The “Grey Swan” of COVID-19

One of the few upsides of getting older is experience. When something happens, it’s no longer necessarily something “new and novel”, and from that well of past experience, one can better formulate actions as life presents new challenges.

When COVID-19 arrived, some might have argued that it was a “Black Swan”, and while I agree that it has been impactful, I would suggest it fits more into “Grey Swan” territory. Human history is peppered with stories of germs and viruses that have decimated populations, and while there hasn’t been an event of “Black Plague” proportions in modern history, we needn’t look too far back to find numerous smaller pandemics, such as SARS (2002-2004), Avian flu (H5N1 2008), and MERS (2012), all of which have happened in the very recent past. With these having occurred so recently, it suggests that COVID-19 was a swan much more grey than black.

Most of us (myself included) could never have predicted how exactly an event like COVID would play out, or exactly what impacts it might have. However, from an investing perspective, if there is one thing I have learned it’s that events such as this will continue to happen – with almost painful regularity. Investors who are successful over the long term learn from these events, and come back more prepared the next time. The pain of each of these events are valuable lessons, and the learnings which they impart are ignored only by the foolhardy.

I started managing my own capital in the late 90’s, and in doing so, I have seen my fair share of bumps along the way. Wikipedia lists no less than a dozen or more crashes and mini-crashes since 1997, but the most significant of these that I distinctly recall were the Tech bust (2000), the impact from the world trade center attacks (2001), and the Financial crisis (2008), to name just three. Since all of these are so different, some might ask how learning from one helps predict (and avoid) the next event, but that isn’t the intent. Forget about “predicting and avoiding”, because it’s usually a fruitless task. Sure, I can predict that there will be a major health scare (or financial crisis) in the future, but when, and where? Predicting when crashes will occur is a mugs game. The learning is utilized not in avoiding, but in having a plan, preparing, and reacting – appropriately – when such an event does occur.

Each of these market downturns (and all the others that I didn’t mention) were different with respect to the root cause, but each were the same when one views the outcome: initially there is shock, followed by denial, despair, acceptance, and finally, recovery. When that shock initially hits, it signals to the prepared investor that they need to implement their plan, as opportunities will undoubtably present themselves.

I once heard a money manager compare the investing process to fire fighting. For firefighters, there are long stretches of boredom, when there are no fires or emergencies to attend to, and finally, a fire breaks out somewhere. Firefighters often experience long stretches of “nothing”. Those with experience know that this time is precious – it allows the firefighter to train for the actual event and check and re-check the life saving equipment they will need when things do get ugly. When that call finally comes the last thing you want to think about is whether or not the fire engine tires are pumped up, or whether those holes in the hoses have been repaired. What you want to be able to do is put on your gear, turn the ignition key, and go – without any thought other than getting the job done. Preparation is the groundwork on which useful actions takes off from.

For the investor, this means doing “something” when nothing is really happening. Too many novice investors are action junkies, and feel compelled to hit the buy or sell button in order to feel like they are really investing. The brokerage loves this, but this isn’t what I mean when I say that one should be “doing something”. This may mean different things to different investors, but at the very least, there are some common themes. On a proactive basis, here are just a few examples of what an investor should be doing – before the market starts to nosedive.

• Determine how an extended downturn might impact you. Is some of the money that is currently invested earmarked for something important in the near term?
• If you derive income from your portfolio, how much will dividend cuts impact you? During this last downturn, more than a few companies reduced or eliminated their dividend.
• If you are employing margin, ensure you understand to what degree a margin call might impact you. During the 2008 credit crisis, I personally knew of more than a few investors who did not understand how the margin on their account was calculated.
• Identify those sectors (or companies) where you truly have insight. If you work in a particular sector (tech, real estate, energy, etc.) then your experience gives you an edge.
• Maintain a shopping list of companies you would like to own, especially within those sectors where you have experience or insight.
• For those companies you wish to acquire, develop a 5 or 10 year history of where the shares have traded in relation to various valuation metrics. Data such as this is invaluable in identifying when companies are under or overvalued.
• Develop an understanding of what factors will help (or hinder) a particular company’s prospects. Read whatever you can get your hands on to expand your investing knowledge.
• Lastly, because this blog tends to deal with small and obscure companies, research the different ways to ferret out good small cap opportunities – aside from paid newsletters.

During the first few downturns that I experienced (in the early 2000’s), my portfolio was small, and I didn’t have significant amounts of capital. Not only was I unprepared, but many of the companies that I owned were small and illiquid anyways, so the impact on me wasn’t the same as what I saw in major indexes (and large companies). However, I knew that I was missing something. I knew that opportunities were appearing, but I didn’t know how to assess them, or to determine if they truly were opportunities.

This changed during the financial crisis of 2008. During the credit crisis, I was both lucky and unlucky – lucky because I dealt with a sector that was heavily impacted (banking) and unlucky because I couldn’t allocate as much capital as I might have liked. In 2008, much of the work that I did peripherally involved the world of banking, and I had come to understand how Canadian banks differed from their American counterparts. From both my work and my travels in the U.S., it had become abundantly clear how many more banks were competing for business in the U.S. when compared to Canada, even after adjusting for population size. Nowhere in Canada could I go to a “First Farmers bank of Easter Manitoba”, whereas in the U.S., First Farmers bank is a real thing. What was clear to me was that while Canadian consumers complained bitterly how the “Big Six” gouged them on fees, the fact that they dominated the industry in Canada, and the fact they were an oligopoly made them more stable than their American counterparts (a comparison of the two can be found at Visual Capitalist). When the financial crisis hit, I was lucky in that I already had an understanding of the banking sector. At that time, everything in the banking space was painted with the same brush, and when I saw the dividend yields on Canadian banks hit unprecedented levels, I knew that the opportunity wouldn’t last. I took what little money I had and invested in a basket of the “Big Six”. At the time of writing this, these same investments spit out dividends whose average today is 15% and growing – such are the fruits of preparedness.

When COVID hit, I didn’t quite have the same advantage, but since that time (in 2008) I have always maintained a “shopping list”, I have 10 year histories of many companies on hand, and I update my personal financial snapshot on a monthly basis. As the markets weakened in Q1 and Q2 of 2020, it was clear to me that many companies were “on sale”. Readers who have visited here before are already familiar with the kinds of small (overlooked) companies that I tend to write about and hold in my “high risk” bucket, but I also kept an eye on larger companies, and many of these were fire-sale priced during the depths of COVID. While it was difficult to do, during some of the dark days of the market downturn, I tried to ignore that unsettled feeling in my gut and purchased various companies such as Deveron, Pioneering Technologies, Scotiabank, Suncor, and Vitreous Glass, to name a few.

Ultimately, we can’t reverse COVID and turn back the clock, and by no means am I trying to downplay the human cost of the pandemic. It is my sincere hope that something like this never happens again, and it’s also my hope that the various nations can learn from the missteps of this pandemic, and be better prepared next time. In the meantime, on a much smaller scale, if investors learn from the pain of this event, it also means that they will be better prepared for the next financial downturn, and will be better able to react appropriately once the next Grey (or Black) swan arrives. If there is one prediction I am confident making, it is that another such event will occur in my lifetime – and probably a lot sooner than I might like.

As always, If you have questions or comments, I can always be reached at mark@grey-swan.com.