»The Honest Truth by Ajit Dayal

Majoritarianism, valuations and the coronavirus.
2 MARCH 2020

There are three viruses that seem to be harming our society, of which the COVID-19, as the coronavirus has been branded, is the most recent:

  1. There is the resigned WhatToDo, or kya karen, as we watch societies torn apart on various issues across continents. This is the virus of the "majoritairianism" where the rule of the majority is used for furthering the causes of the majority. The corollary to this virus is the virus of "exclusion": which states that if you don't belong to the majority, you don't reap certain benefits that would otherwise rightfully and constitutionally belong to you. Another side-effect of this sickness of majoritarianism is the ButWhatAbout syndrome where the muck of the present is justified by the muck of the past and Einstein's Theory of Relativity sits comfortably on a numbed human conscience;
  2. There is the epidemic of loose monetary policy that has gripped the financial markets since the bankruptcy of Lehman Brothers in September 2008 when governments decided to use tax payer money to bail out financial firms who rolled the dice, lost out - but got to keep their businesses even after being bailed out. To be fair, the virus of free money did not start in 2008. Fed Governor Alan Greenspan had already infected us with his master stroke of the "Greenspan put" and invited all gamblers to the casino with a solemn promise: you gamble, you win - and the money is yours to keep but if you gamble and you lose, I will bail you out with tax payer money. Greenspan, the Master Craftsman, set that in the rule book of how to run a central bank with his bailout of LTCM in 1998; and
  3. The coronavirus, COVID-19, whose existence was first acknowledged by the Chinese government in January 2020 and whose origins may have come from bats, pigs, or a secret bio-chemical military experiment which "leaked". The creation of a vaccination to fight COVID-19 needs data and a history of patterns and, by definition, more time will need to be given, more data will need to be gathered and more lives will need to be endangered before a solution can be found. There are no sensible shortcuts.

Unlike the first virus of majoritariansim, the coronavirus has no sympathy for classes of people, nationalities, religion, colour of skin, or type of clothes one may wear. Unlike free money which benefits an upper class, COVID-19 has no special treatment for those with different net worth. It attacks at random.

Unlike majoritarianism, the coronavirus has no odour to it, no sweaty hands that strangle or no sharp tongue that can unleash the power of the State on its people. The coronavirus infects your neighbor - rich or poor - and they may not even know they are infected. And then it infects you - silently. It does not need the power of the State to go after you.

The coronavirus, come to think of it, is the perfect military weapon in bio-chemical warfare. Poison and nerve gas is limited to killing the person in the area where it is released. With the coronavirus the infected person harms a lot more people - like a suicide bomber in a crowded area, except the suicide bomber knows his fate and willingly kills himself while on the murderous mission.

India wakes up to coronavirus.

Until this past week, India seemed blissfully unaware of the impact of the coronavirus and went on with its business of infectious majoritarianism. Furthermore, like most global markets, Indian stock markets had enjoyed another spurt in share prices since October 2019 for no particular economic reason. The Indian economy continued to hit lows, but stocks hit highs!

But there was the smiling devil of liquidity lurking in the shadows: a very important reassurance that central banks were ready to step in and print more money. In the US, short-term inter-bank interest rates spiked to 10% in September 2019. The Fed stepped in (and has continued to step in) adding over USD 500 billion into the credit market to ease liquidity. Or prevent insolvency.

Illiquidity and insolvency are often two different sides of the same coin. I am sure the companies facing bankruptcy court proceedings in India would love for the RBI to inject "liquidity". Individuals who cannot repay their personal loans and EMIs would love a dose of "liquidity" too! For over a decade, the real estate mafia dons have received liquidity in the form of bank bail outs which prevented them from being insolvent. Recent laws under the guidance of the RBI and supported by the no-nonsense Modi government have stopped that nonsense!

While the global scenario continues to be driven by free money from the central banks singing the mantra of liquidity, the Indian economy continues to totter at a Hindutva rate of growth. Another budget speech went by, some more economic data came through, some more new schemes to help the poor were launched, and Indian businesses kept waiting for the acche din. Mr. Rahul Bajaj made a brave and valid point and then sat down into oblivion as India went about doing its business. The focus of the State and policy apparatus remained on the tukde tukde folks that seem to have infested the country as the State sought to find ways to set them straight. It will be a long haul to silence so many: 52.6% of the votes cast in the May 2019 elections were against the BJP government, technically a majority of the popular vote.

But by last week Dalal Street began to question its irrational exuberance.

