A Great Reset

First, we hope this note finds you emotionally and physically well. We will get through this pandemic just as previous generations persevered through their hardships.

For seven years, we have authored quarterly letters sharing our collective insight and observations of the world around us and highlighting various factors that help shape our outlook. Pragmatic optimists by nature, we try to identify and handicap risks that could derail and impair investments. We evaluate pros and cons and use our seasoned judgement to weigh the merits. In deploying capital, we know that there are seldom poor investments, just poor prices. A bond that may only return 50 cents on the dollar is a lousy purchase if one pays 100 for it. However, if acquired for 25 cents, provides a fantastic return.

During the first quarter, the world’s economy was delivered a severe blow not from bad actors or corrupt organizations, but by global leaders responding to a virus. Disease is nothing new and history has plenty of examples of what happens when health crises erupt. In the recent past (30 years or so), we have witnessed the effects of viruses that take hold in various regions. However, COVID-19 initially caught many flat-footed which allowed the virus to spread, resulting in today’s global pandemic. The consequence will certainly result in a sharp economic contraction.

Currently, a moderate reset has swiftly priced into investable assets. The question that needs to be answered is whether the severity and duration is accurately reflected in today’s markets. At the time this letter was written, the US 10-Year Treasury Note was yielding 0.70%. Investing in this ‘risk free’ option will essentially provide no return after tax if held for the next decade. That may end up a much better alternative to stocks if this truly is the beginning of more dire times. If the world’s population continues to stay home and avoid virtually all consumption, then by definition, vast swaths of the economy, as we knew it, will cease to exist, and stock and bond holders will likely lose a significant portion of their capital.

We have faith in our institutions, political, financial and social, to find a solution to the crisis at hand. The interim damage will be felt throughout, but we expect to recover in time. We envision the effects will be seen for years to come and some will be disproportionately impacted. However, societies will go back to living and consuming and new market highs will be achieved - eventually. There will be differences in the recovery and these changes are what we are attempting to identify in the months and quarters to come.

In the short-term, markets are likely to gyrate around the news of the day surrounding the spread and rate of change in infections. The announcement of testing and development of treatments will likely have positive impacts on both markets and psyches. This will need to be balanced with the reality that large portions of the world are currently offline and not producing or delivering valued products and services. Some are just delayed (i.e. the timing of elective surgery), but others will be completely lost (meals not served in a restaurant).

The challenging part of the equation is getting the price right. Although stock markets fell approximately 30% in a month and a half, it is a challenge to maintain a fundamental case for traditional valuations with much unknown. From an earnings standpoint (a broad proxy for economic activity) 2020 will be a lost year. We are looking out to 2021 and 2022 for a recovery. If all goes well (and a LOT must go right) we can envision stocks back at all-time highs within a couple of years, but we expect more volatility into the summer until greater clarity emerges.

One of our bigger concerns is a recurrence of the virus in the fall, necessitating additional large scale quarantining this winter to prevent further spread. This scenario is not currently priced into risk assets and should this occur, we most certainly will experience further declines.

Let us end on a positive note. As ‘broken’ as our healthcare system appears at times, we have great minds working individually and collectively to find short and long-term solutions. We are confident that diagnostic and therapeutic solutions will be developed and deployed resulting in renewed confidence, a critical ingredient for a sustained recovery.

As always, thank you for your confidence and trust. Please contact us to continue the conversation.

EPIQ Happenings

EPIQ will begin hosting EPIQ Forums in May using Zoom! More details to follow.

EPIQ Partners