Chairman and Chief Investment Officer
Chairman and Chief Investment Officer
Charlie Munger, 17 April 2020
Donald Rumsfeld, the former US Secretary of Defense in the administrations of George W Bush and Gerald Ford, provided a useful framework to evaluate problems when he stated: “Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know.” It is valuable in deciding on a course of action to have a framework of known knowns and known unknowns about the situation or opportunity. Known unknowns could have material or immaterial consequences if they were to occur and you need to have a reasonable basis to assess their impact and likelihood of occurrence.
At Magellan, our task is to carefully assess facts, known and unknown, and then decide what course of action to take. In some circumstances, we will be optimistic when others are fearful and in other situations the reverse will apply. We are not predisposed to action, nor are we driven by a fear of missing out, nor by a concern that we might underperform a benchmark in the short term. We will do what we assess is the appropriate course of action, after a careful assessment of the facts, and not what other people are doing or saying. We suspect this might have been the failing of the George W Bush administration in deciding to invade Iraq as it appeared predisposed to action.
The Rumsfeld framework is useful in assessing what course of action we should take at the present time. I have set out what we know and what we don’t know about the severe acute respiratory syndrome coronavirus 2 virus (SARS-CoV-2), the search for a cure and the economic impact of the pandemic. The analysis will show why the many known unknowns are making us cautious.
It is helpful to explain the nomenclature for the virus and the disease it causes. SARS-CoV-2 is the virus and covid-19 is the disease it causes. This is analogous to HIV being the virus that results in the AIDS disease.
The economic impact from the pandemic and the response from policymakers have no parallels in modern economic history. There are many variables that will have a material effect on the depth of the economic downturn and the shape of the economic recovery.
We remain cautious and have positioned our portfolios to withstand a further downturn in the economic outlook and markets. We don’t know whether the world is on a bridge to recovery or on a bridge with a cliff at the other end. As we don’t know, we will not speculate or gamble with our clients’ money. We understand the limits of our knowledge. We have no fear of missing out. We feel it is prudent to be cautious when we cannot assess the probabilities of the pathway forward. The events of the past six months are without precedent and the way forward is subject to a multitude of highly uncertain, complex and interdependent variables. This means the range of potential outcomes remains vast. Due to the extreme uncertainty pertaining to so many critical interconnected variables, we have no reasonable way of assessing what the economic impact will be in the next 12 to 18 months. There is a tendency for people to simplify highly complex matters.
This is understandable. Many investors have been gaining in confidence following the massive government stimulus and central-bank support, the move by many countries to reopen their economies, the strong recovery of equity markets from the nadir in March and the positive headlines on numerous vaccines and therapeutics. In simple terms, it could appear the worst is over. Unfortunately, the current situation is highly fluid and we don’t believe there is any way of assessing whether the worst is behind us. There are simply too many known unknowns with material consequences. As Albert Einstein said: “Everything should be made as simple as possible, but no simpler.”
It is plausible that we will have a widely distributed vaccine, or a widely available effective therapeutic, the economic bridges put in place by governments and central banks will prove effective, and an economic recovery will be well under way within the next 12 months. It is also possible that we will not have a vaccine or a widely available effective therapeutic within this time frame and a cure might be years away, and a second or even a third wave of infections occur in many countries later this year or next year, banks start foreclosing on borrowers, tenants default on rental obligations, credit-ratings agencies downgrade hundreds of billions of dollars of debt from investment grade to sub-investment grade, companies cut back on expenditure forcing more job losses, emerging markets enter crisis territory and the world enters a very deep and multi-year prolonged recession. The answer to which pathway the world heads down in large part depends on the course of the virus and this will depend upon science (and the leading scientists do not have the answers). The most dangerous thing to do is to be overconfident that you know the answers to critical questions when it is not possible to know the answers with the limited state of knowledge. Margaret Thatcher said: “Those who think that they know, but are mistaken, and act upon their mistakes, are the most dangerous people to have in charge.”
Even if we get an early breakthrough and we get an early vaccine or therapeutic, investors need to assess what might happen at the end of the government-funded ‘economic bridge’. There are vast numbers of people and businesses that are surviving on government support. Once this pandemic passes this support will inevitably be removed and it is difficult to predict what will happen when this support is taken away. This will depend upon many variables that are almost impossible to predict. These include the scale of the lost economic output, the extent of change in consumer behaviour as a result of the pandemic (and again this will also be interdependent on the duration of the pandemic and the scale of economic loss), actions taken by business to cut costs as a result of losses suffered from the pandemic (the extent of cuts will be a function of the duration of the pandemic, the scale of loss, the level of unemployment, the propensity of consumers to spend and other changes in consumer behaviour; for example, an acceleration of online commerce could result in permanent job losses at many traditional retailers) and the extent of business failures. The extent of business failures will depend upon, among other things, the duration of the pandemic, the level of ongoing government assistance, changes to consumer behaviour resulting from the pandemic, and forbearance by banks and landlords in response to financial stress.
Investors should not take any comfort in the fact that world markets rallied 39% by the end of June from their nadir in March nor take comfort from the reopening of economies around the world or apparently positive news on the development of a vaccine or cure. There are simply too many interdependent uncertain variables in play at present. It isn’t unusual during an extended crisis for markets to bounce strongly followed by a second sharp sell off. While we do not know how things will play out, investors should be prepared for a wide range of potential outcomes in the next 12 months. There is a real possibility of a collapse in equity markets, just as there is for a continued grind higher in equities supported by low interest rates. These aren’t predictions but warnings that such outcomes are foreseeable at present.
Given the complexity and uncertainty of the situation, we are taking a cautious positioning until we can more clearly assess the probabilities on the pathway forward. We feel it is best to heed the sage advice of Warren Buffett when he said: “To finish first, you must first finish.”
Chairman and Chief Investment Officer
10 July 2020