This is our fourth update on the current situation.
By now you are all aware of the gravity of the Coronavirus situation. Life is going to be different going forward. Things are not going back to normal. The structure of society will change permanently. And over the next few weeks, many investors in public markets, private markets, and real estate will experience permanent capital losses.
I implore you to see this for what it is—something that will create once in a lifetime opportunity for those who are prepared and keep their wits about them.
To this point we have done extremely well. In fact, I cannot stress how well we've held up. Through Friday, our Care Tail-Hedged Equity was up slightly year-to-date and our Core Equity was down roughly ten percent. The total U.S. equity market was down -16.9% YTD thru Friday, March-13. Both are excellent outcomes so far, but we still have a lot of work to do. I can't guarantee we will do as well in the next few months as we have year-to-date. However, I can promise you we are very well positioned. I can also say with confidence that what we are about to see in markets is unlike anything most investors have seen before. What follows should excite you, not scare you. For those able to keep their heads on straight, we are likely headed for the greatest buying opportunity in many many years. But very few will avoid giving into the panic and fear that's coming.
This is not about predicting but assessing what has happened and the ramifications. We know what is happening... things are going to get rough. We’ve never seen anything like this before. The world economy is coming to a screeching halt.
When the market panics, you will naturally also be fearful—and you will have a tendency to want to give in to that fear. It will seem like the world is falling apart. Remember, this is what we are prepared for. This is why we’ve been cautious. Build the ark and don’t jump off when it gets bumpy — because it’s likely to get very bumpy. And if you jump off, you lose.
There are two big unknowns right now. (1) Effectiveness of government’s policy measures. (2) How fast the virus is still spreading.
On the first, it is unclear how much stimulus will help. Given this is not a financial crisis, it’s unlikely to help much if this thing doesn’t get solved in short order. On the second, the spread has not died down yet in any country without mass government-enacted quarantine. People have still been acting as if it is going to die down on its own or that ‘herd immunity’ will work. Herd immunity means you let it run its course through the population in one way or another. It might work but there is no evidence it will work. How difficult is it to realize we can't take that chance? (See end of post links for more information.)
Goldman now sees a 5% contraction in second quarter GDP. The Federal Reserve lowered the Fed funds rate to a range of 0-0.25% Sunday evening. Though this is an unprecedented move (in an unprecedented situation), cheaper money cannot solve the problem. Mohamed El-Erian wrote Sunday night "neither a lower cost loan nor cash in pocket from lower mortgage payments will encourage people to travel and re-engage in economic interactions." The only thing that can solve the problem is what people have been most unwilling to do: utter isolation.
I am incredibly fortunate to have been a part of with the Real World Risk Institute (RWRI), a group founded by Nassim Taleb and two other Ph.D. mathematicians. They have been able to see the exponential spread of COVID-19 since January. Links to their work are provided at end of this post.
In markets (and pandemics), you cannot rely on evidence because when you get evidence it’s too late. This is not a normal system. Most "smart" people’s intelligence in whatever domain does not transfer to this domain, including many leaders. This is a complex, non-gaussian, nonlinear, emergent system that could easily produce extreme fat-tailed and utterly devastating outcomes. Anyone who doesn’t immediately know what that means (which is almost no one) has had no clue what is about to happen.
In fat-tailed systems, the past is often a terrible indicator of the future. Hence, we have to assess what is happening before it’s obvious to everyone else. Have to be able to grasp underlying fundamentals to have any chance of understanding what’s going on. In this case, people have been relying on experts who have been relying on other experts. Modern society is trained not to “panic”, but if your house is on fire the longer you don’t panic the worse it gets. The kitchen is on fire and everyone else has been waiting for confirmation it’s going to spread before they take action. The slow response and lack of directness by governments, trying to keep people from panicking, has made it worse.
We have been following this situation very closely and mentioned the risk of pandemics in our January letter. Though we have so far been prepared, no one could have predicted how bad this was going to get. I would never have imagined that, once the seriousness became obvious, so many people (leaders and citizens) would take so little or no action. An Australian immunologist paints the picture of American arrogance here. American's have relied on experts who were relying on experts, who claimed to need "evidence" before taking action. All the while none of them apparently understood the math behind why this was going to be a problem (which I showed in my last post).
COVID-19 is not just killing old people. And 80% of cases being mild and asymptomatic is not good --- it means those people continue to spread the virus longer. There is a severe ethical issue we're going to have to deal with when we begin to recover. How could we have knowingly continued to move around and congregate when we were warned over and over again that it was spreading? (The answer is modernity and academia have made people vastly overconfident in their "evidence based" and data driven "research." They arrogantly assume they know far more than they do, then teach others to do the same. Further, they rarely understand how to use correlation and other statistical measures. As Nassim Taleb has said, “Absence of evidence is not evidence of absence... And it’s okay to mistake a rock for a bear but not a bear for a rock.” They do not realize they cannot wait for evidence in domains where the evidence will kill you.)
Leaders have been conflicted as very few have really understood the gravity of the virus. Closures finally started last week. The gov’t (state and federal) have recently started saying “everything is on the table.” They are trying to subtly let people know that we’re about to have a mass lockdown. No country has contained COVID-19 without a policy of mass isolation. China and South Korea stopped the spread by extreme measures which Americans are not prepared for—initially total lock down for multiple weeks. Then restrictions on where people can go and at what time and with how many people. Life is going to be different going forward. Small business and many families are going to have financial trouble. People will have to make major adjustments.
There is a very low chance things will not be totally shut down by this time next week, either by federal or state mandate. Confirmed cases are not actual cases. The real case count in U.S. is at least 20-40,000. As these numbers skyrocket fear is going to grow. Counterintuitively, this will be the safest time.
Lots of people discussing herd immunity right now. That’s what Italy was trying to do. Easier solution for government leaders but here’s why it’s a dangerous idea.
Below are links to the website setup by New England Complex Systems Institute with the most useful information. I can promise you the RWRI/NECS crowd are the smartest people in the world when in comes to how things cascade/blow-up in complex systems.
For those interested in understanding the math: https://necsi.edu/pandemic-math
Why this one is not the same as past: https://necsi.edu/transition-to-extinction
Short paper from Rutgers statistics professor, Harry Crane, on naive probabilism, or why smart people have been and still are so wrong.