March in Review: A True Black Swan Event


By Rob Edel, CFA

Highlights This Month

Nicola Wealth Portfolio

Returns for the Nicola Core Portfolio Fund were -5.0% in the month of March.  The Nicola Core Portfolio Fund is managed using similar weights as our model portfolio and is comprised entirely of Nicola Pooled Funds and Limited Partnerships.  Actual client returns will vary depending on specific client situations and asset mixes.

The Nicola Bond Fund returned -5.9% in March. The volatility in fixed income markets was caused by a liquidity squeeze, fundamentals weakening over Covid-19 related economic shock, and interest rates. Central banks in the US and Canada cut interest rates to 0% and 0.25%  respectively which pulled forward returns and has reduced the benefits of having duration (weighted average term) in one’s portfolio as a risk mitigator and portfolio diversifier.

As Covid-19 concerns reached North America, many companies tapped into their bank lines to access cash in preparation for an economic fallout. These are committed facilities provided by the banks to companies to have readily available access to capital.

In addition, as equity markets were selling off in dramatic fashion, autocallable notes hit their loss threshold causing pension funds to sell bonds to raise capital. The combined impact of approximately $70B caused significant funding stress for the banks. Unlike 2008, when there were concerns on the viability of the health of the financial system, the current concern is much more a function of liquidity and bank funding issues causing a lack of bids for money market or bonds and spreads to widen materially.

In order to combat this issue, policy makers aggressively reacted with a multifaceted approach, including buying $300 B of corporate paper and bond ETF’s in the US and relaxing bank capital buffers for 18 months in Canada.  During the sell off, the iShares Core Canadian Universe Bond Index ETF had a peak-to-trough drop of -12% and the iShares Canadian Corporate Bond Index ETF fell -20%.

Our Nicola Bond Fund is focused on shorter dated credit and was not immune to the sell off. However, we believe that our Nicola Bond Fund is composed of high quality companies that will bend but not break during stressed times.  Our strategies are focused on bonds that mature within two years, within this short time period we expect our companies to not default and pay us back at par.

The Nicola High Yield Bond Fund returned -4.5% in March. The Nicola High Yield Bond Fund benefited from both defensive positions in high yield and US dollar strength which helped support fund returns. Relative to the market, the Nicola High Yield Bond Fund held in strong as the iShares iBoxx High Yield Corporate Bond ETF sold off -10.0% in local currency terms.

Given the tightness of credit prior to the sell-off, our strategies were defensively positioned entering March and now look to opportunistically take advantage of attractive pricing. All high yields bonds sold off significantly in March, with the most liquid and shorter duration bonds at times suffering more.

Credit spreads in high yields reached over 10% during the month, similar to levels seen in previous recessions including the bursting of the dot com bubble. There have been 45 historical examples of when high yield spreads have crossed beyond 8%. On a two year horizon, an investor has made money 44 out of 45 times. The median return over the next 12, 24, and 36 months for high yields bonds were 24.1%, 18.7%, and 14.8%.

In fact, there have been 25 examples of when spreads crossed beyond 9% and within a time frame of a year an investor has never lost money when spreads have crossed this mark.  The current distress ratio (high yield bonds with a price below $80) implies that defaults will rise to over 10% and are likely to occur in energy, gaming, manufacturing, and retail industries where there is a large amount of outstanding debt and lots of pending cash and liquidity needs.

Compromised credits will continue to see deterioration. Historically speaking high yield credit looks attractive at current valuations but we still believe a prudent approach active management focused on credit is warranted as defaults will pick up.

The Nicola Global Bond Fund was down -4.0% for March. The month saw mixed returns with the Templeton Global Bond Fund benefiting from defensive positioning, while PIMCO Monthly Income saw weakness as credit spreads widened materially. Templeton’s exposure to safe haven assets, such as the Yen, protected returns during the turmoil and may continue to appreciate as there is an increase in the repatriating of assets with escalating risk aversion.

In addition, Templeton had been reducing overall credit exposure and hedged currency positions in more volatile currencies such as the Mexican Peso and Indian Rupee, which helped to protect returns.  PIMCO saw weakness during the month as their barbell approach to high quality assets for a more benign economic environment partnered with higher yielding assets to benefit from economic growth, did not immunize the portfolio from the correction.

