Sick Economics

Searching For Healthy Profits In The Stock Market



The Summer of 2020 has been one for the record books. As the whole world struggled with the Coronavirus and the tsunami of financial consequences that came with it, American stock markets rocketed to dizzying heights. The biotech sector has been particularly hot (After hitting a low of $68 in March, $XBI, a basket of biotech stocks, soared as high as $120 just sixty days later).

While everyone likes flying high, many commentators have feared a correction that almost seems inevitable. On September 3rd and 4th, many felt the first cold gusts of fall air as the Nasdaq market dipped as much as 7%.

What are some upcoming threats you could face as the leaves change and the temperature drops?  How should you prepare for these potential threats?  Read below to learn about four potential adverse scenarios, and how you can prepare for each of those scenarios. 


Scenario #1: Reality Bites

Under this scenario, no one shock causes the Market to crash. Picture a giant, swollen balloon, inflated at three times it’s safe capacity. Just the slightest pinprick causes the balloon to deflate, and fast. Was it the pinprick that caused the disaster? No, it was the underlying, unsustainable situation. 

The flash crash that occurred in March and the equally swift resurrection of our Bull Market has been a widely debated mystery. How can the stock market soar 50, 60, or 70% in just months while unemployment is at its highest level since the 1930’s?  How can stocks party like it’s 1999 when millions of mortgages are in “forbearance” and many renters are clinging to the roof over their head by the narrowest of margins? 

There are a host of different suggested reasons for this bizarre phenomenon. The Fed has printed trillions of dollars, which has created a positive shock that may well have offset the negative shock of the Covid lockdown. The stock market looks forward, not backwards, and the financial pros see a bright future once we extract ourselves from our current imbroglio. Our steady progress on a vaccine demonstrates the ultimate prowess of 21st century technology, and that bodes very well for innovation stocks in the long term. Pick your theory. Your guess is as good as anyone else’s. 

The big risk is that eventually the euphoria wears off and we wake up from a summer of partying with the mother of all hangovers. Nothing to bring sobering reality crashing home like a throbbing headache that won’t go away. In this case, America looks headed for years of headaches related to the Coronavirus. 

Right now, millions upon millions or renters haven’t paid their landlords for months. As of September 2nd, the Federal Government, through the Center for Disease Control, unilaterally decided that a nation wide moratorium on evictions should take effect until at least December, 2020. While this is a very controversial decree, and probably subject to court challenges, this edict has only temporarily stopped the bleeding. In fact, investors may soon wake up to the cold hard reality: this has to end badly for someone. Either millions of renters who eventually will be evicted when the moratorium is up, or millions of landlords, big and small, who are about to be stiffed out of billions worth of rental payments. Neither scenario could be good for stocks. 

In general, millions upon millions of Americans are now unable to pay their debts, whether it be “good” debt such as a routine mortgage, or pre-existing credit card debts. Much like the CDC’s rental moratorium, a lot of this bad debt has been magically wished away by corporations placing struggling borrowers into “forbearance” programs. By some magical thinking that borders on outright fraud, the loan holders get to tell investors that the loans are NOT in default due to the forbearance fantasy program they have invented. The reality is that, for most of these forbearance programs, billions upon billions of dollars will end up in default eventually.  This can’t be good for stocks. 

In general, “Extend and Pretend” has been the chosen modus operandi for a Corporate America that is facing mass defaults. In addition, the Fed has printed trillions of dollars and claims that inflation is still below 2%, despite many consumers noticing that food prices have risen dramatically over the last six months. So, it’s great that money printing has not caused inflation, as long as you don’t need to feed your family. 

There are a wide variety of convenient fantasies that have been propagated to keep this Bull Market going. Lost weekends filled with cocaine and whisky feel great, right up until they don’t. The magic could wear off at any moment. 


How To Prepare

If you suspect that eventually someone will demand that all these overdue bills get paid, then make sure that your portfolio is filled with products that people need. Despite all of the criticism and stress about the failings of our current healthcare system, most patients still tend to get basic needs fulfilled. So make sure you own the companies that provide these basic needs. 

One example would be insulin. Sky high insulin prices have been very controversial, due to some  suspicious anti-competitive practices on the part of the Big Three companies who dominate the market (Novo Nordisk, Eli Lilly, and Sanofi-Aventis…$NVO, $LLY, $SNY).  However, when push comes to shove, most diabetic patients are getting their insulin and other blood sugar medicines. Thus, these companies’ earnings will hold up in a crisis. 

