Rob Arnott is Chairman and Founder of Research Affiliates and is widely regarded as a pioneer in unconventional portfolio strategies, including recognising the potential of ‘fundamental investing’, now commonly called ‘smart beta’. He has published over 130 articles in distinguished academic journals and works to build bridges between academic theorists and financial markets.
GH: There’s only one subject we can start with. How long do you think it will take for the US to get on top of the coronavirus pandemic?
RA: Look at what’s happened in Taiwan, South Korea and Japan. These are modern, developed world democracies, not dictatorships, and they are dealing with coronavirus directly instead of crushing their economies. They are massively testing people, and if you want to be tested, you are tested. And if you test positive, they find out who you've seen in the last seven days and they test them as well. And whoever tests positive is put on strict and monitored home quarantine. The US and European answers are to close the economy and then throw money at it.
GH: People in Asian countries seem to accept the need to comply more readily.
RA: Yes, and the rules are mandatory and people can go to the hospital if they need to. But if it's just flu-like symptoms, don’t waste more hospital resources in a time of crisis. If you step out of the house, you wear a mask and somebody will be there checking peoples’ temperatures. And if you've got an elevated temperature, back to square one where you will be tested and you may be quarantined as we flatten the curve.
It's pragmatic and it doesn't intrude on the workings of the macro economy. Japan, as an example, yesterday had 36 cumulative deaths, but they’ve also had 3,000 less deaths from seasonal flu than they had last year. It’s a silver lining, although 36 people died, 3,000 were saved.
GH: And 50,000 people a year die from the influenza in the United States.
RA: Exactly. And if this new virus kills 50,000 people, it would not be a surprise. So we're crippling the US economy for maybe a doubling of seasonal flu deaths. That strikes me as borderline insane. That’s not a political statement about the current administration as both parties share the same policies. They want to crush the economy and then write cheques. It’s astoundingly-badly run.
GH: Would Americans tolerate the personal intrusions?
RA: We have to look at the countries that are getting it under control and ask, what are they doing that we can borrow in a freedom-loving democracy? And the short answer is you can do pretty much all of the things they're doing. Not the command and control they do in China, but the things that worked well in those three countries.
GH: But take the example of Singapore. Anyone who comes in from overseas must go into quarantine and register their mobile phone number, and the location of the phone is checked and they receive a text message a few times a day which they must respond to. And to confirm they are in isolation at home, officials visit the house and check the phone hasn’t simply been left there. In the land of free enterprise and individual rights, in both the US and Australia, would our societies tolerate such things?
RA: They might object to Big Brother knocking on their door multiple times a day, but they need to realise that aggressive actions are needed for a few weeks, and mandatory quarantine is the trade off to stop the spread. I hold to libertarian values and I'm a huge believer in human freedom, but that does not include the right to inflict lethal pathogens on your fellow citizens.
GH: Australia’s approach is closer to Europe and the US than Singapore or South Korea, and our market is off another 7% today, taking it over 30% down because we are closing down the entire economy. There’s no way back now. How do we avoid losing thousands of companies and millions of jobs and heading into a depression in both our countries?
RA: Yes, it’s a government policy-inflicted depression that should have been a short, sharp recession. That said, if the government doesn't compound these missteps, it could still be a short, sharp depression. Goldman Sachs now estimates there will be two and a quarter million new jobless claims within a week, which would be an all-time record. I think they're sandbagging, I think it'll be more than that. In the next three weeks, we could see 10 million new unemployed.
In the US, 10 million people work in aviation, 14 million people in restaurants, and half of those jobs are gone. The numbers will boggle the mind. And both sides are trying to politicise it and blame the other party. Winston Churchill is credited with saying, “Men and nations behave wisely when they have exhausted all other resources.” There's a lot of truth in those comments, but we'll find our way back eventually. Roll the clock forward five years and this will be a bad memory.
If that's correct, then sometime in the coming weeks or months, there will be a stupendous buying opportunity. I don't think we're there yet. The time to buy is when we’re at peak fear. Right now, we're at 20% growth in infections per day. That's 10-fold growth every 12 days. If those numbers continue on that exponential growth curve, we go from 200,000 cases outside China to 2 million to 20 million in less than a month.
GH: Yes, we have trouble grasping the numbers. It’s terrible that 10,000 people have died but the real issue is the growth path and the ability of the health system and resources to cope.
RA: Yes, when do we get it under control so that the growth starts to slow. People need to take personal responsibility, stay home, avoid crowds, wash hands, and we can sharply reduce the spread. If we're idiots, slowing growth might take more than a couple months.
GH: Do you really think there’s a good chance of sensible behavior by enough of the 300 million Americans?
RA: Yes, but not quickly enough. We should post the National Guard at the entrances to stores and apartment buildings and offices and screen people using remote temperature gauges as they walk in. Anyone with a fever goes for a test. It's mandatory and if you don't, there's a big fine.
There's another angle. I'm in my mid-60s, which means I'm in roughly the 1% mortality range, I have a modest chance of dying from it. Okay, but I have one in 100 chance of dying this year anyway. People under 50 have about a 0.1% chance of dying from something else, people in their 80s have a 15% chance of mortality from coronavirus but they have about a 15% annual chance of dying anyway.
The way I look at it is, you have this health emergency, that seems likely to be temporary. It doubles your risk of dying in 2020 if you catch the virus. But we're destroying the economies of Europe, North America and Australia with the lunacy of these policies. The focus should be on taking people who are at risk and saying, “You do not have a human liberty to infect others.”
GH: Research Affiliates is well known its long-term market forecasts. How will they change?
RA: When markets are down 30% plus, the forward-looking return is improved by 2% or 3% if all else equal. But all else equal is not equal, especially for industries such as airlines and restaurants and so forth. Other parts of the market will see widespread bankruptcies. The weaker players go out and that gives the survivors a clearer runway and less competition, and higher profit potential in the aftermath in recovery. And the government deficit spending has a one-to-one relationship with corporate profits, and the US will spend trillions on this.
GH: What happens to the US government debt to GDP ratio, which was already heading rapidly towards the north east corner of the chart?
RA: It will just get worse and worse until it breaks. It’s like Thelma and Louise heading towards the Grand Canyon cliff. Everything looks fine until you go over the cliff. We're playing a very reckless game, and the end game is almost certainly be severe inflation to reduce the real value of the debt to a manageable level.
GH: How do you feel about the messages investment professionals give their clients to ‘stay the course’ and ‘hold your investments’, and then the market continues to fall each day? We said it at 10% down and 20% down and now it’s 30% down. Should we modify these messages more towards taking the opportunity to rebalance portfolios into a more conservative stance? It’s not a time for aggressiveness.
RA: Well, taking risk off the table was obviously better a few weeks or months ago than today. I don't harbour any illusions that I have a crystal ball, but the day of fear will come soon as people start to see how fast these numbers are growing. Then again, when the number of infections crosses a million, then when the deaths cross a quarter million. These things are all coming. The main thing, though, is to avoid doing stupid things in terms of our own personal health, for the sake of everyone.
From an investment perspective, you want to make sure that three months from now, you're ready and back to a ‘risk on’ stance. A year from now, I don't see this health emergency getting any worse. It’s a 1% mortality rate for older folk based on the best-case study, the Diamond Princess, where everybody was tested. If this year, we wind up with as many people dying from coronavirus as from ordinary seasonal flu, that will shock a lot of people but it shouldn’t.
Graham Hand is Managing Editor of Firstlinks. This article is general information and does not consider the circumstances of any investor.