Not because the coronavirus hit India (that is the breaking news as I write this on Marc h2) - but because the world markets began to take notice of the potential impact if COVID-19 continues to spread. The virus was accelerating its pace of infections in countries outside of the "home" country of China. (By the way, this is another attribute of a successful weapon of warfare - widespread and lasting damage away from the core.) The virus had spread beyond the "near East" geographies of South Korea and Japan and had landed in northern Italy from where it could spread by car, train or plane to the 27 borderless countries within the Schengen visa region. And from Europe, it can spread everywhere....

Table 1: Coming to a mall near you?

Country / Region China, cases Outside China, case Total cases China, deaths Outside China, deaths Total deaths
January 31 37,251 307 37,558 816 1 817
March 2 80,026 9,055 89,081 2,912 145 3,057
% increase 115% 2,850% 137% 257% 14,400% 274%
Source: Worldometers, Quantum Advisors

SARS and coronavirus: it's not the numbers, it's the unknown.

I was at a research conference and factory visits in China and had just gotten of a train from China to Hong Kong in February 2003 when SARS started to catch the attention of the international media. I reached my hotel room, got my dose of information from CNN, and flew home to Bombay to be under the watchful eyes of my father, who was also my doctor! I was feeling fine and wore a mask on the flight back. At Bombay airport, they scanned people with a digital thermometer (probably inaccurate, and Made in China?). I rested at home for a week, stayed healthy, and then took a flight to USA to resume my work.

Table 2: Watch this Classic that lasted for 8 months - but not available on Netflix

Country / Region Start date End date Total cases Total deaths Fatality rate
SARS Nov 2002 June 2003 8,098 774 9.6%
COVID-19 Dec 2019 ? 89,081 3,057 3.4%
Source: BusinessInsider, Worldometers

But this time, it may be different. Within less than 3 months, COVID-19 has caused more fatalities than SARS did in 8 months. The percentage of people who can die from it is lower than SARS ("only" a third as fatal) but more people can get the infection.

And this may just be the beginning.

When SARS hit in 2002-2003, there must have been maybe 10 flights a day from China to HK in 2003 and possibly a handful of flights to other global destinations.

Today, China has many more flights linking it to the world and it has a lot more share of factory output globally; tourists visiting China and Chinese tourists visiting the world; Chinese labour working on the New Silk Road and in Chinese factories around the world. China accounted for 4% of the world economy when SARS hit in 2002 and today it accounts for 18% of the world economy, with possibly 11% of total world consumption. It is an engine of production of goods to the world, an engine of consumption and - by extension - a guzzler of raw materials to feed the world and itself!

Table 3: When an oak falls, the earth shakes? And inflation may decline further...

Product, China's share 2002 2019 Increase in share
Crude oil, consumption 6.6% 13.5% 2x
Crude steel, consumption 22.6% 47.5% 2x
Copper, consumption 17.8% 53.3% 3x
Semiconductor, sales 5.0% 34.6% 7x
Smartphone, sales 11.2% 29.2% 3x
Passenger car, sales 7.3% 34.5% 5x
Source: from WhatsApp, no original source ascribed

The unknown can be measured - or remain unknown.

Markets hate uncertainty; they hate the unknown which cannot be measured or estimated. They prefer simple known facts on which to extrapolate their views and then place their bets.

To make life easy, for decades there was one, uni-directional bet: take a punt, bet big and if you win, you will enjoy the rewards. If you fail, the Fed will use tax payer money to bail you out but you still get to keep and enjoy your past loot.

That business goes by the brand name of Wall Street with all its clones and cronies in every nook and corner of the world. The outcome of those bets is "the 1%, now a point of debate in many political and social circles. Those debating belong to Main Street, or the "99%", those left out in the cold. The '99%" were the dumb bystanders taken for a ride by the street artists and their con game of "follow the ball and the three cups" - what happened is slowly dawning on them and they are wising up to the con.

Wall Street, though, is not sympathetic to the 99%. That is a certainty. No change there.

What Wall Street can no longer bet on is the extent to which the uncertainty will last - and how long it will be on their doorstep!

Unlike the mortgage crisis, COVID-19 impacts them. They don't know whether their family or they themselves may be around by Christmas 2020 to enjoy anything. It's a frightening thought: You may be sitting in a log cabin sipping cognac as your kids ski on Alpine slopes and boom! - before you can say Gesundheit! - the person who sneezed next to you may have just planted a droplet of death on your family and you! No amount of money may save you. No TARP, no Twist, no Repo Purchase....your day of judgement may be upon you sooner than you think.