High quality and defensive positions such as non-agency mortgages saw some weakness as the flight to cash caused liquidity strains in the mortgage market as well. To combat liquidity induced weakness, the Federal Reserve announced a program to purchase $200 B of non-agency mortgages. These assets have both principle and interest guarantees from either the US Government or US Government agencies.

The returns for both the Nicola Primary Mortgage Fund and the Nicola Balanced Mortgage Fund decreased in March with the Nicola Primary Mortgage Fund and the Nicola Balanced Mortgage Fund returning -1.9% and -1.5% respectively last month.

The decline was due to a downward revision in the NAV of the Nicola Primary Mortgage Fund and  the Nicola Balanced Mortgage Fund as at March 31st. The mortgage loans in each fund are valued weekly on a mark to market basis and the reduction in value is a result of rapid changes in credit markets, and specifically changes in the commercial mortgage market which has not been seen since the Global Financial Crisis.

There have historically been very minor variations in the mortgage NAVs (both upward and downward), however the current environment has resulted in a swift and significant increase to yields for all types of mortgages including the segments of the market we invest in, resulting in a decrease in the market value of the underlying loans and ultimately the NAVs.

This change in value is not a result of any loan losses or defaults. The market’s perceived risk of the loans has increased just like there is a heightened risk across most asset classes given the current economic situation and uncertainty about the future. Although the loans in the Nicola Primary Mortgage Fund are more conservative than those in Nicola Balanced Mortgage Fund, the Nicola Primary Mortgage Fund loans more closely resemble the conventional mortgage market which is more liquid and as a result sees increased price volatility compared to the loans in the Nicola Balanced Mortgage Fund. The value of the loans is also impacted by a number of factors in the valuation models including the duration and remaining term of the loans, both of which are lower for the Nicola Balanced Mortgage Fund resulting in the valuation changes having a slightly bigger impact on the Nicola Primary Mortgage Fund.

The Nicola Preferred Share Fund returned –21.6% for the month while the BMO Laddered Preferred Share Index ETF returned –22.7%.  The unprecedented sell-off hit preferred shares as hard, if not harder, than equities. The weakness in the asset class can be attributed to preferred shares remaining an unloved asset class with investors selling indiscriminately, corporate credits spreads more than doubling to over 250 basis points, and the ongoing oil price war.

With oil prices in the $20 range all energy companies have sold off significantly. This is not a long term sustainable price; however, a prolonged period of severely depressed prices will cause impairments amongst companies with weaker balance sheets or higher production costs. Over 20% of the preferred share market consists of energy names but the majorities are companies such as Enbridge, which has 98% of their business contracted and utility-like with effectively no commodity exposure.

Preferred shares are paying 8.5% in dividends or 11.1% on an interest equivalent basis for investment grade rated companies that still have a very low probability of defaulting. Large issuers of preferred shares include the major banks such as RBC and TD and telecoms such as BCE. These investment grade rated companies need to cut their dividends to zero before they can suspend payments to preferred shares and there has not been a missed coupon in the space for investment grade companies since 1991.

The S&P/TSX was down -17.4% while the Nicola Canadian Equity Income Fund was -20%. There were no positive contributing sectors to Index returns in February as Coronavirus fears gripped the markets and investors sold everything. The better performing sectors were the defensive ones like Communications Services, Consumer Staples, and Utilities.

The underperformance of the fund was mainly due to being overweight in the more economically sensitive areas in the market like Industrials sector (and Air Canada in particular) and Consumer Discretionary which were hit hard in the month. Our sector positioning more than offset positive contributions from Health Care, Materials and Financials.

The top positive contributors to the performance of the Nicola Canadian Equity Income Fund were Maple Leaf Foods, Brookfield Asset Management and Royal Bank. The largest detractors were Air Canada, Ag Growth International, and Diversified Royalty. We added Riocan in March. We sold Andlauer Healthcare Group and ATS Automation.

The S&P/TSX was down -17.4% while the Nicola Canadian Tactical Income Fund was -22.5%. The Nicola Canadian Tactical High Income Fund was overweight cyclical areas in the market that have been hit hard.

