Two Black Swans

Black swan theory suggests it is an unpredictable event – that is beyond what is normally expected of a situation and has potentially severe consequences. Is coronavirus a black swan event? Global stock markets and the oil price have fallen significantly on coronavirus fears.

Investors have always known there was a global health risk from China based on previous outbreaks such as Asian Flu or SARS in 2003. When coronavirus first emerged, global investors believed the outbreak might be contained within China, but realised there would be an adverse impact on global supply chains. No one envisaged whole cities, regions and even entire countries being locked down. If people cannot travel to work or go outside to eat then it must have a negative economic impact, even in the age of the internet.

A second coronavirus linked black swan event could be Saudi Arabia and the collapse in oil prices. These had already fallen as coronavirus impacted China and airlines – both big oil consumers. While Russia was clearly opposed to further oil output cuts, the second black swan event was the reaction of Saudi Arabia following the OPEC+ meeting. When Russia blocked further OPEC+ production cuts, Saudi Arabia launched a price war – cutting oil prices to the lowest level in 20 years and raising output.

Long-term investing is challenging, but is typically rewarding. From time to time, investors will have to face a black swan event. But early in 2020 we have had to face two black swan events in a matter of a few weeks. Christmas seems a long way off, but let’s hope two turtle doves – central bank support and government fiscal stimulus get us through the coronavirus outbreak.

What have we been watching?

Another bruising week with sharp falls on global stock markets due to coronavirus. Markets remain volatile as investors continue to monitor the progress of new coronavirus cases and watch government containment measures. The latest ‘black swan’ event that rattled markets was President Trump’s decision to ban travel between the EU and Europe for 30 days. Italy extended its lockdown by forcing all shops except food stores and pharmacies to close. Spain implemented similar steps over the weekend, after declaring ‘state of emergency’, and France is likely to follow. Market concerns have therefore turned from global supply chain and air travel disruption to a demand shock. For example, given the UK high street has already struggled from online shopping and business rates, how would cinemas, cafes, bars, restaurants and clothes shops cope if the UK has to follow Italy’s lead and close for a few weeks?          

Market expectations for central bank and government intervention remain high. Government and central bank support together with low oil prices should be positive for the global economy once through the short, sharp shock of coronavirus but in the UK and US this is only just beginning.

Some 60 million Italians awoke on Tuesday to a complete lockdown of the country. Italy has the highest number of cases outside China but does also have the world’s oldest population after Japan. The WHO said the coronavirus outbreak was a global pandemic. Cases in the US are starting to increase. There was however some encouraging news with China reporting no new locally transmitted cases outside the coronavirus epicentre of Wuhan and declared the peak of the country’s outbreak as officially over. New cases in South Korea also appear to be slowing.   

Besides imposing containment measures some governments are considering financial support for households and businesses. The Italian deputy economy minister suggested mortgage payments could be temporarily suspended. In the US, President Trump has pledged ‘major’ steps to protect the US economy which might include a payroll tax cut and expansion of paid sick leave but has not announced any supportive economic stimulus measures to offset the impact of the US/EU travel ban. Japan’s government has said it plans to spend more than $4bn in a second package of steps to cope with coronavirus.  In the UK, the Bank of England and the government both announced measures to combat any short-term hit to the UK economy from coronavirus.

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In the UK, in a surprise move, the Bank of England (BoE) unveiled a number of measures in response to the expected economic shock from coronavirus. Most significantly, interest rates have been cut by 0.5% to a joint record low of 0.25%. While there is no change in the scale of QE, the BoE is introducing a new Term Funding Scheme with additional incentives for small businesses which will provide an extra £100bn of funding. Lastly, the Countercyclical Capital Buffer rate is being cut to zero which could potentially release £190bn of lending to businesses. The BoE has pledged to ‘take all further necessary steps to support the UK economy and financial system’.

Chancellor Rishi Sunak said he expected coronavirus to have a near-term impact on the UK economy and cut the 2020 economic growth forecast to 1.1% with 1.8% in 2021.  He responded by announcing a £30bn fiscal stimulus package including a £5bn emergency response fund for the NHS. This represents the largest fiscal loosening seen in the UK for thirty years. The future path of government borrowing has been raised significantly a logical and widely anticipated shift of emphasis when the cost of borrowing has never been lower due to coronavirus.

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The ECB left its key deposit rate unchanged (-0.5%), and instead announced targeted actions through liquidity measures and asset purchases, which will be expanded by £120bn and will concentrate on private sector purchases in order to support the corporate bond market.

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In the US, the Fed cut rates by 100bps to 0-0.25% on Sunday, while increasing Treasury holdings by at least $500bn and mortgage-backed securities by at least $200bn.

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In China, more evidence of the short-term financial pain from coronavirus. China’s airline regulator confirmed airline passenger numbers fell by 85% in February costing airlines $2.35bn of lost revenue.

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Brent oil slipped back to $34 as Saudi Arabia escalated its price war with Russia by saying it will increase oil supply to a record 12.3 million barrels a day.  Further to weekend developments, Brent oil is now closer to $30.

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Finally, coronavirus – keep calm and carry on? Perhaps not. In another sign of panic buying and stockpiling AO.com reported a 200% jump in freezer sales last week!

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Read Last Week’s Alpha Bites – No Fly Zone

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.