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.
What Benjamin Graham Would Tell You to Do Now: Look in the Mirror
Forget about what the stock market is going to do. Instead, focus on what you, as an investor, ought to do. That advice from Benjamin Graham, the great investment analyst, and Warren Buffett’s mentor, can help you navigate the market’s latest storm.
First, determine whether you are an investor or a speculator. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices and the speculator, on the other hand, cares mainly about anticipating and profiting from market fluctuations.
If you’re an investor, price fluctuations have only one significant meaning. They are an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.
Speculators are in thrall to the mythical, moody figure Graham called “Mr. Market”. Mr. Market always wants to trade. Much of the time, the prices he sets are sensible. Often, however, they are “ridiculously” high or low. Puzzlingly, many people become more eager to trade with Mr. Market as his prices become more chaotic. A speculator is happy to buy more shares when prices rise, betting that Mr. Market will buy them back later at even crazier prices. When Mr. Market’s enthusiasm turns to fear and prices fall, the speculator sells into that panic.
Buying spree
At least one group of investors has gone bargain hunting during the wildest stretch on Wall Street in over a decade. Corporate executives and officers have been scooping up shares of their own companies at a breakneck pace in the first two weeks of March, exceeding the total of the prior two months. Insider buys are outstripping sales by the most since 2011. “When insiders are buying, they think their companies are well undervalued”.
Vanguard’s $55bn fixed income ETF hit by price huge dislocation
This chart is the Net Asset Value (NAV) of the Vanguard Total Bond Fund (BND). It is the difference between the price of the ETF and the value of the bonds it holds. The ETF is trading fully 6% below the value of the bonds! This is no random ETF. BND has $50B in assets and is one of the largest bond ETFs. The NAV discount today is bigger than on the worst day in 2008 (Oct 10). The bond market was so bad back then that the Troubled Asset Relief Program (TARP) was announced the next day.
Thoughts on the Financial Markets and the Current Crisis
“Bear markets are born of pessimism, grow on skepticism, mature on optimism
and die on euphoria. The time of maximum pessimism is the best time to buy.”
“To buy when others are despondently selling and sell when others are avidly
buying requires the greatest fortitude and pays the greatest reward.”
-John Templeton
“Be fearful when others are greedy. Be greedy when others are fearful.”
-Warren Buffet
“Buy when most people including experts are overly pessimistic, and sell when
they are actively optimistic.”
-Benjamin Graham
Thinking long term in volatile markets
Many investors might feel anxious due to current market volatility and headlines about COVID-19 and oil price declines. We know that it’s at times like these that it’s most important to keep your long-term focus and stick with the investment strategy you put in place to get to Point B. Your point B, whether that’s retirement or saving for your kids’ education, won’t be affected by short-term market volatility. So why change your plan to get there because of it? The reason you have a plan is for times like this – to keep your emotions in check and think in the context of your long term goals.
Below is a collection of resources with strategies we believe can help keep your long-term focus and provide perspective on past periods of market volatility.
Investor affirmations
Want to become an above-average investor? Here is a list of 10 things people should and shouldn’t do to avoid becoming their own worst enemies when it comes to achieving their investment goals.
Videos:
Worth your while – knowing the value of what you own
Does that macroeconomic event affect the value of what you own in the long term? Only if you panic and sell. But knowing the value of what you own can help you avoid reacting this way to volatility.
EdgePoint’s investment approach – Investing is most successful when it’s most business-like
The EdgePoint investment approach is deceptively simple, we buy good undervalued businesses and hold them until the market fully recognizes their potential. Understanding the approach helps investors have confidence in it to stay invested through the market moves.
An investor's journey with EdgePoint – not always a smooth ride
EdgePoint’s first decade helped our partners and end clients build their wealth. We made a video about that journey, not to celebrate the results, but as a reminder that the way there meant patience was needed during some very bumpy ups and downs.
Slides:
Time after time
Why do we focus on 10-year performance? Since 1974, Time Magazine has had several cover stories about negative news and events. Those who invested in the S&P 500 Index on the day the issue hit newsstands were usually rewarded 10 years later.
Staying invested pays
Bear markets are inevitable but how you respond to them defines where you stand once the markets rise again.
Bull and bear markets in perspective
Since 1945, bear markets happened approximately every seven years. While past performance isn’t indicative of future results, looking at historical markets shows that bulls follow bears and we believe these are good times to take advantage of opportunities to build long-term value and buy great businesses on sale.