Another move you want to make is to ensure that any smaller, riskier biotech stocks that you hold are already well funded. Many “innovation stage” biotech companies burn cash for years before they see a profit (if they ever do).  So what determines their staying power in a crisis is the ratio of cash on hand to current burn rate. Over the last six months, the biotech shares have been in such a frenzy that everybody and their mother has been able to raise millions by floating shares with barely a thought. However, this kind of “anything goes” environment can come to a sudden, violent, end if Nasdaq crashes. Make sure the smaller biotech companies in your portfolio already have plenty of “gas in the tank” in case access to new capital suddenly tightens up. 

One example of a small biotech in the “innovation stage” (i.e, little revenue) is Morphic Holdings, Inc ($MORF).  This company is focusing on developing a whole new field of medicine related to proteins called integrins. Morphic burned about $30 million in cash for the first half of 2020. At the end of that period, they still had roughly $190 million in cash left. MORF could easily survive a few years without external funding if someone were to take the Nasdaq punchbowl away. 

The gist of the “reality bites” scenario is that Wall Street and Main Street cannot exist in two separate realities forever. If Wall Street finally starts to feel Main Street’s pain, you’ll want to have your portfolio stocked with hearty companies that can take a licking, and keep on ticking. 

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Scenario #2:  Vaccine Flop

One prevailing theory for the Market’s stellar performance over the last few months is that our Biotech/Industrial complex will soon deliver a functional vaccine against Coronavirus. This would be akin to waving a magic wand; with a simple flick of the wrist, many of our Corona problems would  vanish overnight. 

This optimism is not purely magical thinking. In fact, there are several pieces of evidence that support optimism on this front. Dozens of vaccine makers around the world, both large and small, have produced promising candidates against the scourge. Many of these companies employ totally different scientific methods to attack the same problem; this diversity of science gives us multiple “shots on goal,” something is bound to score. Lastly, and most importantly, early phase I and phase II tests have proven safety, and some level of efficacy. Several different companies have reported that, in phase II testing, their vaccine candidates have produced high levels of anti-Covid antibodies in test subjects. In theory, all of these factors should mean that a powerful Coronavirus vaccine is just around the corner. 

But anyone who has been involved in science, or biotech investing, for long enough will tell you that history is replete with cures that should have worked, but didn’t. Just because a vaccine candidate produces immune antibodies, it doesn’t necessarily mean that the vaccine provides a shield against the virus. It may only work partially, or not at all. We don’t know for sure until phase III testing has been completed on very large groups of people. Mounting effective, large scale, phase III trials is onerous and risky. Something can still go wrong. 

Another possibility is that the results of the ongoing phase III trials are not as binary as the casual observer would imagine. Even Dr Anthony Fauci has pointed out that some vaccine candidates may provide 50% protection, for six months, rather than the kind of lifetime protection we have come to expect from our standard vaccines. 

Yet another possibility is that, even with positive phase III data in hand, some kind of logistical or media blunder means that the vaccine gets to people slowly, or is rejected outright by large swaths of the population. Manufacturing and distributing several billion doses of anything is a Herculean feat for the History Books; a lot can go wrong. Additionally, the slightest miscue can spark wild conspiracy theories that shocking numbers of people believe. A vaccine has no beneficial effect on people who refuse to take it. 

Lastly, there is no guarantee at all that the manufacture and sale of a vaccine will even be a money maker for whoever gets to the “finish line” first. The American Public, already highly suspicious of vaccines and Big Pharma in general, will be very sensitive to pricing issues and “equality” around any Coronavirus vaccine. This distrust could open up a Pandora’s Box of world class headaches for a Coronavirus provider. Imagine losing money on each one of billions of vials. This nightmare scenario could be the reward waiting for unwise first movers in the Coronavirus race. 


How To Prepare

Simply put, do not “bet the farm” on companies reaching for the Holy Grail. Many of the leading competitors for the Coronavirus vaccine are actually very established, accomplished Big Pharma outfits with decades of steady profits ahead of them, whether this particular venture works out or not. Names that jump to mind are Johnson&Johnson ($JNJ), Pfizer, ($PFE) and GlaxoSmithKline ($GSK). These companies will be fine no matter what the outcome with Covid-19. 

If you want to take a risk on smaller, more nimble competitors, by all means, do it. CureVac ($CVAC), Novavax ($NVAX) and Moderna ($MRNA) are all companies you could gamble on. But be aware of the pitfalls listed above. Innovation in the time of Covid is not for the faint of heart.