Writing options in a low volatility world was not easy because the premiums that we would receive were low for defensive areas like utilities, telecom, REITs, or even the banks. As a result, we were underweighted these types of companies. We were able to find opportunity in Consumer discretionary and Industrials. These are two sectors that we liked because we could find good quality names where option selling (selling puts and calls) would work, but unfortunately these two sectors are more economically sensitive. With the virus outbreak, 92% of the world GDP is affected under lockdown/social distancing which likely guarantees some very poor economic numbers coming out in the coming months.

As a result, the Nicola Canadian Tactical High Income Fund underperformed. Currently, we view the opportunities in the Nicola Canadian Tactical High Income Fund as very attractive. When we write call options or put options, we are selling volatility. Volatility has spiked and selling volatility is attractive again.

Should the downturn in economic activity last, we feel that we can generate strong premiums and income from the portfolio with our option writing strategy. Currently the fund has a Delta-adjusted equity exposure of 85% and the projected cashflow yield on the portfolio is over 12%.

The Nicola U.S. Equity Income Fund returned -9.2% vs -12.4% for S&P 500. The Nicola US Equity Income Fund’s relative outperformance was due to overweight Consumer Staples, while being underweight Real Estate and Utilities.

Positive contribution from select stocks within Consumer staples (Hormel +12.1%, Walmart +6% and Costco +1.4%), Info Tech (Seagate Technologies 3.3%, which makes hard disk drives) and Healthcare (Medtronic +1.3%).   The worst performing stocks were within the Energy and Financials sectors which were impacted by OPEC+ breakdown and Coronavirus economic consequences (higher credit losses and lower interest rates).

The Nicola U.S. Equity Income Fund took advantage of heightened volatility by writing seven covered-call positions and ended the month 17% covered.  The delta-adjusted equity exposure is 93% and current annualized cashflow is 4.6%.  The only new position added was Union Pacific, though we also added to our existing positions in Valero Energy, Comcast and JP Morgan Chase.

The Nicola U.S. Tactical High Income Fund returned -15.8% vs -12.4% for S&P 500. The Nicola U.S. Tactical High Income Fund’s relative underperformance was due to being underweight the defensive sectors (Utilities, Healthcare, Staples and Info Tech) and being over-exposed to the hardest hit industries (Banks, Travel and Hospitality).

The restaurant industry was particularly hard-hit with Cheesecake Factory alone detracting close to 2% of the returns last month.  The Nicola U.S. Tactical High Income Fund has been reducing cyclically exposed names where the medium-term outlook will be challenged (i.e. auto-related, restaurants and aerospace) while adding to companies that are essential services in the current environment.

Credit risk for put option collateral has been reduced by selling all of the PIMCO monthly Income Fund in the 1st half of the month to ensure all Puts will be fully funded. There was extensive covered call writing within the portfolio (42 options written) with annualized option premiums averaging close to 28% while still providing 30% upside.    There were only six Put options written with average annualized premiums of 47% with 13% downside break-evens.  One of these Put options we wrote was on Costco Wholesale; we wrote a Put option expiring in May with a $260 Strike price and received 26% annualized premium with a downside break-even of 13%. The delta-adjusted equity rose from 73% to 82%.  Two new names were added, Costco Wholesale and JP Morgan Chase & Co.  We trimmed Dollar Tree, Middleby, Gentex, Franklin Resources, Cheesecake Factory, Lowes, Delta Airlines and sold our entire position in Delphi Technologies.

The Nicola Global Equity Fund returned -9.4% vs -8.6% for the iShares MSCI ACWI ETF (all in CDN$).  The Nicola Global Equity Fund slightly underperformed the benchmark due stock selection within Edgepoint Global Portfolio (Airlines, Retail REIT, Energy and food service related companies) and small-caps equities significantly underperforming large caps which impacted Lazard Global Small cap Fund.

Performance of our managers in descending order was Pier21 Global Value -0.9%, Pier 21 Worldwide Equity -4.7%,  NWM EAFE Quant -7.8%, BMO Asian Growth & Income -9.8%, Edgepoint -16.6%, Lazard Global Small cap -18.1%.

