We are in a severe recession. What now for both companies and investors?
We are in a severe recession right now that is unlike any other in recent history. Tolstoy’s Anna Karenina begins with the sentence “All happy families are alike, each unhappy family is unhappy in its own way.” This recession makes me think of this quote as it is quite distinct from other recessions dating back to the early 1970s. This is not a financial crisis. This is not an oil price induced recession. This is not an asset bubble popping induced slowdown exacerbated by a terrorist attack. This was not caused by the Fed raising rates to prevent inflation. Nothing like this has happened in the last 40–50 years. The economy has just stopped. There is no roadmap to follow.
As I have noted on Twitter, I am lucky to be good friends with one of the world’s most distinguished and experienced macro investors. He is older than I am — although younger at heart — and has been investing for over 40 years. I really value experience, so we made a deal almost 7 years ago: he can call anytime to ask me about technology; in return, he will let me know anytime he gets particularly concerned about markets. As I shared on Twitter, he called me for the first time on February 23 — which was a timely call. We spoke yesterday and he is still very concerned. I am the furthest thing in the world from a macro investor and we all know that market timing is not a good idea. Nevertheless, I thought I would share some thoughts on the recession that we are currently living through, what I think the near term and medium term may hold and how companies and investors can think about responding. Disclaimer: anyone who only wants thoughts from an “expert” on macro or the Coronavirus should stop reading now.
This is likely the largest nominal demand shock in modern economic history, amplified by social media. Per my European macro friend, electricity consumption in Madrid — a reasonable proxy for economic activity — is apparently down 30%. As I shared over the weekend, this is roughly confirmed by a dataset from Opentable which showed that restaurant traffic is down over 60% in many American cities. That is likely the fastest deceleration in history. And now that states are starting to shut down bars and restaurants for the next 2–4 weeks, activity will asymptote to zero along with physical retail sales as more stores are shut down. Uber indicated this morning that rides were down almost 50% in Seattle and apparently the Four Seasons in SF has already laid off 50% of their staff.
As far as I can tell, hotel and airline demand is down more than post 9/11 or during the 2008–2009 global financial crisis. Alex Cruz, the CEO of British Airways wrote a memo titled “The Survival of British Airways” which began with the following statement: “Some of us have worked in aviation through the global financial crisis, the Sars outbreak & 9/11. What is happening right now as a result of Covid-19 is more serious than any of these events. It is a crisis of global proportions like no other we have known.” As I wrote in my note about bear markets, this will be the first recession accompanied by broadly available alternative data and we will begin to get credit card data for early March in the next few days which will likely confirm all of this. Lots of traders are focusing on initial unemployment claims as a critical high frequency indicator to watch — while this was absolutely the case in 2008–2009, I suspect that initial unemployment claims will lag the credit card data.
The fact that the Fed cut before Congress really acted on fiscal stimulus (need $500b plus) means that economic situation is so dire that the Fed could not afford to let the market pressure Congress into acting, which is the Fed’s preferred sequencing.
As a result of all this, US Treasury Secretary Steve Mnuchin is setting the stage for the bailouts of multiple industries. After the backlash from 2008–2009, I cannot imagine they will be equity friendly and will focus upon preserving employment. I suspect they will be called “wipeouts” to avoid a populist backlash. It is fascinating to observe the wildly different bailouts being priced into various industries by the market — i.e. airlines vs. cruise lines. Counterpoint here would be that Trump really seems to measure himself by the performance of the S&P 500 so perhaps they will be more equity friendly than I am thinking. I also wonder if PE consortiums will offer private sector alternatives to government bailouts — my sense is that there is more PE dry powder today than there was in 2008.
Since I am an investor, I am focused on what this means for markets. The fact that we are in a severe recession means it is unlikely that there will be a quick market recovery, but it is probably too late to cut risk now beyond some degrossing. The odds that anyone who materially cuts risk will get back into the market at the correct time are almost zero. What will it take for the market to recover?
As I noted in my Medium post on bear markets, almost all companies will miss numbers and guide down significantly. We need companies to begin framing the impact and should begin to get this over the next two to three weeks. It is going to be shockingly bad. I focus on technology and consumer. Most technology companies attended the Morgan Stanley conference in early March and reassured attendees that the Coronavirus was not having an impact on their business. They will not want to be horribly wrong twice in a row so I think they will not only frame the current situation but give conservative outlooks.
Beyond the Fed cutting rates to zero and QE4, important to remember that *massive* fiscal stimulus is coming and the Fed can do much more. The Fed has not shot its last bullet. The government can ultimately do anything including making outright equity purchases to support the market. As I wrote on Twitter, I often think of the Churchill quote: “The Americans will always do the right thing, but only after they have tried everything else.” The public health response to the virus has improved dramatically in the last 7 days and is about to be militarized via FEMA. Political calculations have changed significantly — everyone understands how serious the situation is and no politician wants to underreact. I thought the fact that most of the participants in the White House press conference on Sunday, March 15 were wearing military uniforms was particularly noteworthy.
