The Island Investing Blog

  • Thoughts on the Coronavirus

    From an email sent on March 4, 2020:

    Good evening, IIM investors.

    Below are some thoughts from Retz and I about the coronavirus. We hope they help answer your questions.

    First, though, for Tarpon Folio investors in particular: I’d like to make another plug for the IIM Investor Message Boards.  Energy markets have been especially volatile of late, and if you’d like to better understand how I’m thinking about Tarpon here, I’d recommend a peak at the Boards, which you’ll find here:

    Please let me know if you need a new login.

    Now, on to some general thoughts about this virus…

    On COVID-19

    For the past two weeks, markets have been obsessively focused on the spread of the coronavirus, officially referred to as COVID-19, and its impact on the global economy. Government efforts to contain the spread of the virus have already impacted economic activity in China and other parts of the world, creating significant economic uncertainty. This has resulted in a stock market pullback that some have referred to as the “coronavirus correction” and “virus volatility.” While much ink has already been spilled on the topic, investors naturally still have many questions about what lies ahead from a long-term perspective.

    There is perhaps no topic that can inspire more public fear and panic than a viral outbreak. Too many zombie apocalypse movies. It’s for exactly this reason, though, that investors should continue to maintain level-headed and see through short-term noise. And in order to objectively understand what these issues might mean in the long run, we think it’s helpful to untangle the topics of public health, the global economy and recent market reactions by addressing the following questions:

    How widespread is the coronavirus? How have markets reacted to past epidemics/pandemics? Will coronavirus cause a recession? Why did the Fed cut interest rates? How might the market respond in the coming months?

    Retz and I both feel very strongly that it’s important for investors to maintain perspective in times of uncertainty. After all, the goal of long-term investing is to achieve financial goals over the course of years and decades. What happens in the intervening days, weeks or even months is not only much less important – but overreacting to these events can actually be harmful. Simply put, investors who stay disciplined are much more likely to succeed.

    1. How widespread is the coronavirus?

    The coronavirus has spread quickly since the end of January and is now reportedly on every populated continent. Since most investors (including ourselves) are not public health experts, the spread of coronavirus is highly uncertain and difficult to analyze. So we’ve gotta rely on expert opinions and published data…while not jumping to conclusions.


    At the moment, the data show that confirmed cases continue to rise globally but are slowing in China. The mortality rate, as reported, has been in the 2-3% range, depicted as the shallow red line on the chart above, with most deaths occurring for those who are elderly or have pre-existing conditions. The corresponding recovery rate has been high and rising. The overall numbers are magnitudes smaller in absolute terms compared to the seasonal flu, although the mortality rate is significantly higher.

    So, although it’s still unclear when and if the virus will be contained, the bigger challenge from a markets standpoint is the potential for unnecessary fear and panic. Viral epidemics are by their nature scary subjects and, in our everyday lives, it’s difficult to not react. When it comes to our investment strategies, however, panic is the least useful emotion. By far.

    2. How have markets reacted to past epidemics/pandemics?

    Understanding the history of epidemics and pandemics helps to provide some limited guidance. Prior episodes over the past two decades, including SARS, avian bird flu, H1N1, MERS, Ebola and Zika, resulted in public attention but had few lasting market reactions. In fact, other factors played much larger roles in each episode.


    The chart above highlights these cases and uses Google Trends data to pinpoint the periods of peak public concern. In each case, markets dipped briefly – often for other reasons – before recovering over the coming months and quarters.

    These “other reasons” are important. The SARS outbreak occurred in the wake of the tech bubble which affected markets for years. Avian influenza occurred during the housing boom, MERS and Ebola during the Eurozone crisis, and Zika coincided with an oil price crash and period of concern over Fed rate hikes.

    Even today, with coronavirus front and center in the headlines, investors have been concerned about cycle-high valuations, slowing earnings growth and the presidential elections. So, while it may be convenient to pin a market pullback on one specific cause, in reality there are always many factors at play. Investors should continue to watch longer-term trends around the economy and company fundamentals.

    Of course, these past cases were of smaller magnitudes with mostly localized impacts. Still, history suggests that unless there is a serious disruption to the structure of the economy, growth can recover and markets can move on.

    3. Will coronavirus cause a recession?

    The effort to contain the spread of coronavirus in many countries has already had an impact on supply chains. The outbreak in China also coincided with the lunar new year, effectively prolonging the period during which industrial activity was shut down. U.S. companies have been reporting supply disruptions over the past two months as a result.


    This slowdown can be seen in the February economic data. The chart above shows indicators of manufacturing activity in China and the U.S., both of which have decelerated recently. In China, it should not be a surprise that activity contracted last month due to whole cities being quarantined and companies shutting down. What would be surprising is if this continued to be the case once factories are back up and running.


