Last weekend we sent a special report to our premium users describing our views long term and how the latest Coronavirus (COVID-19) outbreak affects trading and investing in the market. We wanted to release our letter in the blog as we believe it will help our readers as well. Though the last week was crazy in terms of volatility, we believe it still has value to understand how to analyze a temporary external event. Attached is the letter:
After 5 months of printing new all-time-highs in the markets, last week we saw a very unusual drop (-15% in a week). With the Coronavirus fears are high and the media is in an all-panic frenzy, we want to take the time and write a special weekly report that will help give our context to the current ‘crisis’.
Before talking about the current situation, I want to propose a simple exercise, please open this illustration to help you follow with the story:
Let’s say we have 2 identical grocery stores next to our apartment complex. One is 250 meters to the right and the other is 500 meters to the left. Both are identical. We can safely assume that the grocery store that is closer will show higher sales and better results (let’s assume this is the only apartment complex in the area). This means that the grocery store on the right will show higher income and more profits (will be the better business).
Let’s assume that the municipality is renovating the road, and now you need to walk 1 mile to the grocery on the right, but, still, only 500 meters to the one on the left. Since the stores are identical, we can assume that the grocery store on the left will now show better results.
If the stores were trading in the stock market – we will see bad results for the right grocery in the earning reports.
However, after the renovation is over, the store on the right is again only 250 meters and it is closer again and thus will get the clients back and show good results again.
If the companies were trading, then next results the left grocery will show a decrease in results while the right grocery will again return to ‘regular’ profits.
(if you got confused please check the illustration).
We use this simplified story to help understand the intuition behind temporary events. Both businesses were affected by an unexpected event that is out of their control. But we need to ask ourselves two questions: (1) is the event temporary? and (2) Does it affect the long-term profit power of the business?
I think that in the simplified story above we can intuit that this is a temporary event and that it doesn’t affect the long-term profit power of the grocery store since it is still closer and identical to the competitor (meaning it only has advantages on the competition).
Now we will talk about the more complicated real-world example: The Coronavirus is a new disease of the ‘family’ of SARS and MERS. We don’t want to go too much into details here as we are not doctors and don’t want to accidentally misinform (you can track the progress here). However, based on past experience we believe this is a temporary event. Now we need to check about the 2nd question – does it hurt the long-term profit-making-power. The answers here are changing based on companies, but we believe that big brands (KO, PEP, JNJ, etc) and big tech companies for example (FB, NFLX, AMZN, etc) will not be hurt by this. We think that most companies will not hurt by this in the long run, but when everyone is panicking – we will look for the obvious names that will rebound (in our mind). We think you can do the same.
This week we will look for short puts and long calls (and the spreads) and we will use the ‘include symbols’ filter to enter lists of stocks we think that will not be affected in the long run, but lost value in the past week. We don’t think that the market correction is over in the short term (more bad news can still come to light) but we can start scaling into different positions.
If you are checking the sector map we can see all of them are oversold, which is a unique situation and expected since the market dropped 15% in a week. We can expect a bounce, but we are not sure the market has finished correcting (but it doesn’t matter – we will follow our plan).
If you have any questions, please feel free to contact us in email or in-app chat.
(Thanks Mati B. Alon for the idea)
We are working on more features and you can expect more improvements in the coming weeks, so stay tuned.