Release Date: 17th March 2020
“I must level with you, the British public. Many more families are going to lose their loved ones before their time,”
Our generation has never been tested like this. Our grandparents were, during the Second World War, when our cities were bombed during the Blitz. Despite the pounding every night, the rationing, the loss of life, they pulled together in one gigantic national effort. Today our generation is facing its own test, fighting a very real and new disease. We must fight the disease to protect life.
First, to get the full context behind this there are 2 things that would be useful to look at before reading this (assuming you have not already seen them), but even if you don’t have the time, I think the message should still be clear so do still read on.
To fight Coronavirus, Sri Lanka must act now by Indi Samarajiva (8 minute read)
Video on why testing is key to the solution (6 minutes)
The West faces living conditions not seen since the days just after World War 2
This is a hard email to write due to the human tragedy we are seeing around us.
I believe it is very likely that “the West” will shortly (and is beginning to) face a drastic change to living conditions that has not been seen in the memories of most adults in the West. If that is confusing to understand, basically much of the Western world could soon be living in conditions more similar to the very difficult years immediately after World War 2, in key parts of Europe. (Read - The Rationing Years in Britain 1939 – 1954)
Italy seems to already be in these conditions, and I believe this will not be for just a few days, but many weeks at a minimum, and likely for months. (Read - How Italy spiraled from a perfectly healthy country to near collapse in 24 days as the coronavirus took hold)
If governments and societies move fast enough (as they seem to finally be doing), I am hopeful that the mortality rate and death counts might be contained to the historic norms in our memory than the very horrific ones of the past. This link gives a sense of past pandemics - Visualizing the History of Pandemics
In the context that the Asian Flu (1957-1958) and the Hong Kong Flu (1968-1970) are reported to have killed over 1 million worldwide, while the Swine Flu 2009-2010 killed 200 000 people, drastic action can help us keep death rates contained to these levels, rather than comparisons made to the more unthinkable 40 to 50 million killed by the 1918 Spanish Flu.
But the economic cost that will be needed to be borne to implement these lockdowns will be unprecedented and I think it’s vastly underestimated by mainstream economic research. For instance, in what seems to be Morgan Stanley’s most extreme scenario, global growth only slows to 2.1%.
Meanwhile, when the entire world is making very hard choices as we speak, my job is to give a view on Exchange rates, Interest rates and the Stock Market - Right now this does not seem the point, but it’s my job.
So, this is a view on Western Equity Markets, more specifically the S&P 500 - and not local equities
We have found much of the mainstream global Economic and Equity Research lacking and well behind the curve on what’s happening. Global equity market views are not really what Frontier Research has a track record on. We normally just take "current levels" of global markets as the base assumption for our local equity and rates/LKR views.
But given what I have seen in terms of global market research and their outlooks, I feel more strongly in sharing this, given that my view is different and I have a strong conviction in it.
My View is that the S&P 500 will fall by 20%
Context for some: On 9th March, I wrote a view on the US S&P 500 to a group of clients for whom a view on the S&P500 could be very useful. (This time while this is written as a view on the S&P500, it is been circulated to a wider group as the underlying perspective, I hope can help broad decisions they need to make)
In my email titled “This is a Big One for Equity Markets!” when the index stood at 2972.37, I said “I think the U.S S&P 500 will fall by at least 20% from current levels within a short period of time. This is a view I have with a probability of greater than 80% (which for me is what “as almost as certain as I could be” means)”
Last night, it closed at it 2,386.13 (a 19.7% fall)
Given that it did the 20% fall mentioned earlier, and it was an “at least view”, I am updating what “at least” means from yesterday’s close of 2386.
I believe again with 75% certainty it will fall at least to around the psychologically important 2000 level, i.e. a further 16% based on what seems likely to happen next. I very much stress this is not a bottom I predict, but a fall to “at least that level”.
Where the bottom is, really depends on when there is a clear belief that the world is winning the War on the Virus as detailed underneath
For those still exposed to global equities, my view remains to “Keep Selling”
(As I write, US futures are up 2477, and our view is to sell into the dead cat that bounces)
The framework for this is to see it as a War (on the Virus)
My basic framework to look at this situation is to see this as a “War” on the virus - and as one with a magnitude of a World War, rather than comparing this with the GFC which now pales in comparison. All the news we see is indicative of a world mobilizing for war.