Secondly, what can a central bank do to get people - including you - from not dying? For that you need the vaccination, the doctors and the hospitals - and, in most parts of the world, governments have cut back on health spending and research as they were short of money. They needed the money to bail Wall Street out from their poor gambling bets! There are fewer policemen, less firemen, less ambulances per capita in most parts of the world than in 2007. And the hospitals and clinics have been built to fix your eyes, body, lips and reduce that fat around your belly and make you feel better. Private healthcare companies don't invest in research to solve a problem that does not exist. They need to know the problem and then they spend the money to come up with the miracle drug for your problem so capitalism gave you: lasik, liposuction and breast implants. Finding a cure for a virus that never interfered with how your designer clothes looked on you can take a little longer than the 14 to 21 days from infection to death. COVID-19 will be around a little longer than SARS even if the weather patterns weaken its progress.

Future Shock?

Besides the personal risks, the world economy is at risk.

In April 2003, Infosys stock tanked by over 30% in one week because Nandan Nilekani said he had no visibility for the earnings of the company for the near term given SARS (Table 4).

In the US in April 2003, I read an article in the local newspaper (yes, there were still local newspapers then!) about the possibility of the ports on the western coast being shut down because people were scared that SARS may land up in the US from infected crew members. Cargo ships carry much of the imported goods from China to the west coast of USA over a 14 day journey. The incubation period for SARS was 2 to 7 days so it was possible that a "healthy" crew member could have the full blown SARS infection by the time he reached the US and interacted with ground staff at the port as the goods were unloaded. Shutting the ports was one plan to limit that risk. But China was still a side-show then and the US was more concerned about oil and the Middle East and the invasion of Iraq by the US and its allies.

Table 4: How some share prices and indices behaved with SARS

Indices / Stocks Dec 27, 2002 April 11, 2003 % change Remarks
Dow Jones, USA 8,304 8,203 -1% Focus was Iraq invasion
BSE-30, (INR) 3,398 2,998 -12% IT driven
Infosys (INR) 74.48 40.90 -45% Visa issues, ban on travel
FedEx, USA 53.95 57.46 +7% Goods from China were fewer
Apple, USA 1.00 0.94 -6% No I-Phone invented, but computers
Gold, $ per t oz 349.25 328.05 -6% Listless
Source: Bloomberg

And that was at a time when China was a much smaller economy, relative to its impact on the world.

Today, it is a little bigger!

Table 5: How some share prices and indices behaved with COVID-19

Indices / Stocks Jan 31, 2020 Feb 28, 2020 % change Remarks
Dow Jones, USA 28,256 25,409 -10% Focus is China
BSE-30, (INR) 40,723 38,297 -6% Nervousness
Infosys (INR) 775.95 731.70 -6% Visa issues, ban on travel
FedEx, USA 144.64 141.17 -2% Overall shipments may stall
Apple, USA 309.51 273.36 -12% I-Phone parts at risk
Gold, $ per t oz 1,589.16 1,585.69 - Preserving value
Source: Bloomberg

A changing landscape?

The impact of the coronavirus on our daily habits will cause a shift in consumption patterns in the near term and changes in behavioural patterns in our personal lives. Common sense would suggest that people will eat out less often and eat more at home, or watch more movies at home and less in the movie theatre, or scale back on vacation plans and travel.

Companies will have their own risk-assessment and reactions: less travel, freeze on hiring as demand remains uncertain, maybe lower profits which result in lower salary increases, and review of long term investments in factories?

The suppliers of raw material will see demand reduce and the prices of raw materials like crude oil, copper, aluminium will decline if consumption stay low. Supply side shocks may see a spurt in some raw materials: for example most of the basic chemicals from which pharmaceutical products are manufactured are from China. If the factories in China close down, then prices of these chemicals will increase.

The prices of semi-finished goods and components for automobile parts, computers, and mobiles may also surge as the supply chain gets disrupted. A person in self-quarantine at home still needs all these products to "live"! But the end product prices may decline as people, strapped for cash if businesses slow down and cut staff or salary, reduce their urge to but more "new" things.

Prices of some finished products may also increase. China manufactures over 90% of the air conditioners, washing machines and toasters in the world! You are already seeing this impact in the prices of face masks!

The winner in this will be the environment - and possibly India.

Maps from NASA are already showing vastly improved air quality across China! Less economic activity means a lower level of power usage and that means less coal being burnt - and better air.

Environmentalists will be apply to note that the ill-conceived Coastal Road project in Mumbai, a city under threat of flooding from rainfall and rising sea levels, may not be as threatening to human existence if global warming pauses for a few decades! The new airport in Nerul may still survive and have a few years of useful life before water levels submerge it and render it unfit for use!

