The hidden virus in the markets – dishonesty
Trade wars, drone wars, bush fires, impeachment, Brexit and now a virus to scare the daylights out of tourism, global growth and every human on the planet. What a start for sharemarket investors in 2020.
The coronavirus alone is a black swan event that many of us will be highly concerned about. As tourism takes a hit and one of our most important trading partners faces stalling their economy to get control, the ricochet effect causes share prices to fall globally. There is a direct impact on our portfolios and KiwiSaver.
Black swans are economic events that come as a surprise and have big consequences. Their other feature is that in hindsight, commentators will say we should have predicted it. In this case, with the experience and pattern of swine flu and Sars, this hindsight-bias is a dead cert.
There was a nervous check of my own portfolio this week, with a grimace.
No need for the face-pulling; things had ticked up 1 per cent in the six-week summer hibernation. That’s a great result for a few weeks, but the impact of coronavirus has barely hit.
We are all worried for our personal safety, travelling on flights and the global spread. It feels uncomfortable to have fears for the impact on our wealth given the more immediate gravity.
Yet this is a perfectly normal human reaction. We all fear the next big crash and feeling a fool.
When you look back in time from HIV in the 1980s to measles in mid-2019, some confidence can be gained from sharemarket reactions.
Markets almost appear to be immune over fairly short time periods. After swine flu 10 years ago the markets were up 10 per cent in a month. Yet the data is very misleading. We need to look carefully at where in the market cycle the event occurred. Back in 2009 we were bouncing off the bottom of the Global Financial Crisis. Growth forecasts were so trashed, swine flu was largely irrelevant.
For that reason, we shouldn’t trust past performance data or read too much into it. Each black swan is an event in its own right and turns on its own facts.
Personally I’m still nervous, because there are many factors that make this time unique, rather than the same.
This buoyancy and years of optimistic growth gives more space for a reaction. Pessimism will have a far greater impact at this point in the cycle.
1. Markets are high.
This is a new term that reflects the bounce of social media. We now have ‘‘facts’’ versus ‘‘smacts’’. Traditional media prides itself on independent checks, but social
2. The echo chamber.
media delivers instant ‘‘smacts’’ that echo worldwide. The potential for mass hysteria is now greater and we should be prepared for extra volatility. Other major epidemics haven’t been so highly exposed to this.
In the past 10 years, global trade has exploded and become even more interlinked. This progression means we have less and less regional isolation from black swan events.
An early indicator of sell-offs occurs when long-term interest rates fall below short-term (an inverted yield curve). That has just occurred.
3. Supply chains. 4. US interest rate curve.
The big question is, could the coronavirus trigger the next sharemarket collapse? In my view it seems unlikely. This type of event tends to be a volatility creator, not a crash creator. Sure, there will be a slide in share prices, but a massive crash is putting too much weight on the situation.
There are many serious events that affect markets. Red-hot tensions with Iraq, the US-China trade war and Europe losing one of its biggest donors as the UK exits, to name a few.
Like coronavirus, they can all affect growth opportunities for companies. Yet there are solutions via vaccines, diplomacy and political negotiation.
Markets bounce fairly rapidly thereafter.
For a major crash there need to be lies in the financial system. Most crashes are caused by fibs, untruths and things that just don’t stack up. Bubbles are built on lies, not viruses.
What is more likely to cause the next collapse? The global debt bubble for one. With interest rates so low and volumes of easy credit since the crisis of 2008, many companies are highly leveraged and would not be able to meet repayments if rates rose. It’s not a reason to exit the markets, but fund managers are becoming more and more wary of exposing investors to this type of company.
Unicorns are another area of risk. These are startup companies that hit the market with a value of more than US$1 billion (NZ$1.54b). Their valuations are often built on impossible expectations. Uber and Airbnb are examples. Venture capital and private equity money is at bloat level chasing these businesses. Whether the Alicorn (the horn) has magical powers or will pop its own bubble is constantly debated.
Liquidity, or lack of it, is another trigger. Many investors are buying into smaller unlisted companies and startups via private equity and venture capital vehicles. The underlying assets are not saleable and require delivery of a business plan. Savvy brokers create fake liquidity by bundling them into companies with a listed price. Any run on funds from nervous markets can cause the layers to freeze and reveal the real liquidity – none. Frozen funds create panic.
The next six months are bound to be bumpy with coronavirus, but debt, unicorns and illiquidity are the viruses to avoid for long-term portfolio health in 2020.
Most crashes are caused by fibs, untruths and things that just don’t stack up. Bubbles are built on lies, not viruses.
Janine Starks is a financial commentator with expertise in banking, personal finance and funds management. Opinions in this column represent her personal views. They are general in nature and are not a recommendation, opinion or guidance to any individuals in relation to acquiring or disposing of a financial product. Readers should not rely on these opinions and should always seek specific independent financial advice appropriate to their own individual circumstances.