Coronavirus information; A terrible pandemic nobody is worried about; My thoughts; Discussion with a friend on whether it's time to buy

By Whitney Tilson

Monday, March 2, 2020
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Before diving into my usual investing-related content, I wanted to share this post by a doctoral student at the Johns Hopkins School of Public Health who studies infectious disease epidemiology. In it, she provides some practical, non-sensational information: Coronavirus Information for Friends and Family. Excerpt:

I am 99.9% positive there will be a pandemic of COVID-19. When I say pandemic, I mean that the disease will spread across multiple continents simultaneously. This might sound scary, and it is. No one knows how severe the outbreak will become, and there may be disruptions to your daily life. The fact is that no government can outright stop COVID-19 from spreading. But YOU have a window of opportunity now to make practical preparations and to share information that might be helpful.

What can you do, day-to-day? Be hygienic and stay away from people who are sick.

  1. Right this very moment, you can practice not touching your face while in public. Keep your hands in your pockets, on your hips, or elsewhere. Avoid the temptation to scratch your eyelid, bite your nails, and use your hand to wipe your nose.
  2. Wash your hands for the full 20 seconds with hot water, especially when you return home from being in public. You can sing the ABCs song. It lasts 20 seconds. Handwashing is not a panacea, but it is helpful, in your control, and has no downside.
  3. If you are sick, stay home. COVID-19 can have MILD symptoms, which is why it continues to spread so easily. People feel fine, and then they leave their homes – spreading it further. It is critical for people with any fever, coughing, sneezing, or shortness of breath to quarantine themselves and prevent further spread. Remain quarantined until you have been feverless for at least 24-hours without medications.
  4. Offer “elbow bumps” instead of handshakes. The CDC’s full prevention page is here.

1) Have you heard about the terrible pandemic that’s struck 32 million Americans just in the past few months, sending 310,000 to the hospital, and killing 18,000?

No, it’s not the coronavirus, but seasonal influenza (better known as the flu) that comes every year.

There are some important differences, to be sure, but, as an insightful article in the New York Times highlights (How Does the Coronavirus Compare With the Flu?), it’s unclear right now whether coronavirus will even hold a candle to the usual flu season here in the U.S. – which, needless to say, doesn’t cause market panics.

My view right now is that it’s certainly wise for at-risk people to take precautions and for all of us to wash our hands more, but I’m not freaking out (as some of my friends are). It’s easy to get worried by the fake news that’s polluting the Internet (for example, see this Washington Post article: Millions of tweets peddled conspiracy theories about coronavirus in other countries), but I didn’t think twice about going to the movies last night or taking a flight to Tampa earlier today. (Of course, my views might change based on future developments.)

As for investing, I’m certainly not telling everyone to go to cash or to fully hedge their portfolios. In fact, I added some long exposure to my personal portfolio on Friday (from a position of being very overweight cash since I closed my funds in September 2017), and am looking to buy more on any further pullbacks.

2) Here’s a discussion I had with a smart friend who’s been in the investing business as long as I have about whether it’s time to buy. She wrote:

I think it’s too early to buy, but we will see! My non-investor friends are starting to panic a bit on Facebook posts, which is a good sign for buying, but that is the only one I see that gives me confidence we are near the lows.

When I go to look at stocks on my shopping list, they don’t seem to be down enough to get me really excited, mostly because they are down 15-30% from all-time highs and all-time-high multiples. Many of them had created new valuation ranges the last two years, so they have only corrected to the top of what had been the previous valuation ranges for literally decades.

And that is without taking into account any forward hit to EPS/EBITDA beyond what has already been calculated into Q1 for disruptions that have already happened. So I see risk to both the earnings as well as the multiple on most of the names I have looked at, which are admittedly in travel, which has the lowest visibility on earnings now (I looked at these first because they are down the most of my core sectors).

If the coronavirus stops spreading tomorrow and there is no real interruption beyond one quarter to global earnings and GDP, then, yeah, stocks have probably bottomed.

But it feels to me like multiples are still quite full, even with the correction. Hotels, for instance, have generally traded at 12-15x EV/EBITDA, bottoming at 8-9x during crises like 9/11 and the financial crisis. But just in the past six months, they traded up to 20x because of perceived future trends and analysts struggling to validate hanging onto rocketships (more travel, more spending on “experiences” vs. “things,” opportunity to expand in Asia, etc.).

So now, with massive corrections, some of them are back to 15x now and I’m supposed to be excited? I don’t see this as a panic level. I did a similar analysis for the cruise lines and food/beverage, with similar results, by the way.

And from a technical perspective, I think we are one or two more bad days from hitting 20% down, which often indicates further declines.

So I was actually thinking of selling my mutual funds and raising cash to go buy individual names when they get to a more attractive level.

I went full levered long in mid-February 2009, which truly felt like stocks were at once-in-a-lifetime levels. I don’t see a single name that feels like that right now, whereas I had dozens of them then. Granted this isn’t 2008 in severity, but I don’t even feel the excitement that I felt in late 2002, when many blue chips were at 10-15x P/Es.

