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Posted on 17 Feb 2020 by Steve JohnsonAs Chinese workers slowly make their way back to factories and offices across the country, global stockmarkets are hitting all time highs. For all of the headlines and media attention, investors seem to have taken the Coronavirus crisis in their stride. It’s been surprisingly proportional and light on opportunity.
Take Yum China as an example. Yum is an investment in our Forager International Shares Fund that owns KFC and Pizza Hut in China. The stock fell about 16% from its peak on 20 January through to the trough on the 27th. As the rate at which the virus has spread slowed, the share price has bounced some 7%, leaving it roughly 10% off its January highs.
You could argue that’s overkill. Results for the December quarter were better than expected. And, on our numbers, the impact on valuation could be as little as 2% (assuming they lose about half this year’s profits).
Yum China Share price
Source: Bloomberg
But the tail risks are clearly heightened. The most likely case might be only 2%, but the probability of something dramatically worse is far higher than the probability of something better. We have added a little to our holding, but the market response seems a perfectly sensible reaction.
With a couple of minor exceptions, that has been true across our portfolio. And I’d argue it’s been true across the market as a whole. Investors have reacted perfectly sensibly to a significant event that is still unlikely to have a dramatic impact on the value of equity markets.
I’d also argue that this has become a more common feature of equity markets over the last decade. Investors are not panicking as much as they used to. For those of us who thrive on others panicking, that isn’t good news. But there might be good explanations for it.
Index versus closet passive
The first is the rise of index funds. Computers run these “passive” tracker funds, and they don’t feel emotions. They don’t do anything when something like Coronavirus hits the front page of the papers. If Yum China’s share price is down 16%, it is down 16% in the index and the tracker fund alike. Absent inflows and outflows, the computer is going to put its feet up and do nothing for the day.
Of course, the humans who make the decisions that lead to inflows and outflows are still guilty of the same fear and greed as the rest of us. But most of the money has shifted from what I call closet index funds—fund managers pretending to be active but largely tracking the index and charging active fees for it. These closet index huggers used to get the same flows as the tracker fund, but layered their own pro-cyclical human emotions over the top.
When the next liquidity crisis comes along—one driven by redemptions—the computers will be contributing to it. Until then, you can expect less volatility.
Hedge funds and the data explosion
Another argument for the relatively benign reaction to this crisis is the dramatic rise of big data over the past decade.
Ben Graham was getting an edge through alternative data sources in the 1950s. Trying to find indicative information that isn’t released to the stockmarket is nothing new. But access to supercomputers, cloud computing and an explosion in the amount of data being created (mostly thanks to some 3.5 billion smartphones currently used around the world) have transformed alternative data into a multi-billion dollar industry.
The statistics being released by China’s government might not be particularly trustworthy, but the data gathered by New York’s giant hedge funds is getting more and more reliable. In the past, a vacuum of information like we have had about the Coronavirus would cause share prices to fall. Today, Yum China’s share price is likely to be a better guide to the severity of the crisis than the data you’re reading in the paper.
From fairly early on, equity prices have assumed that this latest version of the deadly respiratory virus was relatively benign. Without diminishing the deaths of almost 2,000 people, that reaction is increasingly looking accurate. And it’s unlikely to be a fluke.
TINA to the rescue
Then, of course, there is TINA. There Is No Alternative to equities. With returns hard to come by in any other asset class, any dip in equities prices is seen as an opportunity to invest. Argue what you want about the merits or otherwise of this philosophy, the sentiment is undoubtedly applicable in today’s markets. It has to contribute to downturns being shorter and recoveries sharper than they have been in the past.
This is a market driven by low rates and liquidity. That’s not something a virus will bring unstuck.
12 thoughts on “Corona No Virus for Global Stocks”
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Hi Steve and Team, please check out my views on the coronavirus outbreak on my site at http://macroedgo.com (initial report “Social Cohesion: The Best Vaccine Against Crises” from 3 February which included my initial thoughts, which have not altered, unfortunately, and in my daily updates)… for interest, in my “past life” as a research scientist I worked with the lead virologist in Wuhan who isolated this SARS 2 virus and who has worked on these coronaviruses for 15 years … With my training I do not consider these risks as “tail” risks – for me they are my central scenario… watch Japan closely… I am not sanguine… will not say any more as do not wish to be considered to be scaring the horses…
Great post Steve. It’s a fascinating dichotomy. Passives adding to market inefficiencies (globally), but detracting from volatility.
For now.
Thanks for posting this blog post and interesting thoughts as always.
On the point you make on the use of data – So does it make more sense for a retail investor to invest with a large fund manager (who has more money to buy more alternative data), rather than with a small fund manager?
If the game they are trying to win is data dependent – short-term information arbitrage – I’d argue the answer is yet. Although even then it is hyper-competitive. If you are investing with a small manager, you should make sure they are playing a game that they are a chance of winning. Talking my own book but I’d argue that means smaller stocks, taking advantage of human emotion and a time horizon that is longer than most.
Hi steve and co,
I think the key thing will be the amount of excess inventory in the various supply chains and the time it takes to replenish the various components. Given we are in the half year reporting cycle I’d argue the financial cost will most likely manifest itself in a few weeks time unless guidance is provided at the various AGM’s. I’d argue there is still time and we may not have received all the bad news
No doubt there is more bad news to come. Almost every stock in our own international fund has some exposure through the supply chain. I’m just arguing that the market is getting the magnitude largely right. Let’s say you lose a full 6 months of profit – ie 2020 will be down 50% – the impact on the present value of all of the future cashflows would be small.
Very interesting post Steve. If you are correct then it is a terrible bad news for all value investors who thrive on market over-reaction.
I admit not understanding how the ASX can be at all time high when the main trading partner’s economy (China 25% of trades) is grinding to a halt, education and tourism sectors are suffering badly from the Chinese travel ban and the Australian dollar is at a decade low…
Then again that is why I pay professional fund managers to grow my money.
Interesting my earlier comment on this was deleted.
It’s all come crashing down the last two days, including another big drop in the FASF. It’s almost deliberately perverse how wrong and lacking Steve’s analysis is.
FASF performance has been abysmal for the last couple of years but Steve Johnson has never tried to hide this fact. Moreover he does not blame anyone but himself for it.
A stock market rout is the best thing that can happen for the fund.
The FISF on the other hand has performed well lately thanks largely to hand picked stocks like Blancco and Motorpoint. So Steve has not totally lost his mojo yet.
In the last several days I have added to my suite of reports on the coronavirus outbreak – one article discussing the playoff between political and societal considerations when responding to the outbreak – http://macroedgo.com/2020/02/21/politics-vs-society-in-the-coronavirus-outbreak/ – the other discussing how that interplay and the development of the outbreak (probably better referred now to as pandemic) will likely affect the Global and Australian economies – http://macroedgo.com/2020/02/21/politics-vs-society-in-the-coronavirus-outbreak/ … obviously these have enormous implications for investors… I think that the (unfortunate) mounting evidence over the weekend is allowing people to see what was clear some time back to those with a background in infectious disease… as in my tsunami metaphor, unfortunately the chain of events was inevitable (that does not mean that it is futile to work to minimise impacts, but the difficulty is that the consequence of those efforts will further impact the economy)…
Sorry, that second report is at http://macroedgo.com/2020/02/24/this-is-much-worse-than-sars/
A week later – “ Virus fears blamed for the $60bn ASX ‘bloodbath’”
I’m wondering how much more I’m about to lose in the FASF.