone all in on stocks in response to the coronavirus, but we are not ensconced in the future, and we don’t have that luxury.
You can have clarity, or you can have undervaluation; you cannot have both.
There is a saying on Wall Street: “They don’t ring a bell at the bottom.” They really don’t. So today we have to drive with a foggy windshield and just continue doing what we have done all along — buying high-quality, significantly undervalued businesses. Here is what we know: You can have clarity, or you can have undervaluation; you cannot have both. Nowadays investors have anything but clarity, but undervaluation is coming real fast.
Why not go to cash now and just buy lower? Today our firm owns a lot of 25- to 50-cent dollars (we sold 85- to 90-cent dollars a few weeks ago). We could sell them and hope to have a chance to pick them up for 15 or 20 cents on the dollar. But we may not get that opportunity, and quite frankly we like the businesses we own.
A client asked, why not wait until things settle down, when this irrationality has stopped? My response was, would you rather play poker against professional poker players or drunken sailors? “Drunken sailors, of course!” he retorted. When fear rages, time horizons are squeezed to nothing, and portfolios are liquidated because people were overleveraged to the hilt, the market is awash with drunken sailors. This is when you want to invest. You have to accept that every (buy) decision you make will look “wrong” the very next day, but that is par for the course.
2. Every company we invest in should either be robust or ‘antifragile’: Robust means the business survives the crisis, while antifragile means it benefits.
This doesn’t mean these businesses won’t be impacted by the crisis. In fact, we are counting on the fact that some of these companies will be impacted. That is what will create the opportunity to buy them, because most investors will be focusing on the next six months while we’re focusing on the next six years.
For instance, there are certain companies in the travel industry that we’d love to buy (not airlines) whose business will be disrupted by the coronavirus. We expect their stocks to be kissing dirt, but as long as these businesses survive the virus (we are only interested in the ones that have an excellent chance of doing so), they’ll provide incredible opportunities when COVID-19 is behind us and our lives return to normal. (Which will happen.)
3. Position sizing: Recessions are only events in hindsight; in real time they are processes. We are in the early innings of a recession. This time, its duration is not going to be determined by economic rhythms but by a virus. We are coming to this party with cash reserves (and hedges) that we intend to put to work. But since we don’t know how long this will last, we’ll diversify across time by employing a micro-focused investment strategy.
So, instead of building a position in one or two scoops, we’ll reduce our initial purchases to “micro doses” — 0.25% to 1%. We’ll build positions over time. For example, recently we bought a 1.5% position in Berkshire Hathaway
in two scoops, first 1% and then 0.5%. Our goal is to maximize the buying power of our cash but at the same time to put it to work.
4. Accept imperfection:We are aiming not for perfection but for rational, thoughtful, analytical decisions based on the information we have on hand, though we accept that in hindsight our decisions will probably be seen as imperfect. Here is an example. We raised cash when it became apparent to us that the virus was coming ashore, but we could have sold more. We accepted this imperfect decision and moved on.
5. Options: We buy insurance (put options) when it is cheap and hope a hurricane doesn’t come. We look at these options as a future source of cash, but we are going to tread lightly here, as they protect us against low-probability but extreme outcomes.
Keep in mind that risk for us is not volatility but permanent loss of capital. We almost don’t care what this market thinks about our stocks in the short run (unless we want to add to them).
Meanwhile, check out these Six Commandments of Value Investing — a chapter from my still unfinished book, where I discuss famed value investor Benjamin Graham’s principles of value investing in depth. You can read the chapter here or listen to it here.
So, how does one invest in this overvalued market? Our strategy is spelled out in this fairly lengthy article.