The Depth Report - Net Short
Two weeks ago, we revisited our Royal Caribbean thesis in relation to our initial corona virus projections. In that piece, we acknowledged that the virus outbreak has been worse than we had expected and that we were too quick to dismiss the “breathless conspiracy theory” that the virus had been engineered in a Wuhan bio-lab. Since then, the virus has spread rapidly in non-Asian countries in Europe and the Middle East. In addition, the mainstream media in the West has finally started to acknowledge that the virus was made in China. Even the Chinese media has thrown in the towel on the official narrative that the virus started in an animal market.
Three weeks ago, we wrote, “While we continue to believe that the virus will burn itself out, because we didn’t believe that all the bad news was reflected in the market, we concluded with this advice: ‘We are looking for the right entry points for specific airlines, selected cruise lines, and one gaming company. We welcome subscribers to contact us for more specific information.’ We continue to believe that this is the correct approach.” In accordance with that advice we are currently carrying a large cash position and are effectively net short through option spreads.
A Theory on How the Virus Got Out:
Over the past month, we’ve had numerous conversations with colleagues and Advisors who have questioned the possibility that the virus was man-made. Their assertion was that if it was man-made, then it couldn’t have escaped from the lab. To them, the official narrative that the virus emerged from the animal “wet market” made more sense because it’s easy to understand how a bat virus or snake virus emerged from a non-secure environment.
We’ve asserted all along that a bio-engineered virus could easily escape from a “secure” lab based on Hanlon’s Razor which states “Never attribute to malice that which is adequately explained by stupidity”. Over the weekend, we’ve seen reports that the corona virus can be spread through both fecal matter and urine. The reason that matters is because the number of people who don’t wash their hands after using the bathroom is startling and is a likely contributor to the fast spread of the disease.
Even more revolting are the multiple reports we saw over the weekend that some Chinese researchers sell lab animals for food to make some extra cash. Proper lab protocols dictate cremation for animals that have been infected with viruses. Despite that, researchers are sneaking diseased animals out of the lab, and people are eating them. Add laziness and short-term greed to Hanlon’s Razor, and that explains how a virus escapes a “secure” facility.
For those who think we’re picking on the Chinese, here’s a story showing the same effect here in the United States. The Trump administration made the decision to repatriate from Japan citizens who had been on the Diamond Princess and who were healthy. People who were infected or had symptoms were supposed to remain in Japan. After that decision was made, a State Department official secretly chose to over-rule the President, and put 14 people who had tested positive for the corona virus on the plane back to the US with hundreds of healthy people. It’s easy to see how this could go badly.
Why This Has to Get Worse Now:
Initially, we thought the corona virus would be similar to SARS, MERS, Avian flu, and Ebola. All of those diseases were geographically concentrated (with few exceptions). The reason Ebola tends not to travel from country to country is because people display symptoms shortly after infection and tend not to live very long once they have the disease. There is a relatively short window when people can infect others. The reason the corona virus is behaving differently is due to the long incubation period. New evidence suggests that someone can be a carrier with no symptoms for as long as 6 weeks. With many viruses, people not displaying symptoms are unlikely to be contagious. That’s not the case with the corona virus. It’s possible for someone to infect others for a month and a half without displaying any symptoms, or even without knowing they’re infected. That’s how a disease that started in Wuhan, China becomes a global pandemic.
Closing Borders, Closing Factories, and Broken Supply Lines:
We initially compared deaths from the corona virus to pneumonia and flu fatalities. Pneumonia infects almost half a billion people a year and is responsible for about 3 million deaths a year. There are over a billion flu cases annually with over half a million deaths. The official death toll from the corona virus is currently below 3,000. (We note that we do not believe the official numbers coming out of China.) The key issue is that people are reacting differently due to fears of a virus that’s not well-understood yet.
As a result, factories have been closed in China and Korea. Neighboring countries have closed borders with China and Iran, and Austria just closed their border yesterday. Entire towns in Italy, Korea, and China have been quarantined with little to no work being done. Factories are closed. China is facing a difficult dilemma as continued closures will bankrupt most small businesses, but reopening too soon will result in even more widespread viral contagion. In large parts of the world, travel, borders, shipping, and manufacturing have been completely shuttered.
The economic impact of this is starting to be noticed as companies offer guidance that supply chains are being disrupted. A couple of weeks ago, we offered the opinion that all the bad news was not being reflected in the stock market. We continue to believe that is the case, even after the declines of the past couple of days. We think that as more companies start to issue earnings warnings and lower guidance, the market will become more focused on the issue.
An additional catalyst will be when the virus starts to spread in the United States. As of now, thousands of people are self-quarantined. We applaud them for being so careful. Unfortunately, with a 6-week period when someone can spread the disease without knowing, even reasonable care won’t be enough. It’s also likely that US cases are being under-reported. The website of the Center for Disease Control reports that they have only tested 426 people in the US. If cities in the US start to be quarantined and shut down like we’ve seen in China, Korea, Iran, and Italy, the markets are going to decline. As a result, we’ve established a large cash position and are net short through options.
An Important Note Beyond Finance:
One issue that’s come up a lot in conversation is the possibility that our concerns may need to extend past our portfolios. It’s looking like we’re getting there now. Last week, armed robbers stopped a delivery truck in Hong Kong, and robbed it…of toilet paper. Store shelves in Italy were cleared out over the weekend. Now would be a good time to ensure you have sufficient stores of food, water, medical supplies, cleaning products, and yes - toilet paper. The price of N95 masks has increased, but as of now, they are still available as are protective goggles. Should we have an outbreak here in the US, those items won’t be available at any price. We further suggest getting all necessary prescriptions filled as most of them are probably made in China.