I’m writing this to you as a Miami Beach refugee hiding out on the Florida Panhandle, where they actually let you set foot on the beach; masks are optional and restaurants are open. It’s like I’ve gone back in time to February. Besides, you wouldn’t believe the deal I got on a beach-house during COVID. I also know that I needed to escape my normal routine of looking at cheap stocks. If I’m home, I’m probably looking to buy something and I’m pretty sure that now isn’t the time to be buying anything.
Over the years, I have repeatedly made the point that investing is all about probabilities. If you buy a cheap stock with a macro tailwind, you are likely to do quite well if nothing intervenes to screw it all up. That said, it’s important to have perspective in judging both valuation and the strength of the tailwind that you see. Fortunately, you don’t need to be fully invested—in fact, the best investments often come from having excess liquidity after an event happens.
I bring this up because the current market is one of the most difficult that I’ve seen in my career as the range of outcomes are so wide. Big picture, you have a global depression with hundreds of millions out of work, offset by “Project Zimbabwe” and while I think the big guns at the Central Banks ultimately emerge victorious, there are likely to be many scary moments along the way. I want to buy those scary moments, not the afterglow of one of the strongest rallies in market history.
As I sit on the beach and mull this over, these are just some of my many concerns; as quarantines end and infection rates go parabolic, will governments lock everyone down again? Will people lock themselves down on their own initiative? How has the pandemic changed how we consume goods? How will new regulations impact businesses? How will the virus impact global trade and movement of people? What happens to a business if the revenue level plateaus at some lower level while many of its expenses are fixed at the old higher level? Sometimes; I look at a set of outcomes and say, “You know what; I just don’t know.”
After hearing dozens of my friends tell me why they’re convinced we go one way or the other, I’m willing to accept that they’re all just guessing. This is because we’re off the spreadsheet models here and we’re trying to predict something that has never before happened. More importantly, I don’t feel like the upside is sufficient to justify the risks of most securities that I’d want to own. Markets often work off the second derivative. As long as things are getting better and states are opening up, markets will have a bullish slant. If stores and restaurants are incrementally busier, markets will keep rallying. My worry is that after a few weeks, the rate of incremental positive change likely slows. Then all hell breaks loose in the markets. What if revenue levels only recover to a break-even level? Where’s the “E” in “PE” then? Re-opening is transitioning from Stage 1 to Stage 2, what if valuations are also transitioning to Stage 2, which is dramatically lower?
Part of investing is knowing yourself and controlling your own emotions. I know that I always buy too soon. I have been working on improving upon this trait for two decades, but I’m still a sucker for a cheap stock that’s about to get cheaper. One reason I’m on extended holiday is that I don’t feel like I’m missing much to the upside and potentially missing a whole lot on the downside as I’m not actively researching new positions. I know enough to know that I want to step away until something tells me it’s time to buy.
This doesn’t mean I’ve cut all my exposure, though it’s running a lot skinnier than normal. I have a whole lot of tankers (this remains the most asymmetric trade on my screen). I have my core book of small cap growth names. I’m long a lot of inflation assets (got gold?). I even found a creative way to “play” crypto at a massive discount to NAV. I’ve also written a bunch of puts as implied volatility remains sky-high. It’s testament to the lack of clarity in the markets that I can go far out of the money and write puts at levels where I’d gladly own positions, while collecting a few percent a month if stocks do not drop. I think this is actually the lowest risk strategy today as I suspect I’ll end up pocketing premiums a few times before I end up owning positions at stunningly good prices in the next few months.
I’m not trying to pound the table on anything here. I have no hard-hitting thesis. I’m known as a guy who’s opinionated, takes positions and is vocal about them. This article almost feels contrary to my psychology. The hardest thing to do is say, “I just don’t know.” Maybe, that’s why I felt the need to write this. The range of outcomes is too wide. I find too many of my friends feel a need to be fully invested and bang out returns each month. No one knows what comes next. Why not de-gross and remain flexible? What’s wrong with waiting for a low risk set-up instead?
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Disclosure: Funds that I control are long gold. I personally own gold.