The answer is not that simple. But a lot of people are seeing bargains out there while many market participants are simply not able to buy. Meanwhile, valuation is less relevant versus questions about going concern in this market because great companies may never achieve price targets in a normal business environment because they are facing liquidity constraints as capital markets are closed and refinancing costs are untenable.
Capital Markets are Closed During COVID-19
If you are looking to issue debt, you may be unable to. There simply is no credit that can be extended except to the companies with the largest scale and best balance sheets (with ample liquidity – i.e. the borrowers who need it least). Investment grade creditors are rushing to issue and refinance early in case they cannot later. More troubled credits are starting to draw down on their revolvers to have cash in case they are frozen out.
You simply would not be able to stomach such a dilutive stock issuance today (nor would it clear shareholder voting thresholds) at super low trading multiples.
Ironically, who is looking pretty after all of this is Tesla – who managed to put in a big equity raise just before Armageddon began at their difficult to value valuation.
Have We Reached the Coronavirus Bottom
Already, people are looking to pick a bottom after a lot of blood has been shed. The oil price fell from $50 to $40 to $30 to $20. Stocks have come down 35% from their highs – naturally for those who have liquidity and dry powder, it is ostensibly a great entry point.
After all, if the NASDAQ was approaching 10,000 just a few weeks ago and now it is around 7,000, surely since we have the same infrastructure and a strong economy from before we will pick right back up when the virus subsides.
If you subscribe to news headlines, Larry Fink is telling you to buy equities, Bill Ackman (who supposedly made $2.7 billion on a $27 million clearly asymmetric credit bet in two months) is telling you he is buying aggressively since this pullback and private equity funds are looking to raise money for distressed purchases.
Notwithstanding the large human and social cost, the market will recover – eventually. As a reminder, even if you purchased equities at every peak before a crash, you would still be doing far better than if you held bonds or real estate. If you purchased right before the financial crisis, you would still have roughly doubled your money today (taking into account the more recent COVID crash).
That said – this does not mean that people can actually afford to sit it out when they are unsure about their jobs and do not have emergency funds. If you are working at a bank, are you prepared for a much lower bonus or even losing your job? If you are another market participant without liquidity, you can easily find that you have to sell when the tide is painfully low.
A lot of people want to come in now – borrowing while interest rates are astoundingly low as the federal solution has relied heavily on monetary policy. But there are certainly no guarantees that we have bottomed, nor do we know what the true time horizon is for a recovery. Alluded to above is a V-shaped recovery. A sharp decline and a sharp rebound.
Coronavirus Grey Rhinos
There are a few problems with this perspective. The first one is that the coronavirus by itself is a large unknown. The second one is that the coronavirus may morph into second and third order effects that reverberate around the economy and society as an extension, as well as vice versa.
The first thing that we have to come to terms with is that coronavirus was handled poorly and has a ways to go before peaking. If you consider 80,000 cases in China – a regime with strong controls over the population and a culture of respecting authority – to be high, that the largest economy in the USA has taken a decidedly anti-science and freedom of movement approach coupled with an unbalanced healthcare system (to be polite) is starting to see aggressive exponential growth in cases may be catastrophic.
We do not price human lives into the equation if assets are the future value of their cash flows – however, if an index is a discounted cash flow function of its future earnings, what happens if the economy does not restart for one year or two?
Do we have a solution once cases start coming down? Do we just sit at home until a vaccine comes a year later or treatment is identified? Do we let the coronavirus become a new annual occurrence and simply let a larger number of our elderly and immunocompromised pass each year? If this is the case (and from two anecdotes from friends who have been afflicted with the coronavirus, it absolutely does affect productivity) – maybe the earnings are not just delayed, but also impaired.
For a lot of companies, they cannot simply wait it out. If you are an airline or an oil producer, you now have to face the reality that you have a high cost structure that needs to be fed even when your revenues approach zero. If you do not have cash, you need to borrow. If you run out of revolver capacity or you have an upcoming debt maturity while capital markets are closed, you may need to restructure. This means bankruptcy and total loss of capital.
If you invest, have you assessed the possibility of total capital loss?
The spillover effects may end up being as much of a challenge as COVID-19 itself. People are going bankrupt and unemployment is ramping up. If people cannot go to work and meet their obligations, we may see greater social discontent. Perhaps it will be mild, but we cannot ignore the possibility of riots and an increasingly polarized society where loss of trust in government (which is already happening) leads to civil strife.
If Brazil or India go down, what does this mean for the future growth engines of the world?
There has to be a consideration that this may be a U-shaped recovery, with the economy in the pits for a while. A worst case scenario could be an L-shaped recovery and a balance sheet recession. What if the US becomes Japan circa the 80’s? A lost decade – and then another, and another.
There is certainly no guarantee that this is going to happen, just that we have to be cognizant of these outcomes before rushing in.