Why is the War the right framework for this?
It gives a sense of the magnitude of the crisis we are facing.
Border closures, closure of much international air traffic, overrunning hospitals in the West are stories we last heard or read about in times of war.
The following article gives another sense of it - The Weekend the World Declared War on the Coronavirus
The GFC was a crisis about financial markets and economics, and a crisis that could be solved with financial and economic policy. The current crisis is about financial markets as well, but it originates from fears of survival and societies no longer functioning as normal. As such, the GFC which most have come to liken this to, seems the wrong frame, and we are guilty of this too.
The following article helped my thoughts on this as well. (it’s a must read in my view!)
“But for the first time our federal government is treating the fight against this virus like the war that it is.
But we all see the danger now. All of us rabbits see the virus dog chasing us. Even Donald Trump.
I said it at the start of this note and I’ll say it again, there is no country in the world that mobilizes for war more effectively than the United States. And I know you won’t believe me, but I tell you it is true.
How do markets perform in a War?
Looking at what happened during previous wars, especially World War 2, is a good start for this. When Germany first invaded Poland, US markets didn’t care much, similar to how they didn’t react a lot when East Asia was seeing the outbreak of Covid. However, when Germany invaded France, the danger seemed to be far more real, and markets crashed, similar to the reaction when Italy saw their Covid outbreak. “The market was already in a serious decline, which had begun in the summer of 1941, when the Japanese attacked Pearl Harbor on Sunday, Dec. 7 (2).
The Dow fell 3% on Dec. 8 and another 3% the next day. The Dow hit 92.69, its lowest level since 1934, on April 28, 1942.Then the market turned. There seems to have been no single event that triggered it. It was, perhaps, the realization among investors that the U.S. was fully mobilizing for war and would eventually win.”
But looking at World War 2 – the tide for markets turned not when the war was won, but when victory was in sight and people believed it. This is what we believe would be the key to timing when the S&P is close to bottoming - but I think we are not close to that anytime soon.
How can you monitor to know if victory is in sight?
Victory in this sense is the idea that we can contain the virus without shutting down economies the way it’s currently being done.
Keep an eye on the level of infection and death rates. But a sense that it is peaking/stabilizing due to lockdowns (as I expect will happen) without any assurance that it remains contained once restrictions are relaxed is not useful from an economic and markets point of view. China seems to be opening up again after around a 50-day lockdown and South Korea is returning to low new daily cases after close to a month. But can (and will) the West follow those models once China and South Korea show conclusively that they have figured it out?
Medical developments like treatments and treatment protocols that allow you to manage the virus without overcrowding hospital system or allow a faster level of testing, early detection or vaccines being developed much earlier than expected.
What does Victory look like for me? Testing at will
The way we win this war will be through strong action that avoids too much disruption.
For me, this will be through the widespread testing of people, not only those that are sick or those who had contact with a foreign country, but also those that seem to be healthy and at no risk at all. This is what South Korea did, and we can see how quickly the situation got under control there.
This was also WHO’s main message last night – Twitter- WHO "Once again, our key message is: test, test, test.”
Such widespread testing is right now difficult for many countries. Test kits have been limited, and accurately getting results can take time and specialised effort. It will also require a massive coordinated effort in each country, and ideally across the world. This is especially important for poorer countries that don’t have the capacity to mass produce test kits at the same speed that laboratories in richer countries might.
But there are game changers that could happen like:
Senegal is leading some research into a test kit that is both cheap and takes less than 10 minutes to get results out of. (Read - Ten-Minute Coronavirus Test for $1 Could Be Game Changer)
Once widespread testing is in place, then governments can ramp up their quarantining efforts much better.
All of this will be needed to win the war. But, from where we stand now, most of this feels quite far away. So, I am rather certain that the S&P 500 has substantial downside left.
With a near certain view that global equities will collapse due to the uncertainty, we recommend you sell out of equities and raise cash positions.
There will likely be buying opportunity later in Global Equities, but at much lower levels than now.
“It's hard to imagine what the next few months will be like. But what's comforting is knowing that in this battle, we're all fighting on the same side.”
This is what is unlike the World Wars, we are all on the same side and now the whole world is mobilizing for this War very fast. Given that, I am hopeful that a lot of lives will be saved worldwide, much more than was the case a week ago.
Stay safe, help others where you can!
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