    Global GDP forecasts are also beginning to reflect this lost output. The chart above shows consensus GDP forecasts as well as the OECD’s forecast for global growth in 2020. The OECD has recently warned that growth could slow further, possibly to 2.4%.

    It’s undeniable that growth has decelerated due to lost economic activity. However, a one-time loss of output is very different from suggesting that there will be a prolonged recession. If coronavirus can be contained, or if recovery rates are high enough for people to return to work, then economic activity can get back on track – even if it takes some time. In textbook economic terms, this may be a classic “shock” to the system that causes a short-term decline in growth which is often followed by a rebound.

    For long-term investors, the U.S. economy is still fundamentally healthy. Despite the coronavirus, unemployment remains near historic lows, inflation is still tame, and corporate activity is vibrant. Despite short-term fear and concern, the data does not yet suggest that these trends will change.

    4. Why did the Fed cut interest rates?

    In response to the short-term economic data above, and in an effort to be cautious, the Federal Reserve announced an emergency interest rate cut of one-half percent yesterday. This was the first emergency move by the Fed since the 2008 global financial crisis and took place two weeks ahead of their scheduled mid-March meeting. At the moment, the federal funds rate sits at a range of 1 to 1.25% – a level last seen in 2017.


    It’s clear that rate cuts cannot solve the underlying problems related to the spread of coronavirus – a fact that the Fed understands – nor can it spur activity in all parts of the economy. The best the Fed can do is to bolster confidence and reduce frictions in financial markets. Like their other recent rate cuts, this amounts to an “insurance cut” in that it may help to prevent other problems down the line.


    One immediate result of the rate cut was that interest rates across the yield curve declined. The 10-year Treasury yield fell below 1% for the first time ever. The 30-year Treasury was in the 2’s today, as well.  So if you ever thought about refinancing that house…

    In any case – investors who need portfolio income will need to continue to find it from places other than bonds. But that’s not new to the coronavirus, either.

    5. How might the market respond in the coming months?

    The bigger issue around the emergency Fed decision is that a 50 basis point rate cut was already widely anticipated. Since 2008, many investors have come to rely on the Fed to bail out the stock market. This is often referred to as the “Fed put” since it is like a put option – which protects investors on the downside.


    For long-term investors, however, it’s still more important to focus on economic fundamentals, valuations and corporate earnings. Following the recent market pullback, the overall stock market valuation has fallen somewhat to levels last seen in 2018.

    While this is, of course, partially driven by a decline in market prices, it’s important to keep in mind that valuations also take into account future earnings expectations. In other words, estimates of the economic impacts discussed previously are included in these numbers. The fact that valuations have fallen – rather than rising or staying the same – suggests that stock prices have declined faster than earnings expectations. So this implies that are still many opportunities for long-term investors.


    Additionally, it’s normal and expected for the stock market to swing in either direction on a short-term basis. In fact, several 5-10% moves in the broa market are quite common each year. The chart above shows that investors have experienced two such moves in recent weeks and that, historically, the average year experiences several of these pullbacks before recovering.

    In fact, when the market does recover from corrections, it often does so swiftly and without warning. Those who try to jump in and out of the market to avoid short-term declines often miss the subsequent rebounds. At least two significant positive stock market moves over the past week illustrate this point.


    Ultimately, the best way for investors to handle the anxiety and uncertainty caused by things like the coronavirus is by holding an appropriate portfolio. While many global asset classes are in the red two months into the year, the fall in interest rates has also pushed up many bond prices. So, a balanced portfolio has fallen by far less than the overall market…exactly what it is designed to do.

    In the end, much of investing is emotional and behavioral. A steadier ride helps investors to stay on track and not overreact to short-term events. So if you feel like there is a significant difference between how much volatility you can tolerate and what you are seeing in your portfolio over the last two weeks, please let us know.

    What’s the bottom line?

    The spread of coronavirus is a public health challenge and may slow the economy in the short run. In the long run, however, investors should continue to stay focused on their goals.

    So, while we don’t want to be cavalier about this virus – our advice really is that simple.

    This, too, shall pass.

    Again – if you’re feeling particularly unnerved by all this coronavirus angst, please let Retz or I know. We can be available to talk it all through on the phone, or meet up in person, at your convenience.

    Thank you. 

     – Cale

    Posted by: Cale Smith , Commentary, For Investors
  • IIM International Portfolios: 2019 Letter to Investors

    What A Year It Was

    What a difference a year makes! Overshadowed by Brexit, trade wars and fears of a recession equities dropped precipitously the last quarter of 2018 and created a bit of trepidation entering last year.

    Indeed, these forces still played a part in investor sentiment during 2019, but as the year progressed, some stressors were alleviated. Although not overly robust, the economy kept churning forward.    In December UK Prime Minister Boris Johnson retained his position almost ensuring that an “orderly” Brexit will  go forward. Also in December,  both China and US took steps toward decelerating the trade war with the US offering to reduce some tariffs and China offering to better protect US intellectual property. In the fourth quarter, the MSCI All Country World Index jumped 8.95% leading to a net return in 2019 of 26.6% and the ACWI ex-US had a net return of 21.51%.   

