Coronavirus – the latest
Our experts share their thoughts
A global pandemic looks to be about to end the longest US expansion in well over a century, with a global recession now expected by many. Difficult times lie ahead for the world.
It’s been a breathtaking start to the year in capital markets. Nicky Eggers, our Head of Investments, speaks to Will Hobbs, Chief Investment Officer, and Rob Smith, Head of Behavioural Finance, about the latest on coronavirus and its effects.
Will, what is the latest information we have on the spread of the coronavirus?
Will: The first point to make is that this is now a truly global outbreak. There can be little doubt about that, even if the paucity of detection capabilities continues to deny us solid proof. It is this lack of testing that is also preventing us from making authoritative statements about the case fatality rate. The range of plausible estimates here goes from around one person in every thousand (comparable with seasonal flu) up to a much more serious ten in every thousand. We can say with a little more authority that containment efforts around the world, of varying severity, have seen success in slowing the spread. China is the most extreme case here, but much of Asia now enjoys a more stable case count, with most new victims coming from overseas. European and US containment measures are younger. At the time of writing, we lack convincing evidence of their efficacy, but early signs from Italy are so far encouraging.
Rob, you’ve mentioned before about the difficulties we have with dealing with uncertainty and the way in which we instinctively forecast events. Can you explain that in more detail?
Rob: It’s important to know that we don’t deal with uncertainty well. There are many common traps we can fall into when trying to think about what may happen in the future. When we think about the future of a specific event, say the spread of the coronavirus, it is natural that we overweight the importance of the recent past, as it is most easily recalled, and use this as a basis for our predictions. For example, when the virus first broke out in China, it was easy to believe that we, in the UK, would never be affected. Now that the outbreak is global, it’s not hard to imagine that the number of cases will grow quickly and that the situation can only get worse. It is easier for us to mentally process the future if we believe that current trends will continue, and the simplest way to do this is by extending recent trends in a straight line. The problem with this way of thinking is that we are using only a small amount of information to infer something about the future of a very complex process.
What are the possible effects of this in terms of how we assess the seriousness of coronavirus?
Rob: Looking at the way past epidemics develop, we know that there is a general pattern – a slow start followed by a period of exponential growth before a tailing off of infection growth rates, and eventually a reduction in new cases. In the early days, when cases are developing slowly before transmission accelerates, a simple extrapolation of the current trend can dramatically underestimate the future growth in the number of cases. Then, if we take the same simple extrapolation during the steeper more exponential growth phase then it can overestimate future growth of cases as the number of cases will plateau at some point.
Will, is there anything we are hearing from the experts on seasonality? I know other coronaviruses have exhibited this to some degree, but do we expect lower transmission rates as summer arrives?
Will: Again, I’m simply relaying what I have heard from genuine experts on this subject. Like you say, there are basically four coronaviruses currently in circulation that cause colds and so on that regularly afflict all of our winter seasons. This is an addition to that family of viruses. So, although we don’t yet have firm evidence of seasonality, there is some potential for slower transmission as the northern hemisphere warms. This will potentially have the reverse effect on the southern hemisphere though.
What are our latest views on the economic effects? Markets have moved extremely fast – it seems like investors are expecting a much larger and more long-lasting economic hit than originally thought based on these market moves?
Will: Yes, that is surely the case. There are other factors to throw in here too. There is some increased uncertainty resulting from the sharp declines in oil prices that followed on from the collapsed talks between OPEC and Russia. Essentially, a market share scrap in the oil market is fueling worries that a default cycle amongst oil companies is coming. The reality is that there is little we can say about the economic costs of containing and delaying the spread of this latest coronavirus. For those looking for some reassurance, the world economy entered this crisis with many of its most important participants in better health than feared. Also, policymakers around the world, with the freshly inked playbook from the last crisis to hand, are acting with reassuring vigour. Our best guess is that the world economy will find its feet again at some point in the second half of the year after an admittedly sharp blow in the next quarter or so.
