Everyone thinks the markets crashed because of the virus.
I think that’s overly simplistic and limited, but does it matter?
If they’ve swallowed that narrative, then once the virus fears abate, perhaps that narrative will carry markets back up?
The thing is – if you were selling because everyone was far too optimistic and valuations were too high, then it didn’t matter that you didn’t predict the pandemic or get perfect timing.
Forecasting the future is impossible, and unhelpful because you’ll probably be wrong.
Evaluating the present however, while very, very difficult, does at least have the potential to offer value.
A month ago, prices were too high. Now they are less high. In some corners of the market, they are low.
The oil market is a classic example.
I don’t want to tell you what is going to happen in the oil market. A million people are pretending to know if it’ll go up or down, and why. Some of them will get lucky, their predictions will come true and they’ll look clever. The Financial Times and CNBC will interview them to find out how they predicted the oil market move.
But the truth is, if you ask 1,000 people to pick a number between 1 and 1,000, one or two of them will get it right and look like geniuses.
Instead, try to understand the present. Oil prices and stocks are at multi-decade lows. While there’s lots of good reasons to think they could go lower, that doesn’t mean they will, or even that they probably will. To go lower, reality would have to be even worse than current expectations, which would be tough.
Source: Tavi Costa on Twitter
Presumably the previous two marked lows were also the peaks for calamitous predictions about oil.
The thing is, I am an oil sceptic! And a massive energy transition advocate. That’s a topic for another day though sadly.
Because before I stray too far, I want to wrestle things back to my original point about the corona-narrative.
There’s a lot of chat about how markets will bottom when the virus peaks.
My first question is: what does “peak” mean?
(Oil faces a similar question by the way – again, I’ll write about this soon.)
Does a peak look like a perfect volcano, with a clearly defined top?
Maybe… but it may be unhelpful to look for an actual, absolute peak in that sense. Mainly because it will have happened by the time you notice it, and so you’ll be too late.
I’m following a different path.
The virus grows at an exponential rate. That means it doubles every few days.
That’s how it goes from a few hundred cases in total, to a few thousand new cases per day only a couple of weeks later.
And that’s how charts like this appear (linear scale on the left showing exponential growth in the line, logarithmic scale on the right showing exponential growth in the units on the y-axis):
In the UK, we had 2,500 cases in total on 18 March. By 27 March, we had 2,880 new cases… in a single day.
That’s the power of the exponential function, and therefore the power of the virus too.
That’s why I’m not looking for a peak in total cases, new cases, or deaths.
Rather, I am looking to see when the main data being reported shows a loss of exponential growth.
And to be honest, I think we may be there. Here’s a chart up to 27 March.
Exponential growth, right there. Scary stuff. What happened next might be surprising though:
The UK reported over 3,000 cases in a single day over the last 24 hours (1 April), for the first time. A new peak, undoubtedly. But you can see that it’s no longer growing exponentially – it’s not doubled since four days ago.
I think that’s absolutely crucial.
(By the way, don’t think for a second that I believe these statistics are accurate or particularly helpful, because of false positives, false negatives, and the inability to find out if people have already had it and recovered. And we’ve not tested everyone. That only matters to an extent though, because they are the best we’ve got right now, and they are what most people are working from).
Baking a cake
We’re all doing a lot of baking at the moment I would guess. Flapjacks last week, banana bread this. Rinse and repeat, rinse and repeat.
The ingredients in the article so far need to be brought together now.
So, here’s what I’m getting at, laid out as clearly as possible.
I think that markets were overvalued before this crash, unrelated to the virus (No S*** Sherlock award – I know).
Now, everything has fallen 25% or more. Because the virus sparked the crash, everyone thinks the crash is really bad primarily because of the virus.
The pandemic is a very easy scapegoat, eagerly swallowed by professional investors looking to blame anyone but themselves.
My fear is that in the same way that the virus is blamed for the crash, a surge of good news and optimism regarding the virus will send markets back towards their pre-crash peaks. With the added bonus of mega quantitative easing and stimulus packages, this could be a powerful move.
If the spread of the virus has been accepted as the prime cause of the crash, could Covid-19’s containment lead to an equal and opposite reaction? I think that would be a mistake, but the way the markets have been the last few years, I wouldn’t be totally surprised.
