CoronaPanic, Edition 14

Very random thoughts follow.

Throw all the rules out the window. Even though the economy is going to stall (and go into recession, if not depression), people are going to get dumb-founded when the market goes up. The explanation is pretty simple – with central banks pumping as much liquidity into the system, mostly anything that got sold due to liquidity will be brought back to life, and that liquidity will ooze back into real assets.

Dust off the 1970’s playbook because we’re going to see inflation. Not immediately but it’s coming. It will also hit quicker than what we are typically used to, just like how the Coronavirus kicked us all.

This makes bonds of any lengthy duration (let’s arbitrarily define this as more than 2 years) less profitable, in real terms, to invest in unless if you’re going to get a massive nominal return in the process. Ask yourself what will be happening to real estate when entities like Riocan can no longer borrow unsecured at 2.5% – when cap rates go up from 3% to 6%, you do not need a Ph.D in finance to realize that asset values go down, and when asset values go down, the mandated 50% or 60% loan to value that typical REITs manage themselves to will be heading down as well – previously the model was to take mark-to-market property gains, and then leverage the remaining fraction to buy more income-producing real estate, but look out what will happen when this process goes into reverse!

This should hit residential as well, although governments have a huge incentive to stem this, and you can see it when the Bank of Canada is out there busy buying residential mortgage portfolios from the financial institutions – socialized losses, privatized profits. One would also find it difficult to see the mortgages paid off when a third of your population is going to be unemployed… the nightmare scenario that Genworth MI (TSX: MIC) is prepared for is going to come to fruition – loan-to-value ratios will rise, and with this will come increased capital. Real estate valuations haven’t adjusted for this, but they will.

Will we see spot oil head below US$15/barrel? It’s possible. You just can’t hit a button and stop oil from flowing. Western Canadian Select is at US$6 today… will this go negative? It’s possible. Start digging a big hole in your backyard, and they’ll pay you to store crude.

Gold mining companies might seem like a refuge when gold commodity prices are rising, but the problem here is when somebody in a gold mine gets Covid-19 and then you have to shut down for a few months like everybody else. I don’t see gold mining equities as a refuge, but gold itself should do better. There will be a time that the inherent leverage of gold mining companies (at least the legitimate ones) will take over, but for now, the commodity is the place to be rather than the equity (short-term headlines of everybody saying “buy gold” notwithstanding).

With all this inflation, one would assume that government debt yields will rise to account for this. It will eventually.

The “confirmed cases” statistic is almost a useless figure at this point. The real figure is “how many people have Covid-19 that aren’t confirmed”, coupled with “how many deaths attributed to a trigger of Covid-19 were from individuals that did not fit into the main risk categories (age, lung/heart conditions, obesity, etc.) giving them a predisposition to dying?”.

Iceland is a fairly good laboratory, with the majority of its population in one major urban centre. It has sampled nearly 5% of its population, 2 deaths.

With all the fitness and recreational centers closed, I am forced to partake in exercise through two ways: running and cycling. Last week’s weather was unusually good for a March in Vancouver, but in the past few days it has regressed to the mostly usual overcast and grey, and today I forced myself to run 5km out in a mild drizzle at a balmy 7 degrees Celsius. I see other places in Canada today that it is still -10 outside, and will Covid-19 turn us all into couch potatoes? I did walk through the isles of the places that are still open, such as Canadian Tire, and notice that most of the exercise equipment has been cleared out. Bodes well for Nautulus (NYSE: NLS) and Peleton (NYSE: PTON) (seems to be priced in)?

How can the news get worse? Obviously we will hear about unemployment, we will hear about grossly negative GDP numbers, and we will hear about closures and lockdowns lasting months, and the general breakdown of society. Then we will hear about defaults (especially in the sectors that are heavily leveraged to begin with), and this other bad news. Barring a geopolitical invasion, I can’t see anything other than implied volatility heading down.

Finally, you’re going to see decisions that were going to be made anyway justified under the guise of Covid-19. Watch out for it. Get rid of paper cash? It’s because Covid-19 will infect paper currency and exchanging it will transmit the virus! Can’t build the Trans-Mountain Pipeline because that’s going to spread Covid-19. Shut down municipal roads and install socially-distant bike lanes, because of Covid-19! You name it, this is the time where politicians are going to do their usual thing in the name of Covid-19. Before it was climate change. The motivations have always been there, just the excuse to do it is different.