Magical Thinking

There is a dangerous type of "magical thinking" going on in the markets right now. Investors appear to believe that since the lockdowns are easing, coronavirus is a solved problem and that a V-shaped recovery is a given. On the back of such enthusiasm, even failed businessmen are giving the greatest investor in the world stock-picking advice. But just because the coronavirus has been overshadowed in the news recently doesn't mean it has gone away - in fact, its spread is still increasing in many places.

Nor does it make sense to extrapolate that a single month's increase in payrolls or a weekly increase in the number of airline passengers will ramp up linearly until we are "back to normal." The fundamental reason for unemployment and the decline of travel - that most people no longer trust being in close proximity to strangers - has not gone away, nor will it fully until there is a vaccine or cure. The virus will not magically "go away" in the summer; there will be unpredictable flare-ups, and, if history is any guide, a second wave, which will continue to cause fear and uncertainty among consumers. This uncertainty will have fundamental implications for almost all businesses, regardless of whether a society is "officially" in lockdown and regardless of what one's political affiliation is.

Even if there is a cure, the recovery will likely be slow, and there will be many long-lasting structural issues to overcome. 2% of small businesses have already permanently closed and "the sentiment among restaurant operators is that only 20% of [restaurants] are going to survive." 24% of people in the US are experiencing housing insecurity, defined as the "percent of adults who missed last month's rent or mortgage payment, or who have slight or no confidence that their household can pay next month's rent or mortgage on time." These negative trends will likely accelerate once the Paycheck Protection Program expires and if unprecedented federal unemployment stimulus comes to a halt.

This is not a market prediction, but simply an observation based on my updated valuations of individual companies, valuations that attempt to realistically reflect the scope of the pandemic and its response. "We're only down 15% from the all-time high of February 19," Howard Marks said in April, when the outlook for the world was arguably better than it is now. "It seems to me the world is more than 15% screwed up." Even if the market is fairly valued, the margin of safety, given the great uncertainty ahead, is minimal for many securities. There may still be some bargains out there, but on balance it seems like the time to be extra cautious with respect to preserving capital, and tilt more towards defense than offense.