01 Apr History doesn’t repeat itself …… but it very often rhymes
Not my words, but those of Mark Twain and perhaps nowhere is this more of a truism than in the financial world. Whenever there is a major inflection point, researchers and analysts can be found flicking through the history books to see if parallels can be drawn with previous events.
When the COVID19 outbreak got closer to home, we were exactly the same, looking at how markets reacted to the likes of SARS, Ebola and Zika virus. Whilst financial markets (and ourselves) undoubtedly underestimated the impact COVID19 would have on society and the world economy, history can provide some comfort and the answer lies in the little-known Farr’s Law of 1840.
William Farr was a British epidemiologist, and a pioneer of medical statistics, who postulated that epidemics tend to rise and fall in a symmetrical bell-shaped curve. In other words case numbers accelerate, slow, plateau and subsequently decline. The issue with coronavirus is that this curve is at differing stages across the globe. China, Japan, South Korea and even Italy appear as though they might be past the worst. The UK is still on the upward slope and the US is still further behind. But if the law holds true, and we see no reason why it shouldn’t, infections will peak and decline.
As I mentioned last week, because the economic impact is so severe, financial markets have taken fright. As the chart below shows, using US data, until 24th March the equity market had gone 32 days without back-to-back rises, making it one of the longest losing streaks in recent history. The worst was in 1931 (37 days).
During this period, the primary response has been one of panic, but the more fundamental cognition has been the challenge of how to value stocks. After all, how do you value an airline when all the planes are grounded or a retailer with all its outlets temporarily closed? The bottom line is that the longer society stays in lockdown, the worse the economic impact is going to be, and that will potentially lead to more instability in prices, so all eyes are firmly on the trajectory of infection rates.
So just how bad is the economic downturn going to be? I have said that Q2 economic performance is going to make depressing reading. Certainly the US jobless data last week gives us a clue, as we saw 3m Americans register as unemployed, a number which dwarfs the previous worst (695,000 in 1982 and 665,000 in 2009). Second quarter GDP could easily see a 20% annualised decline making it one of the steepest in history. Subsequent quarters could return positive, provided there is encouraging news on infections and the shutdown rules are relaxed. There will be scars. Savings rates will likely trend higher and large ticket purchases for many households (such as cars) will be deferred.
The correction in markets has been a realisation of the gravity of the downturn as the chart below highlights.
This model tracks earnings estimates for corporations. The dotted line plots average consensus estimates for company earnings. From this you will see forecasts were generally steady, but overall compared to last year, analysts were expecting a 4% improvement year on year to Sept 2020. This has been sharply revised to a 23.7% contraction for Q1 this year. The previous estimate of an 8% fall was produced only a week ago and this amplifies the severity of the downturn on company earnings.
So we know, and the market knows, the economic downturn is going to be ugly but markets notoriously look forward. Once infection rates turn, market sentiment will improve and when it does, prices can snap back extremely rapidly. This is completely consistent with previous crises and explains why I have been at pains to point out the vagaries of selling out too soon. Looking at the day we produced the last update, the 24th March, this witnessed the biggest one day rise in US stocks since 1933. Closer to home, the FTSE rose 9% in a day. The past week has seen UK share prices rise over 13%.
This does tell us something valuable about the characteristics of equity markets. The annualised return for the FTSE100 since 1991 for example is a fraction over 9% but this has not been delivered evenly. Over this period, the return has ranged from -28% (2008) to +29% (1997) but only around 25% of the individual calendar years have been negative. This is akin to the children’s board-game ‘snakes and ladders’ where steady reliable and frequent ascents up the ladders can be undone by less frequent but severe and often steep descents.
This takes us back to the issue I highlighted earlier, that infection rates are at differing trajectories around the world. The chart below makes interesting reading:
It highlights the daily percentage change in various stock market indices around the world. Whilst it is a few days old, notice those eastern economies where the virus emerged early but looks to have peaked, such as China South Korea and Japan. Here, market volatility has moderated considerably and probably helps to answer another question I raised last week which was when stock prices might stabilise. It is also worth mentioning the 49 day ‘rule’ I touched on, that markets typically take 6-7 weeks to come to terms with shocks to the system such as we have seen.
Returning to the title of this note. Parallels have been drawn with the great depression of the early 1930s and it is easy to see why. The market fall was similar in magnitude and the ensuing pattern of volatility is consistent with what we have seen recently. But here the similarities end. In the 1930s central banks did not even exist let alone offer stimulus, deposits were not protected, and there was little or no regulation. The 1929 crash was a culmination of extreme leverage and speculation which brought about a collapse in the banking sector, foreclosures and ultimately destitution for many.
One of the most dangerous phrases in the investment world is ‘this time it’s different’ but this time it really is. As the title suggests, there are parallels with history, but it is rarely the same.
Dr Andrew Mann
Investment Director