WE ARE EXPERIENCING A “BLACK SWAN”
This is a metaphor used by Nassim Nicholas Taleb to describe events such as Coronavirus, which happen unexpectedly and infrequently with significant market and economic consequences. The last ‘Black Swan’ we experienced was not that far ago in 2008, when the Global Financial Crisis (GFC) hit financial markets as well as global economies. However, these events are not supposed to occur so frequently!
Donald Rumsfeld, US Secretary of Defence under George W Bush, has also described these unpredictable events as ‘Unknown unknowns’. “There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know.” It is the latter ones which trigger crises and shocks to the system.
MARKET REACTION THUS FAR BREAKING NEW RECORDS
The reaction to this Black Swan event has been unprecedented with global equity markets having had their worst performance in such a short period of time. To put this in perspective, the S&P 500 was down nearly 30% from its all time highs (made a month ago), major European equity markets such as Germany and France have fallen by nearly 40% whilst China remained resilient due to signs of stability from the virus, policy support and intervention.
My concern surrounding markets was expressed during a 3rd February interview with Bloomberg (when I first called this a Black Swan) and 9th March interview with CNBC. During both interviews I stressed that my biggest concern was neither policy mistakes nor the unknown of the virus, but instead the structure of the market having shifted significantly towards passive funds and quantitative/systematic models which accentuate sentiment and momentum. However, as well as the excessive levels of valuations and the changing structure of the market, another driver has been the complacency of markets after an 11-year bull market run. This is best depicted through one of the most important leading indicators, the volatility of the S&P 500 (also known as VIX) with levels having surpassed those of the Global Financial Crisis in November 2008.
ECONOMIC IMPACT— SMEs in the UK, EU and US
The uncertainty surrounding the virus’ economic impact is real as cities and countries are locked down, all travel plans cancelled and supply-chains disrupted. The hospitality, leisure and travel sectors are particularly impacted and a key focus for policy makers.
Worth considering therefore not only the direct impact on the economy through large cap indices such as S&P500 and DAX30, but also the impact on the SMEs which are the backbone of most economies and represent 60% of all employment in the UK as shown in Charts 1 and 2.
More specifically, the Accommodation & Food sector in the UK employs 2.5 million people, of whom 17% in Micro companies (0-9 employees), 29% in Small (10 – 49), 13% in Medium (50-249) and 41% in Large companies with 250+ employees.
The significance of SMEs may be high in the UK, but it is even higher across Europe. Chart 3 highlights how the importance of SMEs (as a % share of overall turnover) declines from Malta on the top left with 79%, Italy at 67%, Germany at 55% and finally UK at 48%.
Breaking the EU SMEs by sector (see Chart 4), further denotes the importance of SMEs within the Accommodation and Food sector with over 75% of employees working for Micro, Small and Medium enterprises within the EU.
Last but not least, in the United States small businesses (less than 500 employees) employed 47.5% of the private workforce (or 58.9 million people in 2015) as shown in Charts 5 and 6. More specifically, 11% of all private sector employees in the US work within the Accommodation and Food Services section and 61% of those work for SMEs.
In summary, within the Accommodation and Food sector, 59% of UK, 61% of US and over 75% of EU private sector employees work for SMEs.
The initial lack of a concerted effort across policy makers and central banks had been very disappointing; neither finance ministers nor central banks were able to find a common plan of action. As the epidemic widened its impact, however, we have seen more deliberate albeit unilateral action by governments and central banks to contain the economic impact.
The latest attempts include the US administration’s push for a $2 trillion package alongside $750bn of bond buying by the Fed; the UK provided £350bn as its ‘first step’ to ease pressure across corporates and households with further measures expected soon; Germany shifted away from its fiscal prudence to announce up to €500bn in loans for all companies; France, has promised unlimited budgetary support to the cost of €45bn and €300bn of guarantees for bank loans. Last but not least, the hardest hit Italy will distribute funds worth €25bn and has suspended mortgage payments, whilst Spain provided approximately €200bn.
In terms of monetary policy, developed and emerging central banks with room to cut have already cut rates, with the Fed leading the pack with 150bps and the UK cutting to a bare 0.1%. Central banks with zero or negative rates such as ECB, SNB, Sweden and Japan have not acted as the jury is still out on whether this adversely impacts the banking sector.
SO WHERE DO WE GO FROM HERE? WHEN WILL THE ECONOMY RECOVER?
The last time I recall having this debate was between Q4’08 and Q2’09 amidst the global financial crisis. Taking it for granted that we have already entered a global recession, what type of recovery should we expect?
V – a swift reversal in economic growth and market sentiment. Assumes Coronavirus subsides by the summer AND there is ample stimulus to ensure an economic turnaround.
U – a protracted period of economic weakness, either due to Coronavirus staying with us for longer than expected, or Policy makers fail to provide the necessary stimulus.
W – even with Coronavirus subsiding, and ample fiscal support, we still have the excesses of corporate balance sheets and the symptoms of a late cycle to deal with in due course.
L – assumes a significantly worsening situation of the virus with second and third waves reappearing and delays in finding an appropriate vaccine taking years instead of months.
From initial results out of China and S Korea we hope we can avoid the worst case scenario surrounding the virus; therefore we expect scenarios W and U to be the most likely with ample support from policy makers and central banks.