**please note the above returns were from Bloomberg with representative Funds converted back to CDN$.

The Nicola Global Real Estate Fund return was -6.5% in March vs. the iShares S&P/TSX Capped REIT Index (XRE) -27% as all sectors in the market were hit hard. Canadian REITs, typically viewed as a defensive sector, performed even more poorly than the broad S&P/TSX Index which was -17% in the month.

The market does not like uncertainty and currently investors are worried about how the COVID-19 crisis will impact REITs in the near and long term. Investors are correct to worry about rent payment deferrals and tenant bankruptcies but we believe that the REIT sector as a whole was in fine shape (financially and market fundamentals) to head into a “black swan” event like COVID-19.

Balance sheets appear well-positioned to handle short-term increases in rent deferrals. REIT prices have always been more volatile than the actual value of the real estate that they own. Overall, we believe investors should view this price volatility as a relatively rare opportunity to buy some of the highest quality names at discounts to their net asset value. There were no new additions or deletions in the month.

The Nicola Sustainable Innovation Fund returned -15.1% (USD)/-11.0% (CAD) in March and has returned -13% (USD)/-5.8% (CAD) year-to-date. The full-month result is disappointing as the portfolio had held in better than the broad North American indexes during the extensive selloff but we did not fully participate in the roughly 17% S&P500 rebound that took place between March 23-31st.

Our portfolio has more Utilities and Industrials exposure which are more defensive but this late month rally was driven by sectors like Information Technology, Health Care, and Financials, which we do not own. In days when the market sells off aggressively we’ve performed better given our defensive positioning and money-market/green bond positions; however, when we’ve had big upward swings we often haven’t participated in all of the upside. With that said, on a relative basis we are still outperforming our Cleantech funds and the broader markets for the year.  AquaVenture Holdings, American Water Works, and the iShares Global Green Bond ETF were the top contributors to performance this month. Evoqua Water Technologies, Hannon Armstrong, and TPI Composites were the largest detractors to performance during the month.

On March 31st we were formally taken out of our position in AquaVenture Holdings at $27.10 US/share by private company Culligan International. Our total return on AquaVenture since we started purchasing for the portfolio in October 2019 was roughly +40%. No new names were added in March; however, we took advantage of the market volatility and our cash position to add tactically to existing portfolio positions that were hit particularly hard including Xebec Adsorption, NextEra Energy Partners, and Aptiv PLC.

The Nicola Alternative Strategies Fund returned +1.1% in March.  Currency contributed 3.2% to returns as the Canadian dollar continued to weaken through the month. In local currency terms since the funds were last priced, Winton returned -1.9%, Millennium -1.6%, Renaissance Institutional Diversified Global Equities Fund -15.0%, Bridgewater Pure Alpha Major Markets -9.7%, Verition International Multi-Strategy Fund Ltd -0.11%, RPIA Debt Opportunities -1.18%, and Polar Multi-Strategy Fund 0.7%. Renaissance is structured as a beta neutral fund, meaning the risks of having long exposure to stocks is offset by shorting stocks. Renaissance uses mathematical models to manage risk exposures and adjust accordingly to try to maintain zero correlation to global stocks markets. Unfortunately, March was a historically violent sell off in the marketplace causing Renaissance’s risk models to underappreciate risk. In addition, several European countries banned short selling of stocks making it even more difficult to hedge risks.

The Nicola Precious Metals Fund returned -5.9% for the month while underlying gold stocks in the S&P/TSX Composite index returned -6.8% and gold bullion was up 4.4% in Canadian dollar terms. Gold stocks have fallen in sympathy with the overall market as investors have sold most assets to deleverage and raise cash, or meet margin calls.

Gold has been a traditional safe haven, but currently the markets appear to favor the US dollar in terms of safe haven assets. Like many other businesses, operations in some mines have shut down (predominately in Latin America and Australia) to reduce transmission rates of Covid-19. There are similarities in the market to 2008, where initially gold stocks fell in-line with the broader market but rallied significantly afterwards.

