How does a pandemic affect your portfolio? Your investing plans? Don't panic! Here's how to look at the long term.
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2020 was an interesting year, especially with the global pandemic of COVID-19 spreading in Q1 and Q2. With organizations around the world racing to find a cure and governments and municipalities enforcing social distancing, testing, and tracing the world of 2020 looks a lot different than the world of 2019.
What's going to happen to your investments?
Expect Short-Term Economic Pain
With people doing fewer things, economic activity has diminished and will continue to do so. While some earlier coronavirus predictions focused on decreased supply, it's clearer now that long-term pandemic effects will affect demand.
If people stay home more and eat out less and shop less and cut their non-essential spending, businesses which rely on non-essential spending—directly and indirectly—will make less money. Be careful putting your money in cruise lines right now, for example.
Consider one industry as instructive: the movies.
No one can predict with certainty whether a vaccine sometime before 2022 will mean that the days of the Memorial Day blockbuster movie weekend will return with pent-up demand and crowds of happy people crowding into crowded theaters, buying lots of concessions and filling the coffers of theaters and studios, but the current prices of all of those types of businesses are starting to reflect the uncertainty.
We know movie theater chains and studios aren't going to bring in the revenue we thought they would.
We don't know if and how they're going to adapt to replace that revenue, find new markets, or find new (and even better!) ways to make and sell products.
On one hand, a big studio like Disney is delaying tentpole releases in the Marvel Cinematic Universe (and expecting to delay that revenue accordingly), but it's using things like its streaming service Disney+ to release Hamilton a year ahead of schedule. An opening weekend that normally would have people in seats in a theater could see even more of them on their couches in their living rooms... in front of tablets, phones, smart TVs, etc cetera.
What would that mean for Disney? The ability to control who sees things and when without being limited to physical location. Does that mean spending less on marketing a specific movie in specific locations or worrying about how many screens are available or how to distribute a film everywhere? Maybe! Does it mean sharing marketing budget with the streaming service in general, and getting and keeping long-term subscribers? Probably!
What does this mean for your Disney stock? Who knows yet? Though it's clear to see that a short-term loser (the movie industry) could turn this pandemic into a long-term gain, if it survives.
Expect Business Bankruptcies
Struggling businesses will reorganize. Some will survive bankruptcy and others won't.
This is a law of business, so why is it different now?
Highly-leveraged businesses struggle without cash flow. A car rental company like Hertz has to own or lease a lot of expensive real estate (land near airports, plenty of parking) and depreciating assets (cars that get older every day and worth a little bit less for every mile put on them). If people aren't traveling, these expenses aren't going away and they're not especially liquid. Sure, they can recoup a lot of their costs with their used-car sales business, but if people aren't traveling or driving, they're not buying used cars, and that's a huge glut of used cars that can't be sold and won't produce revenue.
Think about airlines too. They have to spend a lot of money on real estate (buying and leasing limited space in airports) and an enormous mount of money buying and repairing their airplanes.
Now think about their fuel costs. They spent a lot of time in the past several months trying to predict where fuel prices will be and buying fuel to meet anticipated demand. (You can't just take a 737 to the local gas station and fill it up when it's empty; you need plenty of fuel available in every airport every day, at least if you want your planes to go anywhere!) How many of those predictions are wrong now?
If an airline spent hundreds of millions of dollars preparing for a normal summer 2020 travel season, and if travel has dropped off by double-digit percentages, they've ended up paying a lot of costs they're not going to make back in revenue any time soon.
Does that mean a bankruptcy for an airline? Maybe. Does that mean a bankruptcy for a company close to an airline, such as a parts supplier or maintenance team? Perhaps!
Expect Personal Bankruptcies and Evictions
With a 14.7% unemployment rate in the United States reported for April, lots of people are un- or under-employed.
How are they going to pay their bills? How are they going to pay their rents or mortgages?
While the US Congress has done some work (see the CARES Act, for example) to help Americans struggling with their financial situations and plans to do more work, unemployment may become a huge problem.
What happens when someone loses a job and falls behind on mortgage payments? Will a bank repossess their house?
What if this happens to hundreds of thousands of houses? Just like Hertz has trouble selling used cars when there are more cars than buyers, what happens to home prices when there are far more houses than buyers?
We've seen this situation before in the 2008 financial crisis, when sometimes it made sense to walk away from an underwater mortgage. That situation hurt. If it happens again, it will hurt again.
Expect the Unexpected in the Market
The idea of another housing crash may make real estate holdings like REITs less attractive, but who can say what's going to happen in the market?
After a series of broad market declines in March and April, the stock market hasn't shown the kind of nerve-wracking huge declines that people might expect if another Great Depression were imminent.
While the US Federal Reserve has continued to "inject liquidity" into the market, the stock market is not the economy.
Some companies have reported Q1 earnings. Other companies have delayed them. What is currently happening in Q2? We won't know until July at the earliest, and it could be ugly.
If you look at the M2 money supply graph, you'll see what looks like a lot of potential investors keeping money out of the market right now. Does this mean they're worried about their personal situations? Are they expecting big drops, with the plan to swoop in to find bargains? Or is something else happening?
It's too early to say.
So what should a value investor do?
Value Investing During a Pandemic
The world has changed. These changes reveal the shaky foundation of some businesses but also open opportunities for very smart other businesses. A Hertz or a JC Penny may not survive this in its current form, while a Disney may have the good fortune and planning to emerge even stronger.
Consider your goals and your timeline. If you're going to want a strong portfolio in the next five years, maybe your tolerance for risk has gone down and you need to rethink your investments now. If instead you're in the market for twenty years, start looking for good and underpriced and overlooked opportunities as they come up.
The tough thing about a big change like a global pandemic is that, even if you predicted it would happen eventually, you couldn't predict the timing or the details accurately. The good thing about a big change like a global pandemic is that it can reveal new opportunities.
Be safe and be cautious, but don't be fearful, especially if you've done your homework and are investing wisely.Some industries will lose. Some have already lost. Q2 results will be interesting.