In the short run, India could emerge as a winner. The decline in oil prices saves us maybe 0.5% of GDP from the benefits of lower oil prices. But what if economic activity further dulls the other 95% of the otherwise dull economy? In the longer run, India could be a winner if multinational companies decide to diversify their sources of supply. That was done after SARS in 2004, supported by the myth of BRIC play money. For all their faults, we had a band of UPA's western educated ministers marching around the world show casing India to the world. Who do we have selling India? And, by the way, don't tell me that the Houston event of Howdy Modi did any good: how many of the 50,000 NRIs moved back to India after the victorious Trump-Modi show? Probably not enough people to fill up a rickshaw!

To be a reliable supplier to multinationals, India must guarantee:

  1. Policies that don't change depending on whether Indian cronies enter that business or not: those bidding for mobile licenses and airports or setting up online retail businesses can tell you more about this!
  2. Taxation levels that don't change: ask the FPIs how they feel about their tax rate changes and ask any Indian manufacturer how they feel about the approximately 200 notifications in circulation since GST was born in July 2017;
  3. The labour better show up: ask the Japanese automobile suppliers how they felt when there was a strike in the Maruti factory in 2012 and how they would react to floods in Chennai, Mumbai, Bangalore that could prevent people from reaching the factory or riots and strikes that prevent people from reaching work?

Even greed or capitalist decision has a measure of social risk implanted within its calculations.

Lastly, the geo-politics of the world could change. If the Chinese people don't see an end to the suffering, they may ask for a change in regime. Reportedly, the last words of Liu Zhiming, the doctor who tried to warn the government about the Wuhan virus but was asked to shut up and subsequently died, were that leaving all decisions to one man is not always a good thing. A possible reference to President Xi Jinping and his one-man rule over China.

In Iran the deaths due to the virus could spark regime change.

In the US, President Trump's report card glows with the performance of the stock markets. Despite a lack of earnings for the past year, share prices have surged. Any change in the Dow and a spreading of the virus in the US could stir things up. With Bernie Sanders providing free health care, a pandemic could entice people faced with rising medical bills to tilt over to the Sanders camp, were he to win the nomination for the Democratic party.

To add to the uncertainty, Turkey's President Erdogan wants Europe to back him in his war against Russia and Syria. After the recent air strike that killed Turkish soldiers in northern Syria, he has decided to open his borders and allow illegal immigrants and refugees to walk over to European borders. Greece is already feeling the heat and has increased the presence of armed guards who fire tear gas to dispel and discourage refugees.

There is only so much happiness that money can buy.

There is only so much feel-good that free money and zero interest rates can buy.

Allocate gently on this dip.

Well, for those who had kept money aside waiting for a market opportunity, allocate more.

If I had kept 100 aside for this allocation, I plan to invest about 33% of that into some of the three equity funds managed by Quantum Mutual Funds, where I already have my investments.

The coronavirus is only one of three things that trouble me: the local social unrest within India and the irresponsible behavior of central banks in the US and Europe remain two other worrying factors so I will keep some money aside till those risks and worries play out.

Table 6. A:

Date 1-Aug-18 12-Feb-19 16-May-19 28-Feb-20
Event ILFS Pulwama Poll est Now
Scheme NameĀ  NAV(Rs) NAV(Rs) NAV(Rs) NAV(Rs)
Quantum Equity Fund of Fund 35.11 32.82 33.88 35.30
Quantum Long Term Equity Value Fund 53.53 52.10 53.39 48.28
BSE 200 Index 4,869.00 4,555.94 4,694.52 4,718.62
S&P BSE SENSEX 37,521.62 36,153.62 37,393.48 38,297.29

Table 6. B:

Date 1-Aug-18 12-Feb-19 16-May-19 28-Feb-20
Event ILFS Pulwama Poll est Now
Scheme NameĀ  NAV(Rs) NAV(Rs) NAV(Rs) NAV(Rs)
Quantum Equity Fund of Fund 100.00 93.48 96.50 100.53
Quantum Long Term Equity Value Fund 100.00 97.33 99.74 90.19
BSE 200 Index 100.00 93.57 96.42 96.91
S&P BSE SENSEX 100.00 96.35 99.66 102.07

Table 6. C: Moving about 7% of my money from Quantum Liquid Fund to Quantum Equity Funds

Allocation, as of Jan 31, 2020 % allocation My target
Bank deposits (not in FDs) 2% 2%
Quantum Liquid Fund 25% 5%
Quantum Multi Asset Fund 5% 10%
Total, Safer and Liquid 32% 17%
Quantum Equity Funds, various 47% 62%
Quantum Gold Fund / ETF 21% 21%
Total 100% 100%