Coronavirus

March 04, 2020

If I were a humanities professor, I would have students prepare a class presentation on a controversial topic, selecting an argument to support. And on the day of the presentation, in a dramatic surprise, I would require that they forego the work they had done and argue the opposing side of the thesis.

It's important to be able to hold two thoughts in your head that may conflict with each other. Contrary to the winner-take-all tribalism of American politics, this does not display a lack of conviction. Today we're going to attempt this in the context of the big kahuna, the Corona.

Long before Coronavirus evaded an N95 mask, pandemics were something we spent a lot of time thinking about at One Day In July. Coronavirus may not be a true pandemic, but if people perceive it as such there may be similar financial consequences. The term "it went viral" on the Internet came from, yes, viruses. Viral infections can follow an exponential curve. They can disrupt in a way that shakes the assumptions of society. If an investor started considering the repercussions of pandemics in the past few weeks, it was too late.

So, enter Thought #1. The time to protect assets is long before this happens, and the insurance policy for clients are long-maturity U.S. Treasury bonds. At a tiny price, indexes of these bonds protect you in a way that almost nothing else will. This week the long Treasury index that, with certain exceptions, all of our clients own, soared. Remember the lesson here: when the world panics, the world runs to the U.S. Treasury long bond, driving prices up. Here is the performance of the long U.S. Treasury index fund (red line) vs the Lehman Aggregate bond index (blue line) and a high-yield debt ETF (green line)¹:

I went back and looked at a lot of debt protection instruments our clients had owned before they joined One Day In July. In almost all cases the performance of those instruments this year has not been impressive: they failed to accomplish their purpose of diversification and protection right when it was needed most.

Thought #2. It feels good to own a diversified asset class, and it's going to feel better if this gets worse (keep in mind the S&P 500 is back to where it was in the fall of 2019, so this is not 2008 at the moment). On October 17, 2008, in the midst of the financial crisis, Warren Buffett wrote this in the NY Times²:

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

I don't agree with the adjective "terrible" above, given the advances in behavioral economics research over the past decade, but nonetheless the point is a good one. It is difficult to see how owning an instrument almost certain to pay your less than inflation will look wonderful 15 years from now.

But between now and 2035 an abundance of news cycles await, many of which will appear awful, and the purpose of those Treasuries remains intact: diversification and protection against behavioral error, which is devastating to returns. Via behavior or market timing, missing just one or two of the largest up days in the market will haircut returns.

Dan Cunningham

1. Stockcharts.com: TLT vs AGG vs HYG, 1/1/20 - 2/28/20, total return.
2. NY Times. Buy American. I Am. 10/16/2008