You mentioned the sharp declines in oil prices. What is our expectation here? Do we expect Russia and OPEC to continue this market share war?
Will: The last few years has seen a sharp increase in the proportion of global oil production accounted for by the US. The relevant point here is that much of US supply requires a higher oil price to make it worth pumping. So, by driving the price of oil lower, the producers able to profitably operate in a much lower oil price environment may be able to grab back market share. This obviously has many implications for the world economy. There are stresses to consider in the oil sector and in particular for those companies that have provided finance to the more vulnerable parts of the sector. More broadly, you can argue that lower oil prices are a net positive for growth in the medium term. Essentially, wealth is transferred from the few that control the world’s oil resources to the many that use it. However, with such a sharp fall we know that in the short run the negative effects can outweigh those positive longer term effects.
Rob, back to you, do you think the current market conditions may be exacerbated by the biases we have when forming our expectations?
Rob: Given our comments about how expectations of the future are often heavily influenced by the more recent past, I think there is a risk that many investors have been conditioned by the reasonably benign market conditions experienced recently. Specifically, the stellar returns of many asset classes in 2019. As a result, investors were not prepared for such violent market moves and this may trigger a more instinctive rather than reasoned response. It may be tempting to extrapolate the recent market falls into the future. Understandably this would make you want to sell your investments to try and limit any further losses.
And what message can we give to our readers on this front?
Rob: First and foremost, it’s about context and setting expectations. Think about what you are investing for. Unlike the essential supplies being stripped from shelves, investors should not need to use the money they have set aside for investments in the short term. Remember that investing is necessarily a long-term activity. We do expect periods like this to occur at some point, and it is through weathering the turmoil that we get rewarded as long-term investors. Secondly, remember that what you see in the news, that is affecting your perception of risk, is the volatility of the stock market – one of the riskiest assets. Diversified investors will be shielded from the full force of this and will be seeing less extreme movements as a result.
A good analogy in times like these is to imagine when you’re driving on the motorway and you see warning signs saying ‘accident ahead’. There is a strong temptation to take a different route, just to do something. However, the reality is that the news is often old by the time you see it. When you get there the accident may have been cleared and the traffic could actually be better than expected. If we think back to markets, information is incorporated into prices very quickly. So, has the worst case scenario been priced in already? If so, there may be more a pleasant road ahead. Self-control is an important trait for investors. It is difficult, but we have the ability to help ourselves. Setting rules in advance about how we will or won’t behave in times like these can help.
Will, what can policy makers do to manage the situation?
Will: We are seeing an incredible amount of proactivity from policy makers. We’ve seen central banks pull hard on levers that it took a lot longer to pull in the last recession. We are already seeing a significant step in government support for the economy too. So far these policy measures, both enacted and planned, already exceed those approved in the last downturn. A lot of what policy makers are trying to do right now is simply buy time for the economy to endure these increased efforts to contain the virus.
I know you are always telling us to let the long-term asset allocation absorb these punches, it is what it is designed for. But what are you doing with the shorter term portfolio – the tactical portfolio – which is really designed to take advantage of any short-term mispricings?
Will: This is certainly a time when you are very grateful for the diversifying assets in our strategic asset allocation. It is also a time to be thankful for the painstaking efforts the team put in to organising these assets in the most effective way possible, to mitigate exactly these types of markets. However, in the tactical side of the portfolio, there are some extremely interesting opportunities cropping up. When emotions are running high in markets, this tends to be a great moment to stay dispassionate and take advantage.
Lastly then, what opportunities do you think the current situation creates for our clients and investors more generally?
Will: We discuss the cost of waiting and attempting to time the market in detail in one of the following articles. Our experience tells us that for investors there is no time like the present. Given the large sell-off we have witnessed in risk assets, and the increase in long-term expected returns that likely results, this can only be more pertinent now. If you have cash to invest and have been waiting, possibly afraid to dip your toes into the water, then I hope this publication can give you the motivation required to take the plunge.
Things to consider
The value of investments can fall as well as rise. You may get back less than what you originally invested.
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