Adaptation is Key To Survival

A Pandemic Underway
With most markets around the world falling into correction territory last week, we are prompted to seriously look into it. So far, cases of COVID-19 are mounting in many countries with the most infected being China, South Korea, Iran and Italy. What’s interesting is that the US is one of the few countries with the least cases, if we exclude those that were repatriated from the Diamond Princess cruise ship. All investor’s eyes are focused if the epidemic situation will evolve in the US. We think it most likely will for four reasons:

1. Cases are underreported across all US states
The US is only beginning to roll out 2,500 detection kits for COVID-19, representing 1.5 million tests. Any American will be able to get tested, with no restriction (even if they are experiencing mild symptoms), subject to doctor’s orders. Because cases were largely undetected last month by lack of testing, we expect cases to skyrocket in the next weeks. On the plus side, it will give the full picture of the ongoing crisis.

2. The private healthcare system is unaffordable
Going to the hospital is not an option for most Americans. Even if 91% of the population is covered with health insurance, deductibles are often exorbitant. Many have the mentality of “toughing an illness out” rather than seeking medical help. This exposes the community to higher contamination risks. New York is the only state at the moment waiving costs for testing, urgent care and office visits.

3. The government’s crisis team is incompetent
President Trump announced that Treasury Secretary Steven Mnuchin, White House Economist Larry Kudlow and Vice President Mike Pence are going to lead the administration’s response to the coronavirus. The lack of doctors and scientists to guide the country over the crisis may lead to poor decisions. Their plan for the outbreak to disappear in the summer along with aggressive rate cuts, may be proven ineffective.

4. American workers don’t have paid sick days
Except if they are working for large corporations offering more generous employee benefits, the average American only has 2 weeks of holidays per year and no sick days. US workers living paycheck to paycheck or with high debt/income ratio have an economic incentive to keep working even if they are sick. Workers in the restauration industry are especially vulnerable and potential super spreaders for the Covid-19.

The S&P 500 bounced back to 3,100 points after falling as low as 2,850 points last week.  Although investors are hoping the $50B IMF aid program, the Fed’s unexpected 50bps rate cut and Joe Biden’s stunning win on the 2020 race to solve the issue, we still see more near-term volatility and downside potential.  

In the end, the “goal” of a virus, like any living organism, is to survive. The virus does not want to kill its host because it kills itself by doing so. As we are writing this report, Forbes wrote an article stating Chinese scientists found the Covid-19 virus has genetically mutated into two variants: S-Cov and L-Cov.

L-Cov is more dangerous but becoming less prevalent. In other words, S-Cov is more contagious but much less lethal. Although we might have a pandemic of S-Cov, it would be less disruptive than expected for the economy. Another leg down followed by a V shape recovery is our base scenario.

What are we going to do about it?
That’s the one-million-dollar question! This “black swan” event was unpredictable by nature which prompted us to ponder about it. Some of our Factor-Based strategies have protected the capital on this first leg down of the correction. We won’t intervene by going against our quantitative approach. We have more to win by keeping a discipline now than succumbing to the temptation of rebalancing in panic.

For that reason, we will stick to the rebalancing calendar we have on all the strategies. The best we can do is to be more cognizant of the stocks that will serve as a replacement for the ones we are systematically selling with the <70% sell rule. Between two companies that are ranked highly in our system, we should opt for the one that we think will fare the best in this challenging environment.

To avoid unnecessary portfolio turnover, we are also making sure not to sell stocks encountering short term ranking anomalies generated by this historically high volatility environment. This is why we may, in rare circumstances, keep some stocks with a ranking slightly below 70% that we believe can go back above the threshold in the short term. Let us know your thoughts, as your feedback is appreciated.

The Portfolio Management Team