With interest rates at zero, the Federal Reserve returning to Quantitative Easing, and a US federal budget that will be larger than 10% of GDP, both fiscal and monetary policy have aligned to favor gold. Particularly if the Fed keeps interest rates low for an extended period of time below inflation to allow further opportunity for the economy to resemble some sense of normalcy. Gold is a good defensive and resilient investment in the current environment and as central banks ramp up their printing presses and inflation picks up, good defensive may turn into good offensive in short order.

March in Review

It is said March comes in as a lion, and leaves like a lamb.  While it is true the market may have come in as a lion, the beast we saw at month end was no lamb.  The S&P 500 ended the month down 12.4%, but on March 12th  crossed over into official bear market territory after declining 26.7% from its February 19th all-time high.

This was the quickest drop for the S&P 500 into a bear market ever.  By March 23rd the S&P 500 had fallen another 9.8% before rallying 15.5% to the end the month.  In total, over $3 trillion of market cap disappeared in March.

The average daily move in March was nearly 500 basis points, making it the most volatile month ever.  The previous record holder?  November 1929, with an average daily move of 390 basis points.  S&P/TSX hit its all-time high one day later (February 20th) and entered a bear market one day earlier (March 11th), before falling a cumulative 37.2% by March 23rd.  Like the S&P 500, the S&P/TSX rallied into month end to trim its losses for the month to -20.9%.  For both indices, it was the worst quarter since the 2008 financial crisis.

The Coronavirus Pandemic is a True Black Swan Event

The 2008 Financial crisis has been described as a black swan event, an unpredictable event with potentially severe consequences.  While some could argue they saw the financial crisis coming and thus it wasn’t a black swan event, with the exception perhaps of Bill Gates, it’s hard for anyone to argue they predicted the Coronavirus and it isn’t a true black swan.

The difference between this black swan and the Great Financial Crisis, however, is this virus bear market is generally considered to be event driven while the GFC was structural (over leveraged financial institutions).  The good news is event driven bear markets are typically shorter and shallower than either structural or cyclical bear markets.  The bad news is the virus bear is not acting like this, so far anyways.  Compared to the GFC bear market, the virus bear market has fallen more quickly, and it has already declined more than  the past six event driven bear markets, which on average dropped about 22% and recovered 21% a mere six months later.

It wasnt just stocks that were under pressure last month either. 

A lack of trading liquidity became an issue in nearly every asset class.   The US dollar is considered a counter cyclical currency in that it appreciates in times of stress as traders scramble for liquidity and safety.

Not only was the greenback stronger against developed and emerging country currencies, but short term three month treasury’s, considered near cash, actually traded with negative yields last month, falling as low as -0.13% on March 26th   as traders parked money in US T-bills.  Alternatively, longer term Treasury yields rose, which was the opposite of what should have been happening given investors were dumping stocks and would normally be buying bonds, thus driving their yields lower.

The demand for dollars was also evident in the currency swap market, where foreign traders in search of greenbacks saw spreads grow more negative and the cost of borrowing dollars soar.

Credit and energy issuers were under pressure as oil took another drubbing last month.

Also under pressure was credit, namely investment grade and non-investment grade (high yield or junk) corporate bonds.  Both saw credit spreads (yields in excess of risk free government yields) widen dramatically as liquidity evaporated during the month.

Like equities, investment grade bond prices rallied at the end of the month with spreads narrowing.  Non-investment grade also recovered some of their losses, but spreads and liquidity still remain under stress.

Energy issuers were hit particularly hard, as oil took another drubbing last month.  WTI crude fell 54% to $20.7 US a barrel while Western Canadian Select plummeted 84% to just over $5 US a barrel, less than a pint of beer!

Three main drivers for the markets are fiscal and monetary policy, COVID-19 and efforts to contain.

Overall, we believe there were three main drivers for markets last month, namely economic forecasts, fiscal and monetary policy, and COVID-19 and efforts to contain the outbreak. We believe this was the case last month, and will be case for foreseeable future.  All are important and will be discussed, but COVID-19 tops the list so we will leave it for last.

Economic numbers are going to get ugly. 

A recession is largely a given, the real question is how deep and how long.  Will it be a V shaped, U shaped, or L shaped?  The market needs to know how much the economy will ultimately contract, and how steep the forward demand curve will be going forward.  Sadly, it looks more and more like the odds of a V shaped recovery are becoming remote and a U shaped recovery is largely being priced into the market.

