Covid-19: a black swan that we could have seen coming


by Giles Coghlan, Chief Currency Analyst at HYCM 

If there’s one thing that the coronavirus is revealing to us, it’s the extent to which human beings will persistently discount the seemingly obvious until it’s too late. There’s hardly a starker demonstration of this fact than how painfully slow we have been to raise the alarm for this latest outbreak.  

Consider the fact that Chinese authorities first alerted the World Health Organisation to several cases of pneumonia in Wuhan due to an unknown virus on 31st December 2019. At the time of writing  just over two months later  there have been more than 111,000 confirmed cases across 111 countries, including over 3,000 deaths. At the rate that this virus has been spreading, by the time you read these words, those figures are sure to be out of date. 

That famous quote by Arthur Schopenhauer rings very true at the moment. “All truth,” he said, “passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.” Anyone who has been following this story for a while will testify to the veracity of the above. 

To those of us who have spent even a relatively short amount of time studying markets, this comes as no surprise. Markets are huge collective representations of the psychology and sentiment of all the humans that participate in them. If there’s one thing that humans love dearly and want to preserve at all costs, it’s business as usual.  

You can see this macrocosmically in how slow certain governments have been to respond to the threat. The United States, for instance, has yet to provide its medical practitioners with enough diagnostic test kits after failing in its first attempt to mass-produce them. Many of you will have already seen that eerie video of Iran’s deputy health minister, sweating profusely while downplaying the virus and denying that he covered up the extent of its spread. This was shortly before he and other members of parliament tested positive for it. 

Microcosmically, we’ve probably all spoken to a friend or relative who has travel plans that they refuse to cancel due to overblown fears over some flu. We’ve probably all found ourselves in a crowded shopping centre or restaurant since coronavirus became a global talking point, myopically ignoring the risk of infection just so that we can get that pair of discounted slacks or that important business lunch out of the way. Perhaps we feel that we should be wearing a mask but don’t want to appear like an alarmist when no one else is wearing one. Much like in markets, our assessment of risk can often be self-serving in ways that don’t ultimately serve us. 

Last week, business as usual finally gave way as the stock market realised what bond markets have been hinting at for a while now. The S&P 500 underwent its fastest 10% plunge from an all-time high in history — faster even than the Black Monday crash of 1987 and the worst losses that the US equity markets have seen since the Great Recession. By the beginning of March, $4.3tn in value had evaporated, that’s almost the entire US Federal Budget for 2019, gone in seven trading days.  

Many of us watched in disbelief as the double-top that formed in July 2019 became a quadruple-top in September, which then transformed into a melt-up that saw US equities rallying an unbelievable 12% from those former all-time highs. This, despite all real-world evidence to the contrary. If the yield-curve inversion, the Abqaiq-Khurais drone attacks, repo market spasms, recommencement of (non-) QE, US-China trade war and the assassination of Qasem Soleimani weren’t enough to deter the US stock market from its upward trajectory (and investors from chasing it), it seems that this virus may be the straw that finally breaks the camel’s back.   

Black swan events are defined as systemic shocks that no one sees coming. The term originates from an ancient saying that uses the black swan as a metaphor for something impossible. It was commonly employed in England before black swans were discovered in the new world. In hindsight, black swans can seem obvious and are often rationalised as such. But before they occur, everyone is so busy reaping the rewards of the current state of affairs, and congratulating themselves for doing so, that they have a vested interest in not appreciating the risks. 

Neither the spread of Covid-19 nor the recent stock market crash came as a surprise to anyone who’s been paying attention. The intriguing part is that one seems to have caused the other. We could have been forgiven for not seeing the crisis of 2008 in advance. It involved extremely esoteric financial catalysts that even many of the world’s leading experts at the time didn’t fully understand. What will our excuse be this time if we’re really headed for a repeat of those events? Not only have we been playing at the same game of extend and pretend but we’ve been doing so in a cynical manner, well aware that the music has to stop at some point and we are overconfident in our ability to locate a chair when it does.  

Even as global markets were crashing, people started speculating that the Federal Reserve would have to step in to avert a crisis. During the Friday and Monday sessions (28th February and 2nd March) we saw US stocks bounce over 8% in anticipation of an emergency rate cut from the Fed in response to Covid-19. True to form, on Tuesday the unscheduled  though broadly expected  50 basis point rate cut was announced. Chair Powell was beaten to the podium by Royal Bank of Australia governor, Philip Lowe, who cut his own country’s official rate to a record low 0.5% in anticipation of the detrimental effects the virus will have on Australia’s economy.   

What’s particularly concerning is that the lacklustre numbers coming from many of the world’s economies are still referencing data that’s pre-coronavirus. European Flash Manufacturing and Services PMIs were heralded for their growth in February, despite these sectors being in contraction and teetering on the brink, respectively. Australian capital expenditure and operating profits were shown to have dropped off substantially in Q4 2019, and in the US, both durable goods orders and PCE contracted. Again, these figures do not take Covid-19 into account. The huge drop in German (ZEW) economic sentiment in February perhaps gives an indication of things to come, but it’s the Chinese manufacturing PMI that provides the bleakest outlook, plunging from 50 in January to 35.7 in February — an all-time low not even seen during the Great Recession.  

How ironic that the just a flu we’ve been scoffing at for the best part of two months has now infected our markets. We’ve been aware of certain very worrying epidemiological details of this coronavirus strain for well over a month now. These include its incubation period, rate of spread and asymptomatic transmission. Yet, anyone who has dared to raise the alarm has been pilloried as a scaremonger. YouTube has gone as far as demonetising channels that have been discussing the risks and unsubscribing people from them. So desperate are we for the band to carry on playing that we stubbornly refuse to heed any warnings until the crisis is beating at the door. How fitting that this virus spreads from person to person before anyone even realises that they’re sick. It’s almost designed to punish business-as-usual. In a bygone age, these details would have been regarded as deeply foreboding. Nowadays, we have central banks to goose our stock markets into going back up again. 

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