Friday, March 27, 2020

This week's interesting finds

EdgePoint Bond Desk
By the end of today (March 23, 2020), the high yield bond market will be down over 20% YTD… the high yield bond market is in a bear market!

Spreads (the premium earned over government bonds) are now above 10% for the entire market.

Weekly Update: Howard Marks
  • Yields and yield spreads have increased significantly (which is another way of saying there's been a lot of damage done). The price declines have been substantial, but the increase in yield for each point of price decline tends to put on the brakes. A yield of 9%, 10% or 12% is impressive in a world of 1% Treasuries and thus tends to slow the fall. Declines to date of 15-20% for the bond and loan indices have brought substantial losses to holders, but also vastly improved opportunities for new investment.
  • "The bottom" is the day before the recovery begins. Thus it's absolutely impossible to know when the bottom has been reached ever. 
  • "Even though there's no way to say the bottom is at hand, the conditions that make bargains available certainly are materializing."

Warren Buffett: Focusing on businesses, not the stock market.
Everyone wants to know what happens next. When will it end? Was that the bottom? The only good answer is: “I don’t know.” But that’s not what you’ll hear. Instead, everyone also has an opinion. Many will go out of their way to express it. The trouble starts when people listen and act on it.

Warren Buffett dealt with this situation in 1966 after a few of his close partners felt obligated to tell him what would happen next. He responded this way.

If we start deciding, based on guesses or emotions, whether we will or won’t participate in a business where we should have some long run edge, we’re in trouble. We will not sell our interests in businesses when they are attractively priced just because some astrologer thinks the quotations may go lower even though such forecasts are obviously going to be right some of the time. Similarly, we will not buy fully priced securities because “experts” think prices are going higher. Who would think of buying or selling a private business because of someone’s guess on the stock market?

We don’t buy and sell stocks based upon what other people think the stock market is going to do (I never have an opinion) but rather upon what we think the company is going to do. The course of the stock market will determine, to a great degree, when we will be right, but the accuracy of our analysis of the company will largely determine whether we will be right. In other words, we tend to concentrate on what should happen, not when it should happen.

Why We Panic: Long Toilet Paper / Short Equities
Panic is an overwhelming feeling of fear that can dominate our decision making.  It typically begins with a significant and sudden change in circumstances.  The outbreak of coronavirus has provided numerous examples of decisions that are seemingly fuelled by stress and uncertainty; from the bizarre stockpiling of toilet paper to the dramatic daily moves in equity and credit markets.  From a financial market perspective, the discussion around the recent explosion in volatility often centres on changes to market structure, liquidity and leverage.  But panic buying and selling is primarily a behavioural phenomenon – what are its main causes?

Scarcity: Panic purchases are often the result of a current or future scarcity of a good or service.  The case of toilet paper hoarding is an issue-driven by self-perpetuating scarcity.

Other people: Panic buying and selling are always about how we react to the behaviour of others (and how they react to us).

Removing worry: As panic is a result of fear and anxiety, the actions that come as a consequence are typically carried out in an effort to relieve it.  Our decision making becomes centred on a single goal – removing the worry. What is the easy way for investors to mitigate the fear and uncertainty around the financial and economic impact of coronavirus?  To sell risky assets and hold cash.

Contracting time horizons: One of the most important features of behaviour under stress for investors is how our time horizons contract. 

Emotional decision making: Our attitude towards a given risk is heavily influenced by its emotional salience.  How we perceive both the likelihood and magnitude of a threat can be dominated by its prominence and how it makes us feel.