Forecasters are slashing their estimates for global growth, with Goldman Sachs forecasting a 1% contraction in 2020, while the International Finance Institute believes it will be even lower.  Revisions continue to be to the downside as forecasters discount a longer containment period and virtual shut down of the global economy.  The service sector is getting hit particularly hard given social distancing rules’ disproportionate impact on most service related jobs.

For the US economy Q2 will be particularly painful. 

Estimates range from an optimistic -9% to an apocalyptic -40% GDP growth rate.  Goldman Sachs had the low forecast on the street at -24% before Morgan Stanley lowered their growth rate to -30%.  Goldman eventually revised their forecast down further to -34%, but Capital Economics bettered them with a -40% prediction.  It appears to be a race to the bottom.   Already in March, over 10 million jobs were lost and Oxford Economics believes a total 27.9 million workers could be eliminated by May with the unemployment rate hitting 16%.  This would wipe out all the job gains since 2010.

Numbers keep declining because America is in the process of shutting down.  More important than how bad Q2 will get, however, is how quickly containment measures can be relaxed and how quickly economic growth can rebound.   The longer the economy is shut down and consumers are out of work, however, the deeper contraction in spending and longer the recovery.  Wait too long and future spending and economic growth may be permanently impaired.  That’s where the L shaped recovery comes in.

New monetary and fiscal policy measures are helping to bridge the gap.

Fortunately, the only thing scrambling faster than forecasters cutting growth forecasts has been central banks and governments with new monetary and fiscal policy measures designed to help bridge the inevitable gap left as huge parts of the global economy shut down.

The US Federal Reserve has effectively lowered interest rates to zero and appears poised to ensure banks and companies have adequate access to capital.  Using lessons learned during the financial crisis, the Fed has been able to respond to liquidity dislocations in record time.  As for fiscal policy, a mere 11 weeks after the initial outbreak, the US Congress has passed three aid packages, the third valued at $2.2 trillion.  At $82 billion, or 6% of GDP, Canada has followed suit.

The goal appears to ensure companies and their employees are made whole.  No one should go bankrupt because of COVID-19 and the Government and Federal Reserve stand ready as buyer of last resort to ensure this is the case.  Execution, of course, is the key.  Making sure money gets into the right hands quickly will determine how successful they ultimately will be.  If they fail, demand will not rebound after the virus and a recession could turn into a depression.  The stakes are big, and the market will serve as an ongoing barometer of how they are doing.  We expect more help will be needed, and more help will be given in the coming months.

Will it be enough? 

It depends on the coronavirus and how long social distancing and containment measures will need to remain in place.  Traders will look past what are sure to be what is going to be a Q2 for the record books (and not in a good way) if they have confidence they can see the other side.

Fiscal and monetary policy will ensure a liquidity event doesn’t turn into a solvency event, but not indefinitely.  Trader’s screens that were once focused solely on markets now include COVID-19 dashboards, like the one produced by John Hopkins University.  It’s all that matters right now.

When will we bend the curve and see new cases turn lower, and more importantly, when can we get back to normal! Hopes the coronavirus could be contained to China seem a distant memory.  Worst case scenarios forecasting a global pandemic and recession have now become most forecaster’s base case.  Still, the market is discounting a reasonably quick recovery starting this spring.  The later that timeline slips, the greater will be its disappointment.

The first difficulty in determining a timeline is we have no firm historical model to base projections on. 

Past Pandemics, like the 1918 Spanish Flu provide some lessons, but the characteristics of COVID-19 are different and the world has changed over the past 100 years.  COVID-19 probably has a lower fatality rate, but is more infectious. Those infected are thought to be able to shed the virus and pass it on to others between two and 14 days before they show symptoms, if they go on to experience any symptoms at all.

This makes COVID-19 particularly hard to contain, with social distancing and aggressive contact tracing the only proven method of breaking the chain of transmission.  Of course there is the option of letting the virus run its course and infect enough of the population until herd immunity is reached, estimated at around 40-60%, but the projected strain on the healthcare system and resulting increase in fatalities make this a very undesirable outcome for society.