Beyond massive stimulus and a more effective public health response, warmer weather will almost certainly slow the virus down. I have heard the chorus of “If you’re not an epidemiologist don’t comment on the virus” on Twitter. I am obviously not an epidemiologist but as an investor, I need to do my best to understand the cadence and broader consequences of the Coronavirus. Warm weather slows down the transmission of most viruses as droplets don’t travel as far in more humid weather, which partially explains why the cold and flu are both seasonal. The higher temperatures and greater UV intensity of summer also outright kill many viruses. More sunlight also boosts immune systems in the summer (sidenote: how cool is it that UVB rays from the sun hitting the cholesterol in our skin cells provides the energy necessary for vitamin D synthesis, which is essential for a healthy immune system). Several NIH papers postulated that stronger immune systems in the summer also contribute to the flu being seasonal. I am willing to bet that the Coronavirus will slow down in the summer (see data or “Ro factor” of the virus in the Southern hemisphere today). Chinese researchers published a paper titled “High temperature and high humidity reduce the transmission of COVID-19” which found that every 1 degree Celsius increase in temperature lowered R by .0383. They projected that Coronavirus risk will change seasonally in the following way:
A summer slowdown for the Coronavirus would be really important; both to the economy and public health. Every day that goes by is a day that we are closer to a vaccine of some sort. Given that there is evidence to suggest that there are already 128 strains of the Coronavirus, the most likely vaccine scenario is one in which the vaccine isn’t 100% effective and has to be administered annually just like the flu vaccine. That would still really help. More importantly, every day that goes by we are closer to understanding how to effectively treat the Coronavirus. Remdesivir looks particularly promising and Chloroquine also looks effective. More effective treatments will significantly lower the mortality rate. A vaccine would be most impactful, but unfortunately we will not have an approved vaccine until the spring of 2021 at the earliest. A horrible mistake related to a rushed vaccine approval decades ago means that the Federal government will not approve a vaccine without at least a year of testing. Therefore the Coronavirus will likely come back next winter. But we should have more effective treatments by then along with significantly more ventilators and ICU capacity. It *always* pays to bet on human creativity and ingenuity.
China is unfortunately not a roadmap for the economies or markets of United States or Europe. Because of SARS and MERS, they were much more prepared from a public health perspective and therefore are a window into a potential public health future for the United States and Europe in 2–3 years IF there is not a successful vaccine for the Coronavirus. I suspect if no vaccine is found — or there is only partial coverage from the vaccine similar to the flu — that it will be increasingly common over the next few years for stores, restaurants, bars, office buildings, gyms, churches, etc. to have temperature sensors at their front door. Assuming we follow the Chinese model, if you set this temperature sensor off, unless you have a confirmed flu diagnosis, then you will be sent to specialized fever hospital for diagnosis and potential quarantine. That is what is happening in China to the best of my knowledge — would really appreciate a fact check on this. This was a great interview summarizing what happened in China from a public health perspective.
If you are a founder or executive reading this, cut costs now. Stop hiring. The earlier you cut costs, the less you have to cut. The later you cut costs, the more you have to cut. Get to profitability as fast as you can. Investors care much less about growth and much more about survival relative to only a few years ago. Companies that cut costs early and get to profitability will be much better positioned for the recovery. Don’t worry about what your competitors are doing, indeed hope that they continue to aggressively spend for market share as they are highly likely to go to zero if this is their strategy. If you are burning a lot of cash and did not raise money in the last 6 months, accept the fact that a significant downround is unavoidable and raise the money right now. If you have a signed term sheet, prioritize certainty of closing when choosing investors and consider proactively lowering the valuation to decrease the odds that investors back out. I am beginning to get recession scenarios from some venture portfolio companies and they look optimistic. There is no reason not to use 2008/2009 as a base case — I promise that it is easier to turn spending back on than it is to cut spending.
If you are an investor, recognize that this was the fastest bear market in history. The VIX and various sentiment indicators are near 2008–2009 bottoms. Dividend yields are approaching historic gaps relative to treasury yields which will eventually matter. This too shall pass. As stated earlier, I think it is likely too late to cut risk outside of degrossing. I wrote up my thoughts on investing in bear markets here, but would note that it is important to start with the balance sheet and focus on cash generative companies that can be valued on GAAP P/E. I think there are basically two paths for investors. 1) Do nothing, especially if you are invested in high quality, cash generating companies with good balance sheets. 2) Try to take advantage of the extreme volatility and reposition. For the second path, recognize that lots of extreme movements are being driven by derisking, degrossing and non-fundamental buyers and sellers. Keep moving and recognize that you are in a knife fight while you are blindfolded and covered in grease. Either way, I do think it is an advantage to have more global exposure given that the experience of individual countries and regions is going to vary widely.
On a personal health note, I am taking 5000 iuof vitamin D to boost my immune system and zinc every night to help my immune system fight the Coronavirus if I get it.
Good luck to all. America survived the Civil War, two World Wars, the Spanish Flu and the Great Depression. America and the world will come out of this. It always pays to bet on humanity. Most of all, remember that “Fear is the mind killer.”