    For 2019, Frigate our international ADR Folio focused on capital appreciation had a net return of 19.47% versus the gross return of its benchmark the S&P 500 ADR index of 16.68%.   Taiwan Semiconductor Manufacturing Company was a very strong contributor as it reported earnings ahead of expectations and raised capital expenditure plans due to strong demand. Additional drivers were French Schneider Electric, a provider of energy and automation digital solutions, and Swiss-based Adecco, which is one of the world’s largest staffing companies. The share price of IT Indian company Wipro fell slightly amidst a slowing services industry as did that of China Petroleum and Chemical Corp (also known as Sinopec)  amid the uncertainty associated with China’s new National Pipeline Company. Neither of these circumstances warranted a change in their positions. Since inception on July 1, 2013 Frigate has returned a cumulative 35.28% versus its benchmark of 30.01%.

    For 2019, Treasure Harbor our international ADR Folio focused on dividend income, was up 14.47% versus its blended benchmark  (15% SPDR  S&P Emerging Market Dividend  ETF and 85% SPDR S&P 500 International Dividend ETF) of  18.97%.  Luxury goods manufacturer LVMH was a very strong contributor to performance especially after announcing its acquisition of Tiffany. Investors also appreciated LVMH’s intent to optimize their portfolio  and use excess cash to buy back shares.  As mentioned in earlier letters,  Rio Tinto performed well along with higher iron ore prices although anticipating an eventual correction, the stock was trimmed.  There were no large negative performers but share prices of telecom companies Orange and Telefonica corrected last quarter, apparently during some sector rotation. Since inception on October 1, 2013, Treasure Harbor has returned 8.7% versus its blended benchmark of 14.47%.

    For 2019, Yellowtail, or international small/mid cap Folio, had a net return of 17.48% versus its benchmark VSS (Vanguard FTSE All-World ex-US small cap ETF) of 21.36%. French animal health company Virbac and electronic components company Minebea Mitsumi had great rebounds consistent with good business performance and improved outlook.  Swiss Life continued to generate good growth and also was a great contributor. On the other hand,  Ireland-based, nutrition provider group Glanbia turned in a very disappointing performance.  Channel shifts and tariffs  weighted on investor sentiment, and the company faced additional challenges in it Performance Nutrition division outside of the US and  increased debt burden from its purchase of Slimfast. French BIC continued to have a disappointing year as it was impacted by a deterioration of the lighters market in the US and softer stationery sales, although they remain confident in their “BIC 2022 Invent the Future” plan. German Wacker Chemie also underperformed as management cut guidance due to week polysilicon prices. Since inception of 12/1/2014, Yellowtail has returned a cumulative 34.29% versus its benchmark of 31.78%.

     It is nice going into 2020 that some trading issues are resolving but there are still plenty of uncertainties and challenges.  For instance, although the UK will formally leave the EU on January 31, 2020, they still will be negotiating during the transition period, which is supposed to end December 31st this year, issues regarding trade, law enforcement, data sharing and security.  In the meantime,  the EU and the US are trading tariffs on digital services, aircrafts and agricultural products. Very worrisome, especially for me,  are prospective tariffs on European wines which will likely have a negative impact on US retailers, distributors and restaurants.*  The uncertainties involving trade and geopolitical tensions are so worrisome that despite noting the cushioning impact of accommodative monetary policies and growth in the service sector, the World Economic Outlook in October of 2019 noted the outlook remains “precarious.” It will be interesting to review the next World Economic Outlook to be published on January 20th.

    Although my research takes into consideration the precarious economic outlook, I am more interested in how individual companies navigate external stressors while still managing to introduce new technologies and products and grow earnings. There are plenty of companies with these characteristics, but with the recent market rise, finding stocks trading at attractive valuations will be a little more challenging. Still, the MSCI US index  is trading at a forward P/E of 18.74x versus the MSCI ex-US index forward P/E of 14.44x so I’m sure if I grab my passport, hop on a plane and keep searching, I will find some good investments.

     What a year 2020 will be!

    Thank you for investing along with Cale and I at IIM. Please don’t hesitate to call or write with questions.

    – Lauretta “Retz” Ann Reeves, CFA AWMA

    *Teague, Lettie. “How Tariffs Could Devastate the Wine World,” The Wall Street Journal, Jan. 8, 2020.

    Disclaimer: This post nor any of the material linked to herein in any way constitutes investment advice. Historical performance data above represents performance results as reported by the portfolio identified. Performance results are for illustration purposes only. Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and timing of initial investment. Investing may cause capital loss. The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.

