I published the following note (with edits) to subscribers on 1st march before things started going downhill in a hurry. I have another note going out which will be posted here soon.
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I have been watching the events around the Corona virus for the last few weeks and started seeing some impact on our portfolio, towards the end of January. I wrote a note – Why are we suffering, sharing the observation that our portfolio was behaving in a bi-polar fashion. The so-called quality stocks which have higher predictability of growth, were holding steady while the cyclical positions were being beaten down as if all these companies were headed to bankruptcy.
In hindsight, this behavior seemed to be a reaction to the risks which were developing in the global economy due to the Corona virus.
In the last few days, these risks have risen substantially. I am not an expert in these things, but the preliminary data seems to point to a high infection rate (also called R0 which is around 2.2 versus 1.3 for common flu, which means one person can infect two others). At the same time, the mortality from this infection is around 1.2-1.5%.
The above numbers are preliminary and likely to change. However, a few things have become obvious in the last 2 weeks
- The transmission rate is quite high, which means that there is high risk of the infection spreading globally
- We have already crossed or maybe are at the brink of crossing the point of containing the infection. Again, there is a lot of confusion around this point
- In the worst-case scenario, even if the mortality rate is low, the absolute number of deaths will be high
Unfortunately, in India, we are quite used to such infections in our main cities due to poor levels of sanitation. We tend to take such events in a stride. However, this is not the case globally. Irrespective of the trajectory of this epidemic, there is a high level of fear across the globe. This is leading to a big slowdown across the globe as companies stop travel and governments quarantine portions of the population.
We are seeing the first order effects of the above event. Like the ILFS event in India, which had a domino effect on NBFC, real estate and the overall economy, the second and higher order effects will take time and will show up in surprising places. In my view, it is too early, and I would say impossible to predict how this situation will evolve (for better or worse).
I have reduced the position size for the three companies where I think the medium-term growth prospects were moderate and valuations continue to be on the higher side. I have raised the cash levels so that we have dry powder available to pick opportunities as they arise.
We have 30% cash in the portfolio now
If we are lucky, everything will return to normal and markets will resume their normal course. However, if the risks of a pandemic increase, we will see a lot of selling in the market. This selling will not be rational, and it will not be tied to the fundamentals of a company. In such panics, people sell whatever they can.
I have no plans of burying my head in the sand. If prices get attractive for some of the companies I have been tracking, we will add them to the model portfolio even if the prices continue to fall. I am willing to bear more pain in the portfolio as I think this will eventually pass.