Volatility. Market declines. Opportunity.
This will be another one of those periods that we will all remember for years to come.
The significant decline in global equity markets over the past few weeks is notable not just for its magnitude, but also for its speed and breadth.
The emergence of coronavirus disease 2019 (“COVID-19”) in China, its spread through Asia and more recently its emergence in Europe and North America, has caused significant panic amongst investors and the general public.
Panic is highly contagious. Perhaps even more so than COVID-19.
Because this virus is new and fast-spreading, it is scary. Understandably so. This means it is also very difficult for individuals and investors – even for the subject matter experts – to model and understand how and when COVID-19 will come to an end. Absent information upon which to confidently model an outcome, investors have reacted by indiscriminately hitting the sell button.
Not insignificantly, this new virus emerged at a time when equity markets were trading at or near all-time highs, and in an era where information (and misinformation) travels at light speed – thus making the markets even more susceptible to an exogenous shock like this. Investor confidence has been rocked.
While each market correction is different, examining historical market corrections and periods of significant volatility can be both insightful and helpful.
The words “this too shall pass” have been accurately stated time and time again.
COVID-19 will certainly have a real effect on the economy and on society in the near term. Areas of obvious impact are global supply chains, the travel and hospitality industries, demand for commodities, consumer confidence, and more. All contribute to negative implications for global growth.
The market correction caused by the COVID-19 coronavirus is different than each of the events we highlight above, and we simply cannot know the full extent of the economic and human impact of the virus at this time. We are not doctors nor epidemiologists and we won’t pretend to be. However, in an effort to understand the potential path and severity of this virus as best we can, we have been studying the trends, statistics, and developments of COVID-19.
We expect to see the number of COVID-19 cases escalate materially in North America and other regions. However, the statistics from China, and more recently from South Korea, appear to suggest that the disease is beginning to crest in those countries and is coming under control. This gives us a window on how it may play out both here and in other countries. If so, then that is a positive development because it gives us a light at the end of the tunnel and, importantly, a wall of worry for the market to begin climbing. That said, we do expect the markets to remain quite volatile and headline driven in the near term (both good and bad).
Where to from here.
As we allude to in our comments above, our working view today is that this is a transitory event, albeit a significant one. We see a very high probability that life gets back to normal. The COVID-19 virus will have a material economic impact in the short-term, but the price declines seen and experienced in many fundamentally strong businesses is not warranted.
In its most simple form, the value of a business is the net present value of its future cash flows. Right now, during a time of stress, panic and fear, investors are extrapolating the short-term situation too far into the future – thus overweighting the current negative environment and underweighting even a return to normal.
If one believes that we eventually return to a level of normal societal and economic activity – schools and theme parks reopen, quarantines end, flight restrictions lift and professional sports leagues restart – then when that happens (and likely before it does) investors will begin valuing businesses based on their long-term cash flows again.
The fiscal and monetary stimulus response from governments and central banks will be huge. We have already seen many countries act and they have promised more measures are on the way. In addition to these announced and future stimulus measures, North American governments now appear to be taking significant action to halt the spread of COVID-19 and, while early, we have seen similar measures in other countries begin to have the desired impact.
Markets have stepped off a ledge and have begun crossing the chasm. We don’t know how far away the other side of the chasm is, but I’m confident there is an ‘other side’.
What are we doing.
We have been active during the last few weeks.
Unsurprisingly, our shorts have performed quite well of late and we have opportunistically locked in some of the gains on those positions. Our arbitrage book has also performed well – this market neutral and tax efficient strategy is valuable during both volatile times like this and as a long-term allocation to an investment portfolio.
Apart from a few outliers, the companies that we are long have declined with the broad moves of the markets. We of course already like the companies that we own in the fund, and while their stock prices have moved lower, our view on the medium and long-term value of these businesses has not changed.
In addition to our existing holdings becoming more attractive from a valuation perspective, we are always looking to improve the reward-to-risk composition of the portfolio. A significant market dislocation like this increases our opportunity to do so. In some instances, we have been able to begin acquiring companies on our watch lists at prices that we didn’t believe would be possible even a few short weeks ago.
There is a saying that one shouldn’t let a good bear market go to waste. In addition to the brief comments above on our actions, I believe we are going to see some tremendous opportunities. While the current environment is obviously quite fluid, we are already starting to uncover some unique and compelling situations that we are excited about.
Finally, I would like to thank you, our investors, for your trust and support. I’m sure that some investment managers have had clients frantically calling them, panicking and seeking explanations for what is happening. While I have spoken with many of you, the conversations have been constructive, helpful and – dare I say – even a little optimistic. As most of you are aware, I have a significant amount of my own net worth invested in the fund, as do several of my colleagues. We are working tirelessly every day to grow and protect your capital, and we are excited about the current and future investment opportunities we will take advantage of.
On that note, please do not hesitate to call me directly if you would like a more detailed update or if you have any questions.
I’ll end here with an excerpt from our Q4 2011 fund commentary:
While we don’t want to diminish today’s challenges, we are mindful that throughout history successful investors have prospered through opportunistic buying during panics, not selling. When this crisis is broadly recognized as having ended, security prices will already be higher.
Travis Dowle, CFA
President & Fund Manager
Maxam Capital Management Ltd.
PS: We recognize that our staff and our business, like any other, is not immune to the challenges posed by the COVID-19 pandemic. We have been actively sharing information from the health agencies with our colleagues in order to decrease the risk of transmission and to avoid or lessen any potential impact. We have reviewed and tested our existing business continuity plan (BCP) in order to keep our colleagues healthy and safe, and so that we can continue to focus on the task at hand – navigating the challenges and opportunities of this environment. We have implemented certain portions of our BCP, with some members or our team working seamlessly from home. And all of us are meticulously washing our hands more times per day than I can count!