In today’s Exponential Investor

  • An explosion in Covid-19 cases, but optimism still reigns
  • Markets are resilient – do traders know something you don’t?
  • A look at how markets deduced turning points in past crises well in advance

The numbers are in, and they look grim at first glance…

Less than a month after Professor Ravi Gupta of Cambridge University proclaimed the early days of a third wave, the UK registered over 22,000 new cases on Monday.

The number is partly inflated from a backlog in undercounted cases on Saturday. Even so, the seven-day average has grown from 3,304 new cases on 1 June to over 14,000 today.

But this wave is a little different. And, sure enough, markets are reacting differently too.

Why the FTSE’s shrugging off a third wave

As I write, the FTSE is a whisker above its level at the end of May.

The market may seem complacent – but analysts seem euphoric, with their rosy predictions of post-Covid GDP booms.

Last month, the Paris-based think tank Organisation for Economic Co-operation and Development (OECD) forecast 7.2% GDP growth for the UK in 2021. That’s the fastest rate of economic growth since 1941.

KPMG’s economic forecast for the UK is only a little less rosy – 6.6% in 2021. But it forecasts still-prodigious 5.4% growth for 2022. Ernst & Young goes even further than the OECD in predicting 6.8% growth for this year.

That sounds pretty good… but when consensus seems unanimous, it’s always worth taking a look at the other side…

Today I’m re-upping a Southbank Investment Daily issue from April that examines the ability of the stock market to sense the end of old crises – and the beginning of new ones. Thanks to the research of famous investment analyst Barton Biggs, whose novel Wealth, War & Wisdom scrutinised market movements before and during World War II’s turning points, we have extensive precedent to draw on for this question: are markets telling us that the worst is over?

The wisdom of the crowd

The biggest sin in the investing universe is supposed to be herd mentality. The contrarian is celebrated, and the crowd is reviled.

Most of the legendary investors have their own famous sayings that enforce this.

“Be greedy when others are fearful, and fearful when others are greedy,” said Warren Buffett. Jim Rogers says that what others call contrarian behaviour, he simply calls “looking for value.”

The contempt for crowds even extends beyond financial markets. Friedrich Nietsche wrote: “Madness is the exception in individuals but the rule in groups.”

Or as Scottish historian Thomas Carlyle puts it: “I do not believe in the collective wisdom of individual ignorance.”

Even so, I’ve found myself paying a lot of attention to overall market behaviour and the expectations of crowds these days – and not because I want to place a trade against them.

The crowd is signalling something today – and it’s the same message it correctly sent in the dark days before the Battle of Britain, and the peak of the Spanish flu.

Could it be right again? Here’s what history says…

How the crowd called World War II’s turning points

Is there a bleaker-seeming moment in British history than the autumn of 1940?

The Battle of Britain had begun. For the first time since Napoleon, the British Isles were threatened with invasion. Every night until 3 November, an average of 200 bombers hit London, and more than 13,000 civilians were killed in September and October alone, as most Londoners either fled the city or took up semi-permanent residence in the Tube.

After one night of shelter, one Londoner Rosemary Black wrote in her journal:

Horrified by ghastly sight in the Tubes. Seeing every corridor and platform in every station all along the line crowded with people huddled three deep, I was too appalled for words. The misery of that wretched mass of humanity sleeping like worms packed in a tin – the heat and smell, the dirt, the endless crying of the poor bloody babies, the haggard white-faced women nursing their children against them, the children crammed and twitching in their noisy sleep… why if I wanted to torture my worst enemy I could think of no better Procrustean bed for the purpose.

As grim as day-to-day living had become, the geopolitical outlook was even grimmer. As the UK lost hundreds of planes that fall, even Churchill privately worried that the RAF was done for. But in a tactical mistake, the Luftwaffe shifted to focusing on civilian targets to break morale, giving the RAF vital time to recover. By September Hitler decided to call off invasion at least for 1940, and Churchill lit cigars in celebration in the House of Commons. This blessed plot, this earth, this realm, this England, was saved.

You might suspect that the Battle of Britain’s conclusion would be the start of a rally for UK equities. But as Barton Biggs points out in Wealth, War and Wisdom, the recovery had actually started just after the unofficial fall of France.

Somehow, investors deduced as a group that the UK would survive. Or did they? It’s possible for a rally to come from several catalysts.

But the really interesting thing, as Biggs points out, is that German investors also seemed to sense the peak of the Third Reich – even at a time when Hitler was still on his winning streak.

In the summer of 1941, you would have had to squint hard at the data to find pessimistic news for the Germans. Hitler had outstripped Napoleon, just conquered Yugoslavia in one week, and his Wehrmacht was bagging as many as 600,000 Soviet prisoners at a time as it rolled towards Moscow.

But German investors seemed to sense the turning tide, months before the German army got bogged down in Moscow and mauled by counterattacks – and a full year before the catastrophe at Stalingrad.

We’ll never know how German markets would have reacted to D-Day had price controls not been implemented soon after Stalingrad.

But it’s incredible… at a time when newspaper headlines were heavily censored on both sides, investors seemed to see through the censorship and spin.

Of course, a World War and a pandemic are very different beasts (though I would argue the crowd’s expectations deserves even more credence today, when information is free-flowing).

In any case, the crowd back in 1917-1918 correctly ruled out the worst-case economic scenario back then, too.

At the time, the Dow dropped more than 30% in the end of 1917, when the Spanish flu began a rampage that would take some 670,000 American lives.

As cases worsened, some local governments put lockdown restrictions in place, only to rescind them after public backlash. In cities like Denver and Atlanta, food and entertainment industries successfully reversed lockdown policies, even as cases rose.

Even as hundreds of thousands died, in a country half as populous as the US is today, the economy remained largely open. The humanitarian disaster didn’t translate to an economic one: the impact on economic growth was mild.

Are markets seeing a turning point today?

The FTSE has gained a negligible amount over the last month. Longer term, it’s a different story.

The FTSE has gained 14% since early-to-mid November, when the Pfizer/BioNTech vaccine’s efficacy stats were released. And as foreign markets roar even higher, the optimism in markets is undeniable.  But is it a signal – and if so, is it a correct one?

Ultimately, we’ll only know for sure that markets have bottomed out in a few months’ time, if and when it becomes clear we’re in the last throes of the pandemic.


William Dahl
Editor, Southbank Investment Research