We have been closely monitoring developments related to the coronavirus since late January, and concluded several weeks ago that it poses a potentially significant risk to human life, global supply chains and economies around the world. Paladin has long considered the possibility that some geopolitical event of unknown origin might disrupt asset markets that are broadly overvalued and at risk of an abrupt change in sentiment.
Investors are having a difficult time processing the onslaught of new information about this virus; we do not think it’s fully priced into markets. That’s because most people (or investment algorithms, for that matter) do not have an intuitive understanding of exponential growth and its consequences; they rely instead on “base rate analysis” as described in a recent piece by Tyler Cowen. Even those who understand the scope and impact of the disease per se (transmission rates, fatality rates, etc.) may not fully appreciate the intersecting and compounding challenges posed by (a) faltering global supply chains which are reducing the availability of medicines and PPE for health workers; (b) an inadequate public health infrastructure and large un/underinsured US population; and (c) a dysfunctional political process that slows effective decision making and puts narrative management ahead of disease control. Liz Specht has done a good job laying out the likely sequence of events that will--in the absence of swift and aggressive control measures--strain our health care systems over the next few months.
We believe this virus will have far-reaching consequences for our economy and society. It’s the combination of disease attributes and systemic fragility--described in our July quarterly letter, Valor Added--that makes the situation so dangerous, yet difficult for most people to comprehend.
Meanwhile, our leaders have been spreading falsehoods about current testing, which is encouraging the spread of this disease. The CDC actually instructed hospitals not to test until patients demonstrate severe illness—at which point they’ve probably infected many other people. The guidance has recently changed, but it won't help much, given the shortage of test kits. The number of health care workers exposed to the virus is rising rapidly, with implications for the care not just of coronavirus patients, but all others who need urgent medical attention. In Korea, where the authorities have been aggressive in identifying and managing the disease, there is nevertheless a long waiting list for hospitals. The same is true in Italy, which went from zero cases to hospitals at full capacity in the span of one week. We may already be approaching that scenario in major urban centers. Many are comparing this to the flu, but that's wrong: the coronavirus is 10 times more deadly than flu, even with good health care.
Just think about it: does it stand to reason that the 2nd largest economy in the world (China) just collapsed because the government decided to shut everything down due to a bad case of the flu? Reports suggest that perhaps half of Iranian leaders have been infected, and many have already died. Investors have not begun to reckon with the geopolitical consequences of these developments.
We anticipate a period of severe market turbulence that will create new opportunities for patient investors, and our clients will be in a position to take advantage of those. Our greater concern now lies with the many individuals, families, teams and societies who have been hurt by this terrible disease, in China and elsewhere. We hope for swift discovery and testing of an effective vaccine. In the meantime, whatever ‘social distancing’ might be required to protect our societies, let us pull together in other ways, direct and indirect, to support one another.
Gabriel Garcia Marquez wrote eloquently of the transformative power of loss and longing in Love in the Time of Cholera. The coronavirus will require a different kind of love--involving extra precautions against infection, yes, but also heightened compassion and support for our fellow citizens. That is how we will come through this together, building a stronger community that is immunized against dishonesty and distrust.