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Opportunities From The Chaos (Covid-19)


The Catch 22:

Investors have a once in a decade opportunity to capitalise on opportunities across multiple asset classes. The catch though, is whilst this will be a once in a decade opportunity, navigating the uncertainty of virus economics and investment entry points is vastly different to other downturns. The enforced government shutdown duration (currently an unknown) is the main risk factor as well as the virus itself!

This means recovery can be a lot quicker than previous down turns, providing we aren’t in lock down for an extended period and civil liberties are not lost! Policy makers have their own Catch 22 to deal with! Shutdown the economy to save lives, or keep things going and risk loss of life.

“From chaos, emerges opportunity!”

As I write this article British scientist Neil Ferguson from Imperial College, who modeled 2.2M deaths in the US and Britain from Covid-19 has revised his numbers down to 20k with new controls. As the evidence changes, policy decisions too will change.

As we transition through four major different consumer, business and economic stages as the crisis evolves (outlined later). We will witness changes in demand and supply across various products and services (essential vs non-essential). Consequently, each shift will determine which businesses will succeed and which will not. All of this however is subject to the severity and duration of the crisis.

In parallel to this crisis, we are amidst a trade war and geopolitical power struggle between East and West (Ray Dalio writes extensively about this here). Ultimately the longer the crisis lasts, the stronger nationalism movements will become due to high unemployment. As a function of time, West and East will start blaming one another (already there are undertones).

The challenge for investors is not to fall victim to their own Catch 22 during this period:

1. Discounted assets don’t equate to future success. What is relatively cheap today, can always go lower tomorrow, if things deteriorate. Knowing where you sit in terms of the short and long-term cycles is critical (as discussed by Howard Marks).

2. What is successful today, may not be tomorrow: The situation is fluid at best, and businesses that flourish during the crisis may be the new Tesla’s of tomorrow, or a failure post crisis.

3. Balance Sheets & P&Ls: Whilst past earnings may be a sign of capability and performance. Investors must seek to understand if the business model is still relevant in future and if future profits can cover past liabilities.

The Consumer, Business & Economic Shifts

The table illustrates the four shifts I expect to see as the crisis unfolds. The shift in consumer sentiment and unemployment rates will largely determine the buying habits of consumers from essential to non-essential goods/services as recovery occurs.

Consumer trends will emerge from this experience, for example the extensive use of home delivery. Businesses too are shifting, realising the reduced costs of having staff work from home.

Timelines can be shorter or longer and sentiment can change quickly, however the general principles will remain. On a positive note, I expect the time it will take for us to recover to be vastly shorter than other crises, depending on the length of the crisis. Thus stage 3 and 4 duration, will be reflective of the stage 2 duration, the longer it lasts, the longer the recovery. Credit and interest rates, are also subject to change if a credit crunch occurs.

“Just because a business succeeded pre Covid-19 or during, doesn’t mean it will succeed after”

The Bad – The Immediate

Whilst the governments will create a series of stimulus packages, the fundamental reality is that if people are confined to their homes the velocity of money is greatly slowed down thus reducing economic activity! Businesses that were struggling before the crisis, will most likely be purged as a function of time especially if they had low cash reserves.

The Ugly – To come after the crisis is done and when debts are due

The current loan deferrals being offered to businesses by banks and governments, has the assumption that businesses will have the loan serviceability capabilities post Covid-19 as they did pre covid-19. Which is possibly a very large risk, as revenues post Covid-19 may not be the same as pre Covid-19. The same risk applies to businesses who have expensive leases, who upon return may not be able to pay their landlords the same amounts.

In my opinion more businesses will fail once they become liable to pay loans and leases, if revenues do not match pre crisis levels. This after shock, will come however within the year following the crisis and more so in the first 6 months, subject to consumer confidence. This will have its own effect on property values later on, if we go through a prolonged downturn.

The Opportunity

Currently I am working my way through finding the below opportunities for the cohort of investors that i serve. The largest challenge with the below table is timing entry points, as we do not wish to deploy capital that is sitting idle. As the crisis period is unknown (stage 2), this is one of the greatest risks for investors.

I personally can’t see people being forced to be in lock down for 6 months. This would cause mass unemployment, and civil unrest. The longest I can see a lock down going for is 3 months (where people are forced to stay home), given overseas cases. Especially considering the low numbers here in Australia, border restrictions are another matter.

If you would like to get on the mailing list of my latest opportunities, feel free to email me at tarek@roycestonecapital.com.au

The above is not personal advice and is intended as commentary only.

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