The Imperial College of London models estimate the US could experience up to 2.2 million deaths if no mitigation or suppression measures were employed.  It should be pointed out, however, since we don’t really know how many people actually have been infected, we can be sure that we haven’t already experienced herd immunity.

An Oxford University Study speculated 50% of the UK population had been infected.  Only mass serology testing, which tests for antibodies produced after exposure to the virus, will ultimately answer this question for sure.

 

Fortunately given China appears to have been successful in suppressing the virus, epidemiologists are able to use data from China’s experience to build models and compare how the US and Canada look compared to where China was at the same point in the outbreak.

Italy and Spain, which are anywhere between one and two weeks ahead of the US, also provide a good comparisons for a Western developed democracy.  Neither are an apples to apples comparison, however.  China’s social distancing and quarantining measures were more severe than Europe’s, and certainly more severe than the US, and some question the accuracy of China’s numbers, especially reported fatalities.

Number of cases is also largely dependent on how many people are being tested while fatality rates are influenced by a wide range of factors, such as average age of the population, number of acute care hospital beds, and social customs.  In Italy, multiple generations tend to live in the same household leaving the elderly more exposed.  Regardless of the differences, the US appears to be following the path of Italy and Spain, rather than that of China.

The outbreak in the US also appears to differ from region to region, which is good and bad. 

It is good because parts of the US, especially the sparsely populated interior states, have been spared so far and resources can be allocated to other regions.  It’s bad because a lack of a national strategy means some states haven’t been locked down and will likely end up eventually getting more infections, and even create a second wave for regions that have recovered.

The US was too slow in dealing with the pandemic and lost vital weeks of preparation.  Testing was slow to ramp up, and social distancing rules were not established until outbreaks had gained momentum.

There is some hope COVID-19 will die off in the summer, like the seasonal flu.

While there is no exact scientific explanation why the flu is seasonal, it is through humidity, temperature, and sunlight all make it harder for viruses to survive and be transmitted in the summer.  While COVID-19 outbreaks are on every continent except Antarctica, the largest outbreaks appear to be in winter climates with temperature between 5 to 11 degrees Celsius and higher humidity.

It is also the case that people naturally social distance in the summer by spending more time outdoors and their immune system is stronger.  Kinsa Health uses internet connected thermometers to track the flu season and believes we could already be seeing the virus peak.

While their data can’t differentiate between the flu and COVID-19, they do believe current social distancing is having a positive impact on the number of fevers they are tracking.  While it is likely there will be some summer reprieve, because COVID-19 is a novel virus to which we have no immunity, it is more likely to survive the summer than a weaker seasonal flu that is already struggling to find hosts without at least some immunity.  In other words, wash your hands, keep your distance, and don’t count on being bailed out by warmer and dryer weather.

Once we bend the curve, and infections get lower – now what?

Regardless if it is due to warmer/humid weather or prudent social distancing, eventually we will bend the curve and new infections will turn lower.  And then what?  What does life look like once we have contained the outbreak and how do we prevent a second, or even third wave.

First off, life is not going back to normal, not until there is a vaccine or very effective treatment options.  In combination with extensive testing and rigorous contact tracing, social distancing measures can gradually be relaxed but large gatherings will be problematic.

Schools and Universities will be tough calls.  Sporting events even tougher.

Experts believe a Champions League soccer match in Milan with 40,000 spectators was behind the large outbreak in Northern Italy.  It’s hard to see 100,000 people in a stadium watching a college football game if there is a chance even one person might be carrying the virus.

More likely teams playing in empty stadiums with fans watching from home will be the norm for the next year or so.  The timetable will likely be region dependent and success based on the ability of local health authorities to carefully monitor any new infections.

COVID-19 outbreaks tend to occur in clusters so the quicker the sources can be determined and isolated the more effective the suppression will be.  President Trump at one time had talked about an Easter timeline for removing lockdown measures. He later called this statement aspirational and extended the administrations social distancing guidelines to the end of April.

All decisions are likely to be data driven and approved by health experts, at least we hope so. There is obviously a huge economic incentive to getting America back to work.  It’s not just Donald Trump making the case that the cure can’t be worse than the disease.  It’s going to be a trade-off we may be faced with well into next year.