Scenario #3: The Corona Comeback

As I write this, a number of the geographies that were hit hardest early in the epidemic look like success stories. In early April, New York City alone was getting hit with as many as 6,000 new Covid cases per day; today, in early September, that number is just 253 cases. Major European cities are showing a similar pattern of a formerly raging epidemic that has been mostly brought under control. 

The conventional wisdom is that cities like New York and Berlin saw a dramatic reduction in sickness and death because they developed strict protocols around masks and distancing that have made all the difference. But no one really knows. It’s also possible that cases simply dropped as Spring turned to Summer. 

It’s a lot easier to open up your windows, meet your friends for an outdoor picnic, and keep a safe distance from others when the weather outside is a balmy 75 degrees, as opposed to 7.5 degrees. Winter in Northern cities such as Chicago and New York is long, and bitter cold. Outside dining? Forget it. In fact, even opening the window is out of the question for months on end. We can’t rule out the idea the the Coronavirus is merely waiting, dormant, to torture us yet again as the temperature drops. 

Another factor is a return to school. Of course this has been a massive polemic throughout the United States and beyond, but now many students are returning to the classroom in one form or another. The economic pressure to “normalize” the lives of working parents is excruciating. How will this big experiment go? Only time will tell. 

One theory for our ebullient stock market has been that Summer has been good to major cities in cold weather climates. We know that the top 10% of earners now own 80% of publicly traded shares; those top 10% of earners are disproportionately centered in cold cities like New York, Seattle and Boston. What happens to shares prices if the virus makes a comeback during the six long months of freezing weather coming our way? 


How To Prepare

Be very cautious about businesses that offer services that are optional. We found the hard way in March and April that a lot of highly recommended medical services are still, when push comes to shove, optional. Medical Device companies, and the hospitals that make huge money implanting the medical devices, saw revenues plummet by as much as 50%. The exact same thing could happen all over again if Covid numbers suddenly start going the wrong way. Many of these “optional” medical providers survived the first time by loading up on debt to tide them through three bad months. How many have a strong enough balance sheets to endure greatly reduced revenue all over again? Avoid names such as Intuitive ($ISRG), Medtronic ($MDT) and Tenet Health ($THC).


Scenario #4: Political Unrest around the Election

This is perhaps the most dangerous scenario, and the “Black Swan Event” that could cause the Market to crash hard, and crash fast. 

Whether you are Republican, Democrat, or Independent, many Americans feel that we have never been so polarized as a nation. The stress and strain has become so acute, that both sides doubt the basic fundamentals of Democracy. 

Many feel that law and order is falling apart before our very eyes. This fear manifests itself both in allegations of underhanded political and financial behavior, and in visible disturbances such as riots and violence in the streets. 

The number one thing that the Market loathes is uncertainty and disorder. We have a lot of both going into the November election. Democrats insist that America is at real risk of a 3rd world style Coup D’Etat, while Republicans swear that the White House will be overrun by Cuban Communist Revolutionaries days after the Democrats move in. Footage of burning buildings and heavily armed citizens seem to flood our social media daily. This tension around the building blocks of our Society is very bad for stocks. 

Remember, 90% of investors buy or sell stocks based on feelings; objective reality has little control over the panicked mind. Therefore, we don’t really need widespread violence to cause a panic in the stock market. All we need is the perception of violence and chaos, and many investors will sell everything. 

Most investors are willing to risk their hard earned capital when they feel that the game has certain rules. Certain basic, fundamental rules that are agreed on by all of Society’s stakeholders. When the basic rules become fuzzy, and order seems like it could break down, financial markets become exposed to a fear driven crash. 


How To Prepare

If you fear a “chaos” scenario around the time of our November Presidential Elections, stick with the fundamentals. Companies like Pfizer and Johnson&Johnson have been pumping out reliable profits and dividends for more than a century. This means they have survived TWO world wars, the Red Scare, the Hippies, The Tech Boom&Bust, and the Housing Crash. It’s very, very likely that Big Pharma will also weather whatever storm hits us in November. 

Nobody has a crystal ball. It’s entirely possible that none of the four above scenarios will ever come to pass. Perhaps by this Winter we will have a proven, accepted vaccine. Perhaps New York City’s stringent mask and isolation protocols will beat the Corona beast back for good. Maybe the upcoming November election will be executed with all of the transparency and efficiency that a Great Democracy deserves. 

But if not, you’ll be ready.

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