    Posted by: Retz Reeves , Commentary, For Investors
  • IIM International Portfolios: Thru Q3 2019

    What I Learned During Oktoberfest

                After hearing my travel woes – typhoons, earthquakes, electrical shocks  – Baader Investments invited me to their September conference in Munich where investment opportunities converged at the Sofitel in Munich, Germany during Oktoberfest. Too bad I don’t drink beer, but certainly I enjoyed the pageantry and gaiety that infused the crowds who filled the trains and roamed the streets. Even better, I met with some of our food, auto, industrial and pharmaceuticals companies,  found some  new candidates and heard updates on  economic and geopolitical outlooks. I remain grateful to Baader for this opportunity.

                Unfortunately the issues covered in the half year report carried over into the third quarter, including: Brexit,  trade tensions, emerging market volatility and anemic economic growth. Consumer stocks, in particular autos and their suppliers, and IT companies seemed particular challenged.  This phenomena was reflected in the negative performance of some of our Yellowtail stocks including, Groupe SEB, which manufactures household equipment, and Japanese AGC, which supplies auto glass and semiconductor related products.  In light of the challenging market for industrial trucks,  KION, the world’s second largest forklift manufacturer  also detracted from performance. On the other hand, reporting good second quarter number animal health provider Virbac, generic pharmaceutical provider Hikma and watch and calculator manufacturer Casio contributed positive performance.  For 2019 through the third quarter,  Yellowtail, our small/mid cap international Folio, was up  approximately 6.21% versus the estimated performance of  its benchmark VSS (Vanguard FTSE All World Ex-US Small Cap. ETF) of 7.6% .  Since inception date of December 1, 2014 through September of this year, Yellowtail’s cumulative performance is up  an estimated 25.4% versus VSS of an estimated positive 21.1%.

                For the third quarter of 2019, detractors for Frigate, our International ADR portfolio with a mandate for capital appreciation,  included Ericsson, which quantified a 12 billion SEK provision for non-compliance with FCPA (Foreign Corrupt Practices Act) enacted by a former management regime. Global software vendor SAP gave back some previous gains, although its price jumped after the CEO announced he was stepping down.  A slow down in the IT service sector, negatively impacted Indian provider Wipro. Following reporting of good quarterly results,  luxury goods provider Burberry, contract chip manufacturer Taiwan Semiconductor Manufacturing and financial exchange company Deutsche Boerse were strong performers. For the first nine months of 2019, Frigate’s net performance was 10.03% versus the gross performance of the S&P ADR Index of 9.37%.  Since inception on July 1, 2013 through September of this year, Frigate’s cumulative performance was 24.59% versus that of its benchmark of 21.86%.

                 As expected, when we trimmed positions the first half of the year, miners BHP and Rio Tinto gave back some of their gains in Treasure Harbor, our international ADR yield portfolio, during the third quarter of 2019.  Spanish Banco Santander, which recorded a 700 million euro restructuring charge, was also a detractor.  On the positive side,  Canadian telecommunication provider  BCE and Taiwanese semiconductor assembly and testing firm reported good results and Vodafone rebounded after finally completing the acquisition of Liberty Global assets in Germany, Hungary, Romania and the Czech Republic. For the first nine months of 2019, Treasure Harbor was up 9.64% versus its benchmark (15% SPDR S&P Emerging Market Dividend ETF; 85% SPDR S&P International Dividend ETF) of 13.07%.  Since inception on November 1, 2013, Treasure Harbor’s cumulative return has been 4.18% versus its benchmark of 8.79%.

                After quarter end,  the EU approved the UK’s request for a Brexit extension, China and the US continued trade discussions and central banks remained accommodative. Many equity markets redbounded, although whether the gains made this year are sustained will likely depend on progress on all of these fronts.  I expect we will continue to see fluctuations in the indices.

                Despite the near-term uncertainties, my attendance at the Baader conference reinforced my confidence in long-run investing.  The last day included presentations by smaller companies pioneering in such fields as windfarms, molecular diagnostics and cloud telecommunications. These may not make their way into our international Folios yet, but some day they and other cutting edge companies just may.

                In the meantime, please contact myself or Cale if you have any questions on our Proprietary Portfolios or our Financial Planning Capabilities. Thank you for investing alongside us at Islamorada Investment Management.

    – Lauretta “Retz” Ann Reeves, CFA AWMA

    Disclaimer: This post nor any of the material linked to herein in any way constitutes investment advice. Historical performance data above represents performance results as reported by the portfolio identified. Performance results are for illustration purposes only. Historical results are not indicative of future performance. Positive returns are not guaranteed. Individual results will vary depending on market conditions and timing of initial investment. Investing may cause capital loss. The publication of this performance data is in no way a solicitation or offer to sell securities or investment advisory services.

    Posted by: Retz Reeves , Commentary