Commentaries and articles:
Our Investment team has successfully implemented our investment approach thorough many periods of market turmoil, learned from them and is stronger for it today. In periods of market pessimism, we have written to our investors on our thoughts. Here are some excerpts:
What helps us sleep at night, part 6
With all the negative headlines recently about the COVID-19 virus, we’ve received a few requests to update our “What helps us sleep at night” series. As our partners know, we don’t get too fussed by noisy headlines. No one knows answers to questions like this. Instead, we focus on the performance of the businesses that make up your Portfolios. The reality is nobody knows if the markets will experience a further pullback from here, how sharp it could be or how long it might last. However, the media is full of people willing to give you their opinion. We don’t waste our time (or yours) trying to forecast such things. Rather, we consider the facts surrounding the underlying businesses we own.
Things are always bad…or so you might believe (Q3 2018 commentary)
Armed with the fact that the market historically has experienced an average drawdown of 13.8% every year, and that paying a lower price for an investment is better than paying a high price for that same investment, there should be no drama in the head of any strong investor the next time the market moves lower. The drawdowns should be looked at as a constant, something that has taken place every year. Knowing that it happens every year and will happen again next year will make it harder to overreact and easier to act on good investment opportunities.
Understanding these two simple facts leaves less room in one’s head for the drama. Adding in some other facts and insight about the individual businesses you own leaves even less room for the drama that will be created around you at the time, giving you a much higher probability of doing something intelligent. In fact, the lower prices will make it easier to do something intelligent with your investments as well.
The most important question (Q4 2015 commentary)
What gives us the ability to buy a business below its true worth is volatility. We like to capitalize on volatility as much as possible.
As many of our investment partners already know, we believe volatility is the friend of the investor who knows the value of a business and the enemy of the investor who doesn’t. Volatility is caused by emotions. The two primary emotions that drive volatility are greed and fear.
The right choice for our families (Q4 2011 commentary)
The financial impact of emotional investing can be devastating as it causes investors to behave irrationally. The good news is irrationality creates opportunities for those who can resist it. It’s our job to live in a narrow emotional band and seize opportunities presented to us by the irrational investor.
The spotted zebra versus fortune tellers and noise makers (Q2 2009 commentary)
“History has shown that it is not the economy that tends to hurt investors. Over the medium-to-long term, the economy has grown and will continue to do so.
Fortune tellers and noisemakers are very good at getting people to listen and unfortunately, they are also good at amplifying emotions, such as fear and greed, in investors which can cause them to make poor financial decisions.
What helps us sleep at night - part 6
The recent market volatility is undoubtedly keeping many investors up at night. While we have no idea how long the recent downturn will last, the investment team continues to rely on our investment approach and long-term thinking. Today, Tye and Geoff wrote “What helps us sleep at night – Part 6”, which should prove to be useful in conversations with clients.
Nobody Knows II
So many questions and few answers surround the coronavirus and its impact on global markets. In Howard Marks’s latest memo he shares his own questions, guesses, observations and inferences to help make sense of the potential impact of the virus on global economies and markets. Here are some takeaways.
There’s no doubt about the fact that coronavirus
represents a major problem, or that the reaction so far has been severe. What
really matters is whether the price change is proportional to the worsening of
fundamentals. For most people, the easy thing is to say:
The disease is dangerous,
It will have a negative impact on business,
It has kicked off a major reaction to date,
We have no way of knowing how far the decline will go,
We should sell to avoid further carnage.
But none of the above means selling is necessarily the right thing to do.
Will stocks decline in the coming days, weeks and months? This is the wrong question to ask, primarily because it is entirely unanswerable. Instead, intelligent investing has to be based on the relationship between price and value. In other words, not ‘will the collapse go further?’ but rather ‘has the collapse to date caused securities to be priced right; or are they overpriced given the fundamentals; or have they become cheap?’
US traditional flu in numbers
The stock market is not the economy
The chart below plots every time the Fed changed rates since 1994 against U.S. real GDP:.
What’s amazing about this plot is how little U.S. real GDP fluctuates in comparison to the stock market. For example, the largest decline in U.S. real GDP since 1994 occurred during the 2008 financial crisis when it contracted by only 4%.
This is just a simple reminder that the stock market is not the economy. Just because investors react quickly and negatively to a breaking news story doesn’t mean that those fears will ever materialize.
30-Year Mortgage Rate in the US hit a new all-time low
Canada’s economy remains dependent on housing
While the U.S. economy has only spent about 3.8% of GDP per quarter on gross private residential investment, Canada is spending roughly twice that … even after large declines since the peak at the end of 2017.
Most private equity firms are not achieving their projected margin expansion
For 65 fully realized buyout deals completed between 2009 and 2015, the average margin was well below the deal model forecast.
