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7am Saturday

February 22, 2020

Good morning!

This week was much busier than most outside of the office. My daughter had her 16th birthday this week, so we spent some time celebrating.

She’s 16! 🎂

I also started a writing course offered by David Perell. This course will be very intense for the next 5 weeks and includes virtual class every Monday and Wednesday evening. I can’t wait to share more and see what comes out of this!

Pandemics and Portfolios

After the S&P 500 hit fresh highs on Wednesday, it closed the week on a down note losing 1.3% for the week.

The question everybody seems to be asking these days is: How will the coronavirus (now officially named COVID-19 by the World Health Organization) affect my investment portfolio?

Of course, the unsatisfying answer is: we honestly have no idea. You can count the unknowns. The virus is now up to more than 77,000 cases and over 2,200 fatalities—and counting. But nobody knows whether the virus will eventually run rampant across the Chinese economy or burn itself out. Nobody knows if it will spread widely beyond China and become a global crisis or remain largely confined to the Middle Kingdom. Either way, it’s hard to predict the impact of the virus on the Chinese or global economy, much less on the U.S. and global stock markets.

There are three different ways to estimate the impact of this latest pandemic…

1️⃣ The first and easiest is to look at how U.S. and world markets responded to past health scares. When the public became aware of the SARS epidemic (a previous strain of the coronavirus) back in 2003, the S&P 500 index fell 14% over the subsequent two months, from mid-January to mid-March. But, according to a historical look-back by the MarketWatch economists, the market was up 20.76% a year later. The Avian flu outbreak in 2006, the Swine flu outbreak in 2009, the Ebola outbreak in 2014 and the Zika epidemic in 2016 saw initial downturns between 5.5% and 7%, but a year later, the markets had recovered by between 10 and 36 percent.

We can note that the S&P 500 index fell 3% in the two weeks after January 17, when the coronavirus outbreak first made headlines. Since then, the index has bounced back to all-time highs.

2️⃣ The second is to assess the impact that the COVID-19 outbreak is having on the Chinese economy—which, while its stocks are seldom a major part of U.S. investment portfolios, would certainly affect the world economy through disrupted supply chains and reduced demand for products and services sold by outside firms. China now makes up 15.5% of the global economy. It is a major purchaser of commodities like oil and agricultural products, and companies as diverse as smart phone makers and auto companies rely on its manufacturing output.

The Chinese government is trying to contain the spread of the virus by imposing severe travel restrictions and by forcing 50 million people in affected areas to remain in their homes—which, of course, means they are not going to work and not being productive. At the same time, however, the Chinese government is pumping liquidity into its economy—an estimated 1.7 trillion yuan from the People’s Bank of China—in order to contain the economic damage it is causing with the quarantine measures. Will the two balance each other out? We can note in passing that the SARS epidemic caused a temporary 2.4% decline in Chinese production. Nobody knows if the new epidemic will have the same, greater or lesser impact.

3️⃣ The third way to evaluate the potential damage of the pandemic is to focus on certain individual companies that are being affected by the initial phase of the outbreak. A recent U.S. News & World Report analysis singled out Carnival Corp., whose Diamond Princess cruise ship is currently quarantined at a dock just off the Japanese coastline—with 3,600 passengers onboard. More than 200 of them have come down with the coronavirus, which means that this single ship has more cases than any individual country besides China. Carnival stock is down about 17% since mid-January.

The article also mentions Wynn Resorts, which has major holdings in China’s gambling Mecca of Macao. The company’s Macao resorts have been shut down by the Chinese government, causing Wynn to lose $2.6 million a day. The stock is down roughly 15% from its peak.

You may not have heard of Yum China Holdings, but it is the parent company of the KFC, Pizza Hut and Taco Bell brands. The $20 billion company has had to shut down its China-based locations, and the stock has lost 15% of its market value this year.

Finally, consider Nike, which has closed half of its company-owned stores and stores managed by partners in China. About 17% of the company’s revenues come from China, and Chinese factories produce about 20% of Nike products. Nike’s stock doesn’t seem to have been hammered like the other companies on this list, but you can expect a reported decline in earnings this quarter.

So what does this mean? Well, unfortunately, nobody can tell you that they know how the COVID-19 epidemic will play out in American household portfolios. We simply don’t know. But so far, history suggests that the market reactions to past pandemics have been temporary, just like all other kinds of market downturns. Not knowing when to get out and back into the markets constrains our options to hanging on and hoping—maybe expecting—that this time around won’t be very much different.


This Week’s Notes & Resources

+ MUST READ 👉 Warren Buffett’s annual letter to investors which comes out today. I’ll be reading it as soon as it comes out. If I get a chance I’ll share my notes with you next week.

+ PODCAST 👉 Don’t Fall For It – An Interview With Ben Carlson (The Invested Dads) – Josh and Austin had a great conversation with Ben about his new book, Don’t Fall For It: A Short History of Financial Scams. Listen in as they discuss stories from the book, some key takeaways, and ways you can help yourself avoid scams

+ PODCAST 👉 Episode #352: Patrick Lencioni – The Five Key Actions Of Excellent Leaders (The Learning Leader Show) – Patrick Lencioni is out with a new book next week called The Motive: Why So Many Leaders Abdicate Their Most Important Responsibilities. In this interview with Ryan Hawk Patrick says this book is the prequel to his others which are all required reading for leaders.

+ BLOG 👉 How Much Life Insurance Do I Need? (The Everyday Advisor) – If you know me, you know that I do not believe life insurance is a great investment vehicle. It is, however, important to replace a breadwinner’s income in the event of an early death.

Here’s a hypothetical example: Single income household with kids and a stay at home spouse. Assuming the family isn’t yet able to make work optional…what if the income earner dies mid-career? How will the family maintain their lifestyle? How will they pay the mortgage? How will they pay for the kids’ college?

Most young families will need some term life insurance to protect them financially from a tragedy like this. But, how much? Check out this post from Jess for some tips on calculating the right amount of insurance for you and your family.

+ BLOG 👉 How to juice your investment returns – Michael Batnick and Nick Maggiulli ran the numbers to see how a 3X levered ETF portfolio would perform compared to an unlevered portfolio. From 2005 to today, a 3X levered 60% stocks / 40% bonds portfolio compounded at 14% annually, compared to 8% for the unlevered version. To get these returns there had to be rebalancing and a huge awareness that leverage presents some risks that can wipe you out quickly!

That’s it for this Saturday. Thanks for reading!

Have a great weekend,


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