I could be totally wrong. But all my reading indicates coronavirus will get worse before it gets better and I don’t think there is panic beyond the highly informed and those who follow the market closely… We have yet to see Main Street stop eating out, traveling, etc.

I don’t have any insight on coronavirus beyond tons of publicly available journalism, but it doesn’t seem like we’re anywhere near the bottom in terms of the impact on the U.S. economy. I also think China is understating the cases, likely Iran as well. And our government will not be effective at containing given the mess we saw with the evacuees from the cruise ship.

China was slowing before the coronavirus outbreak, plus there was already some weakening in the U.S. manufacturing numbers as well. Pre-coronavirus I thought U.S. stocks were trading at very full valuations, despite a weakening outlook. The argument against selling was the resilience of the market, low rates, and the pervasive buy-the-dip mentality. Even you joked to me that valuation didn’t seem to matter anymore.

I am not sure further rate cuts do much from here – they were already so low. And I think this recent market turmoil has been an arrow into the hearts of the buy-every-dip crowd. Plus some large portfolios (pods) at multistrategy hedge funds are likely going to see their capital cut or even shut down, so that could lead to some forced selling.

In summary, I believe that this is the end of the melt-up and traditional valuation metrics will apply again. If I’m right, stocks are nowhere near cheap, even without the major earnings revisions that an extended coronavirus contagion could prompt. (This analysis applies to things I focus on: consumer cyclicals, staples, tech, media, and telecom. Other sectors could be cheap… I haven’t looked.) I am making a shopping list with entry levels for initial positions in names I am circling…

I replied:

I’m certainly keeping some dry powder, but I think it’s a mistake to anchor on valuations of 2002 (post bursting of tech/Internet bubble and post 9/11, plus much higher interest rates), much less the global financial crisis, which was a once-in-a-generation event.

The U.S. economy is fundamentally healthy (with caveats, I know: income inequality, artificial/unsustainable $1 trillion annual deficit spending, etc.). But it is. There is nothing resembling the Internet or housing/credit bubbles, inventories are fine, and interest rates are super low.

The biggest risk is the markets and businesspeople freak out over the election of Bernie Sanders – but that’s nine months away.

She replied:

I agree we are nowhere near the valuations during the tech wreck or global financial crisis, and shouldn’t be looking for that. But I’m not anchoring on previous low valuations – more the normal ranges.

As I noted earlier, the hotels have usually traded between 12-15x EV/EBITDA. They were 8-9x post 9-11 and even lower in 2009. I don’t want to buy them at 15x just because they went from 15-16x to 19-20x in one year and are now back to 15-16x. I don’t think 19-20x is the new permanent normal. Maybe they go back there or maybe they revert to the 12-15x they have been at for 30 years, and stay there, and 2019 and the last 30% was the aberration, save massive panics (the range has previously been broken only to the downside). They literally never traded at those multiples before except the last six months.

This didn’t just happen among the hotels – outside of retail, most sub-sectors I cover were in truly unprecedented terrain, a good 20-35% over the top of the range that usually signaled time to sell over the last 25 years. You have to be betting on a return to melt-up valuations to get aggressively long here, since we really have only given back part of 2019 – and most people who are at all sensitive to valuation could not justify the 2019 move.

Everyone has been wondering what would end the melt up… I think this could be it because we could be in a “wall of worry” until May… and then you have the possibility of President Bernie on the horizon, as you noted.

Also, you don’t know how much this will slow China’s economy, how badly the Trump Administration botches coronavirus management or economic policy, or how people will react. I am pretty sure that 95% of the population is clueless and just trying to feed their family, pay their medical bills, or catch up on their Netflix backlog. I have talked to friends with Ivy League degrees and professional jobs who have no idea that the Centers for Disease Control Prevention was gutted, for example.

If you’re getting long today, you’re betting on a return to lofty multiples – and implicitly betting that everything goes smoothly and coronavirus blows over fast, which I think is unlikely.

I asked if she had any final thoughts, and she added:

I don’t think the data showing strong stock market returns after prior pandemics are relevant here for two general reasons. First, they’re measured from what we now know was the end of the crisis – which still might be a long way off from today. Second, you have to consider the context of valuation/timing in the cycle. There aren’t enough data points that are late cycle for this to be conclusive for me. What you really need is pandemics that are on all six [inhabited] continents that can be spread through casual contact that occurred well into a market rally as opposed to at a bottom.

The most comparable pandemics were SARS, avian flu, swine flu, and MERS.

Avian flu in June 2006 fits the bill but I am not sure if any of the others do.

SARS was in April 2003, when the market was coming off a bottom after three big down years and the all large-caps were trading at the bottom of their historical valuation ranges.

With swine flu, you were coming off financial crisis. Comparing a return off the valuations of April 2009 versus December 2019 just isn’t relevant.

Maybe MERS in May 2013 is – it was at least mid cycle and not early cycle in its timing.

Best regards,

Whitney

Whitney Tilson

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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to nearly $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor's degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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