The wildcard, would be if a viable treatment comes through.

The wildcard, of course, is if the scientific community comes through with a viable treatment option such that social distancing measures can be greatly relaxed, possibly even negating the need for a vaccine.  This was the case for SARS.  According to Informa Pharma Intelligence, there are currently more than 140 experimental drugs and vaccines in development worldwide.

Including trials for drugs already approved for other diseases, there are 254 trials testing treatments and vaccines for the virus under way with more planned.  In the near term, existing antiviral prospects like malaria drug Hydroxychlorinequine and, Remdesivir, an Ebola treatment developed by Gilead, could release some trial results in April, but early indications suggest both may be only effective if used early, thus negating their benefits in hospital, which normally see patients after COVID-19 symptoms are more advanced.  A more promising target may be neutralizing antibodies therapy, though trials for two antibody cocktails conducted by drug company Regeneron are only planned to start this summer.

Scale is also an issue as the antibodies comes from the plasma of recovered patients and priority will likely be given to at risk patients.  Some scientists believe our own immune response is actually responsible for more deaths than the virus itself and drugs targeting a hyperactive immune response could get patients off ventilators and out of the ICU.  Regeneron’s Kevzara and Roche’s Actemra are two drugs showing promise.  There are a number of other existing drugs that could also provide some relief, but any real game changer will likely come from a new drug that will require safety and efficacy trials lasting months.

A vaccine will take even longer, likely 12 to 18 months.  Quicker progress is being made on the diagnostic front, with Abbott Labs recently being given emergency authorization by the FDA for a point of care test that can provide results in 15 minutes.  GPS tracking apps for smart phones are also being developed in order to make contract tracing more efficient once social distancing rules are eased.     They aren’t cures, but could play a vital role in helping get Canada and America get back to work by determining who needs to be quarantined, and who is free to re-join the workforce.

The most important factor necessary to battle COVID-19 now and over the coming months is leadership. 

People need to feel confident that their leaders are making the right decisions and the sacrifices being made have been carefully weighed against economic and psychological cost to society using the best information available.

Going forward, no bigger decision confronts any leader in the world right now than the decision of when and how to eventually scale back current social distancing rules.  The US is in a unique situation given the upcoming elections this November.  Up in the air is not only who will be President and who will control Congress, but how will the election process be conducted in the present environment.

We assume big rallies and door to door campaigning will make way to TV debates and social media.  It could also mean when the US is entering the crucial flu season this November, the White House could be in transition.  Some might view this as a positive, but putting together a new administration is no small task under normal circumstances, let alone dealing with a pandemic.

Normally, a recession is bad news for an incumbent President seeking re-election, but Trump’s popularity has held up, likely due to a “rally around the flag” effect.  Trump’s handling of the virus also makes him vulnerable, as he played down the risks early on and appeared to contradict his health experts.

On the other hand his near constant media presence have made it hard for his Democratic rivals to get any notice.  In early April, Bernie Sanders conceded the Democratic nomination to Joe Biden, enabling Democrats to unite and focus on the real prize.  Now they need the American public to notice.  Trump’s performance during his daily media sessions aren’t doing him any favors, but this is all the American public are seeing right now.

So what does all this mean for investors?

One Strategist we read recently commented that it was too late to sell, but too early to buy. Markets have rebounded nicely in early April but a re-test of the March 23rd lows are not out of the question.  We worry investors are not fully discounting the negative drag on economic growth the remaining social distancing rules will have until a vaccine is rolled out, hopefully in 12 to 18 months.

Perhaps it will be quicker, and maybe new treatment options will have a shortened the timeline, but we would be cautious of declaring victory based purely on “flattening the curve”.  On the other hand, stocks are already in a bear market and history has shown investors can be handsomely rewarded when buying at market bottoms and not giving in to their fears and cashing out.

Market timing is tough, and missing out on just a few of the markets biggest return days can materially impact long term returns.  A good well diversified asset mix should be structured to endure bear markets and ride through the volatility.  A recent WSJ article suggested investors learn to embrace the bear market.  We’re not going that far.  We believe investors need to maintain a longer term perspective, but maintain a distance of at least two meters.

 

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