Let me build this out for you just a wee bit more.
Three months ago, large parts of the stockmarket were overvalued, on a number of metrics.What has happened now is that because of the above, the impact of the virus has been more severe than it might otherwise have been. Hence the crash breaking records left, right, and centre. It’s also more justified, and not, perhaps, a total overreaction. Don’t forget about the oil shock either…
What has happened now is that because of the above, the impact of the virus has been more severe than it might otherwise have been. Hence the crash breaking records left, right, and centre. It’s also more justified, and not, perhaps, a total overreaction. Don’t forget about the oil shock either…
There was plenty to worry about at the start of this disastrous decade: high valuations, the repo market liquidity evaporation, the explicit and implicit short volatility trade, ubiquitous overconfidence and risk-taking, inadequate concern and risk-reward analysis, a conviction that inflation was dead, and the only way was up for stockmarkets.
I’m worried that coronavirus has been too eagerly gulped down by investors greedy for a black swan.
And when I say black swan by the way, I’m quoting – I personally don’t think this was one.
(A black swan is an event that is unpredictable and which forces a reassessment of previously held views. People who’ve only ever seen white swans would assume all swans are white. But the absence of evidence isn’t evidence – and while a million more white swans could not prove them right, a single black swan would prove them wrong.)
So why don’t I think this very unpredictable pandemic counts? Well, because the man who coined the term and wrote the book Black Swan has come out and said that it’s not one (Nassim Nicholas Taleb). It’s a white swan he says. It was predictable, and he can back it up because on 26 January, he wrote a piece warning of everything that has now come to pass.
He said that while a single individual with a limited life expectancy can take risks, such risks are exponentially larger at the systemic level, and governments must respond accordingly.
You can be cautious and wrong a thousand times and survive, but overconfident and wrong only once.
Historic estimates of spread rates are wildly inadequate, he wrote, because of increased connectivity, and he also explained why policies should be entrusted to statisticians (they understand uncertainty and the exponential function), not health officials and especially not the World Health Organisation which is still not encouraging mask-wearing, and which complimented the Chinese.
His conclusion was prophetic: “It will cost something to reduce mobility in the short term, but to fail to do so will eventually cost everything”.
You can read it in full, here.
So, it’s not a black swan. But most people agree that not only is it a black swan, but also that it’s the only relevant factor in the market crash.
The narrative is so powerful. As Robert Shiller (he of Irrational Exuberance and the Shiller P/E ratio) will tell you, narratives are the most powerful force in investment. They create every bubble (bitcoin will replace banks, the American housing market always goes up, tulips are the most precious commodity on earth).
So, while I think it shouldn’t, it’s possible that containment will be enough for lots of people to get buying boots back on.
And if it is, then I think the loss of exponential growth is more important than any absolute peak. Either way, it is an early indicator that the peak may be sooner than many people think.
I feel a bit weird writing that, to be honest. It makes me feel unsettled.
Because it goes against how I think things should be, how markets should work.
But at the top of this article, I wrote that “Forecasting the future is impossible, and unhelpful because you’ll probably be wrong”.
I must recognise the possibility that my view isn’t the majority one, that it’s wrong.
I think that the virus has unmasked some major flaws in various economies and financial markets, and that some unravelling will now begin.
But there’s a fairly decent chance I will be wrong.
There may be those of you who think that I am indeed wrong, and you are more optimistic.
But I hope what I’ve showed you is that no matter your convictions, you should be prepared to be wrong. And if you are optimistic, the simplest hedge against being wrong is still gold.
Given everything that’s happened, are you so confident to think you don’t need to look into some more gold holdings and options?
I wouldn’t be. To help you out, here is where you can start learning about how and where to invest in gold and related stocks. Just in case.
Annoying, this investment lark, isn’t it?
Best for now,
Investment Research Analyst, Southbank Investment Research
PS A recent Taleb tweet used this image:
Source: Nassim Taleb on Twitter
Japan, Hong Kong, Singapore and South Korea have all contained the virus much better than we have in the West (although it’s worth giving the UK a shout-out which although not the best, is very far from being the worst).
What do they have in common? A culture which easily adopts wearing face masks.
He calls it the most significant statistical correlation with respect to this virus to date, and when Taleb talks, it usually pays to listen.