Hedging My Virus Bets

Hedging My Virus Bets

After last week’s horrendous losses, I spent the entire weekend reflecting, thinking and analysing the macro picture.

This led me to two conclusions:

1. A more than 40% weighting in one share is inappropriate

I discussed my largest holding and highest conviction position RockRose Energy last week. If you’d told me that RockRose could trade at more than a 20% discount I’d say that was impossible – well it’s not. RockRose was moving in tandem with the oil price, with little regard for the balance sheet. At more than 40% of my portfolio, I realised that I’m not willing to accept that level of risk.

2. Deflation could be coming

I believe that China’s disruption to global supply chains could cause deflation.

China’s factory index hit record lows:

(Source: Biznews)

I would characterize China as the manufacturing hub of the world. If companies can’t source parts, then finished goods can’t be shipped.

Jaguar Land Rover stopped manufacturing the I-Pace for a week due to battery shortages. JLR warned this is an issue for the entire automotive industry. Even if people want to buy your cars they can’t.

JLR will survive, but what about all the SME’s that supply parts? If they don’t have decent balance sheets, they could be in trouble. And if you were a worker on one of their production lines – fancy booking a holiday or making a large purchases at the moment? I think not.

There is evidence that consumer spending is reducing. A former LVMH executive described the coronavirus as a disaster (LVMH own brands like Louis Vutton, Marc Jacobs and Hublot).

Consumers are acting irrationally and buying loads of hand gel – normal soap works fine, readers!

A colleague wants to go to Vietnam. He’s booked the time off but is holding off booking flights to see how things develop.

Airlines are cancelling hundreds of flights due to dropping demand. Airlines are notoriously fragile – it wouldn’t be surprising to see a few go bust. EasyJet cabin crew – fancy a new car on finance? I thought not.

In Japan, schools are closed. How does an economy perform with its schools closed? I suspect it doesn’t boost output, but you never know.

Positive News

I’m in danger of sounding like a massive bear whilst there have been some positive events for markets.

Central banks are panicking and bringing out their party tricks (print some more money!).

  • Bank of England  – “The Bank is working closely with HM Treasury and the FCA [Financial Conduct Authority] – as well as our international partners – to ensure all necessary steps are taken to protect financial and monetary stability,” a spokesman said.
  • Bank of Japan“The Bank of Japan pledged to use whatever instruments necessary, including injecting money into the market, to ward off the effects of the coronavirus”.
  • Italy“Italy will inject €3.6bn into its economy to mitigate the impact of the largest outbreak of coronavirus in Europe as policymakers around the world consider the consequences of transport and supply disruptions resulting from efforts to contain the disease.”

The market is already pricing in expected rate cuts from the Federal Reserve and expects that OPEC will cut production in their upcoming meeting this week.

Given all of the above, I’m more comfortable holding a 20% cash position. If I’m wrong and coronavirus doesn’t reap economic carnage, I’m still 80% long and will benefit. If I’m right, I want to have some cash on the sidelines to deploy should we be entering a recession.

My thesis is that no amount of money printing can make up for missing goods, disrupted supply chains and panicked consumers, at least in the short term. I’m still positive about growth and the economy in the mid to long term – the sun will rise and life will go on regardless.

 

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  • comment-avatar

    I think people only learn their true risk tolerance when they have to face it – or the moment when the fear comes that they might have to face it.  It was certainly true for me and it sounds like you’ve made a considered choice in light of the changing environment.  Having position sizing right and having cash on hand to deploy, makes for for strong hands in my experience.

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  • comment-avatar

    Cripes …..really surprised to hear you had 40% in one risky stock . Thats not risk management …its gambling !
    I would not be happy with more than 2-3 % in one stock . Standard risk management however is around 1.5 – 2% ! on a 3:1 risk ratio . ie for AIM sell on 20% fall / take profit on 60% rise giving you worst case 7 losing trades for every 3 winners and still makeing money.
    Forty % is like betting the ranch . Anything can happen and probably will . Just look at Paul Scott …..made millions and lost it all again !
    Get rich slow and keep it !

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  • comment-avatar

    Thanks for the article. The last paragraph is very true but the trouble is nobody seems to know how we will get to the last phrase from where we are now.

    With regard to the:

    “ Consumers are acting irrationally and buying loads of hand gel – normal soap works fine, readers!”

    That’s true but gel is for when your are out and about touching fomites (watch Contagion with Matt Damon et al!) such as door handles or other surfaces and ensuring your hands are germ free.

    I hold RRE as 16.3% position in my portfolio and actually saw it as a cash holding I also hold 10% cash and 4.5% physical gold.

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