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We Have Nothing to Fear but Fear Itself

| Market Forces

So, first of all, let me assert my firm belief that the only thing we have to fear is…fear itself — nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance.” 

Franklin D. Roosevelt during the height of the Great Depression.

Market participants are renowned for their often gallows humour and veneer of self-styled cynicism they use to shield themselves from unpleasant realities. One old joke has it that the definition of a recession is when your friend loses his job and a depression is when you lose yours. The current equivalent might be that the definition of an epidemic is when someone you know catches the Coronavirus and a pandemic is when you do.

What is it investors fear most?

The answer that is most often given to this question is, the permanent loss of capital and an inability to achieve one’s investment goals either, by not having enough money to retire on (solvency risk); outliving their money (longevity risk); or not being able to achieve any other savings goals such as providing for loved ones (legacy risk).

Any large market drawdown therefore focuses investors’ minds on the likely impact on these key areas.

In the book “Thinking Fast and Slow” by Nobel Prize winning behavouralists Daniel Kahneman and Amos Tversky, reference is made to two modes of thinking;

Type 1 – Fast – knee jerk (or instinctive response) thinking – (Automatic)

Type 2 – Slow – considered and deliberate thinking – (Reasoning)

What causes us to falter is often the unknown unknowns. We don’t know what we don’t know and this causes us to extrapolate from the limited, often insufficient, information we have on hand. The correct response in this situation, unless immediately life threatening, is to wait until you have more information.

The current Coronavirus outbreak is a classic example of this.

Is the Coronavirus going to kill us all?

No almost certainly not. Based on the available information to date, it looks like even in the absolute worst case, if the virus was spread to 100% of the approximately 8billion people on Earth, 10% would become ill or symptomatic. Of those 10%, roughly 1 in 3 people will become sufficiently ill to require hospitalisation or to be at risk of dying from the disease. Of the 10% who are sick, and using the worst known fatality rate so far of 5%, only 0.50% are expected to die. Across the globe that equates to a truly horrific 40million fatalities, but it does not equate to the end of civilisation.

However, that is not the full story. Not every single person in the affected areas of Wuhan and surrounds has contracted the virus. Of the approximately 100million people in the area less than 100,000 have so far tested positive for the disease and almost half of those have already recovered sufficiently to be cleared. The number of new cases has been trending down for several days, suggesting the primary outbreak may have been contained. The numbers above suggest that the actual infection rate for the global population is in fact only 0.10% (equating to 100,000 people). If those numbers continue to hold then expected fatalities at a global level are 100 times lower at around 400,000 people.

Why then is the market panicking?

It seems likely that the market, in that absence of sufficient information, is pricing in the first ‘worst case’ assumption that everyone will get it eventually and that 5% of people will die. The impact of that would almost certainly result in a global recession. However, that view is inconsistent with only 100,000 cases in China and really only a couple of thousand elsewhere. The severity and fast spread of the virus is frightening, but on the known facts to date there is a 90% chance you won’t get sick even if you do become infected and a 95% probability that you won’t die from it if you do.

It is likely that the numbers from Italy, Iran, South Korea and elsewhere are going to get a lot worse. Collectively they may even surpass China’s 100,000 cases but almost every other country, with the exception of India, has a much smaller population and most likely a much smaller number of index carrier patient cases than China had. It therefore seems most unlikely that we are going to see hundreds of thousands of cases in every country on earth.

If that is all true then the most likely reason for the panic is:

  1. The Fear of the unknown and
  2. The “Not In My Back Yard” (NIMBY) fear of this is getting too close to home to ignore.

Neither of these fears are consistent with a global recession.

Is the Market wrong?

The collective ‘Market’ is almost never wrong – nor is it this time. At the commencement of the year, the macro-economic conditions seemed supportive of a modest global upswing. The Chinese inventory overhang had reduced, the Sino-US trade ‘truce’ lessened uncertainty, at least for 2020, and there was generally broad global monetary stimulus and expectations of fiscal stimulus, although this was balanced, particularly in the US, by stretched valuations and ambitious earnings expectations.

Indeed, analysis from macro-economic research institute BCA Research Inc. (“BCA”) showed encouraging trends. BCA’s Global Growth Indicator, a variable mainly based on commodity prices and the bond yields of cyclical economies, predicted an improvement in global industrial production, as per the following chart.


Faced with an exogenous shock such as the Coronavirus, the market has to move quickly to re-price risk across the full spectrum of assets. The immediate effect of the outbreak is already evident in the heavily export dependant China numbers with February PMI at 37. As it stands now, BCA’s Global Investment Strategy (GIS) service estimates that the impact from Coronavirus could easily curtail global growth by more than 1% this quarter. China’s economy is experiencing a severe contraction, which should result in negative seasonally adjusted quarterly growth in Q1. The supply shock of China not filling the market with an excess supply of cheap readymade goods has had knock-on effects on other countries. This supply shock has also caused US inflation to tick up to 2.50% and to the extent that this becomes a permanent feature may limit central bank’s ability to cut interest rates and apply stimulus to the market.

However, as the number of Coronavirus cases in China come down on both an absolute (numbers recovered versus sick) and relative (new cases) basis, people are already starting to return to work. The likelihood therefore is that the economic impact on China lasts for only 1 to 2 quarters of this year.

There are some industries such as Airlines, Travel and Leisure, Hotels and the likes that will be more severely impacted than others. Certain sectors like Healthcare Supplies, Pharmaceuticals, Gaming and Telepresence IT stocks could actually stand to benefit from the knock-on effects of the situation.

The US Yield Curve is Inverted – Surely that means a recession is on the way?

As part of the instinctive reaction to market crises of this nature, portfolio managers and traders flee to the instinctive safety of what they know. Given the US is the largest market, this means the US Dollar and US Treasuries. In this flight to safety they have bid up treasury prices to the point where yields have fallen to levels last seen during the 2008 global financial crisis. Historically when the US yield curve has gone negative, a recession has followed within 18 to 24 months.

US unemployment, however, remains at a very low level and it looks likely that the Federal Reserve Bank is reluctant to cut interest rates until there is confirmation that the US economy is slowing. Other than that the US economy remains in fairly good health with expectations of growth at or above trend.

The answer therefore is that a recession is always somewhere on the horizon because that is typically how business cycles end. Until the growth numbers start rolling over then it seems more likely the current very low yields are a temporary response to the crisis and that the mooted recession remains some time off. Panic sellers have most likely created value in pockets of the equity market and we would expect some bargain hunting to begin soon perhaps as soon as this week.

What is the correct thing to do then?

Given the above outlined expectation that conditions get somewhat worse before recovering towards the second half of the year, the big question is should we take risk off now ?

The answer as always depends on investors’ personal circumstances but they should take great care not to over-react or panic out of risk assets.

Certainly those who are very fearful or within 3 years of retirement may wish to protect what they have by reducing the level of risk in their portfolios. But this means they will almost certainly forgo some upside when the market recovers as it always has. Investors should thus take care to make sure they are making carefully considered and not knee-jerk decisions with respect to their portfolios.

Investors who are within 5 years of retirement and who are worried about the so far 10% decline to their portfolios should consider, if they are able to, increasing their exposure to the  now cheaper equity markets.

By far the majority of investors who were happy with the risk positioning of their portfolios prior to this event, should stay the course and do nothing until more information suggests otherwise.


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