Ian Pizer argues investors would do well to heed the advice of experts through these unpredictable times.
As an investment strategist for an asset management company, preparing for the unexpected and trying to understand its possible consequences on markets is an essential part of my daily routine. Until recently, it never occurred to me that getting a basic understanding of how a virus turns into a global pandemic with the ability to wreak having on the world economy might feature at the top on my list of priorities.
My school history lessons taught me long ago the Spanish flu outbreak that began in early 1918 resulted in far more lives lost than the first world war that ended later the same year. Even so, it is fair to say I, like most others outside the sphere of epidemiology, failed to see recent events coming.
Given the pace and severity of the sell-off, plenty of investors are now trying to call the bottom of the market, perhaps concluding the medical experts are systematically biased to fear the worst. However, if the events of recent weeks ought to have taught investors one thing, it is that going with your instincts and betting against the opinion of the experts is a very dangerous game to play."
Perhaps we should have done, even if it is easy to be wise after the event. Having researched the subject for several weeks, it is apparent numerous credible experts have been sounding sirens in recent years. As recently as January 2019, a US intelligence report warned the country "will remain vulnerable to the next flu pandemic or large-scale outbreak of a contagious disease that could lead to massive rates of death and disability, severely affect the world economy, strain international resources, and increase calls on the US for support."
Later last year, a group of prominent international experts warned there are "increasingly dire risks" of epidemics and efforts by governments to prepare for it are "grossly insufficient". The first annual report by the Global Preparedness Monitoring Board, an independent group of 15 experts convened by the World Bank and World Health Organisation (WHO), describes the threat of a pandemic spreading around the world, potentially killing tens of millions of people, as "a real one."
Meanwhile, in the prologue of the Netflix docuseries Pandemic: How To Prevent an Outbreak, Dr Dennis Carroll, director of USAID's Emerging Threats Unit, warned in reference to the Spanish flu outbreak of a century ago: "This kind of carnage is not relegated to history. When we talk about another flu pandemic happening, it's not a matter of if, but when."
Part of the problem is that since the turn of the century we have seen several other outbreaks of viral diseases - including SARS, MERS, bird flu, swine flu and Ebola. In each case, medical experts raised the alarm only for a pandemic to fail to materialise. But far from crying wolf, we now realise they were right to have expressed concern on each occasion. We should have learnt from their success in ending the threat, rather than believing it never existed.
With the benefit of hindsight, financial markets were far too complacent about the threat posed by covid-19, hooked on the monetary heroin they had depended upon since the financial crisis; viewing that as the cure for any weakness in the global economy. This overreliance has proved costly.
Highlighting just how violently markets can move to adverse events, it is worth remembering that the S&P 500 hit an all-time high of 3,386.15 on February 19 - over seven weeks after China alerted the WHO to several mysterious cases of pneumonia in Wuhan.
On the same day as the US stock market hit a record, the WHO revealed there were nearly 144,000 cases worldwide and that the virus had spread to 25 other countries. Investors' complacency has now been replaced by fear. On March 19, one month on from its peak, the S&P had sunk 29% to close at 2,398.10.
Don't ignore what you don't understand
By early February there was clearly a marked disconnect between what most of the medical literature said and what financial markets wanted to believe. As a result, I was tasked with investigating in more detail exactly what experts had to say about COVID-19 with a view to trying to assess what the market impact could be under a range of scenarios.
It wasn't hard to find the information: much of the research is freely available on the websites of the WHO and various leading academic institutions such as John Hopkins University, Harvard Medical School and the London School of Hygiene and Tropical Medicine (LSHTM). Furthermore, it is written in surprisingly straightforward language, suggesting the authors want it to be as accessible as possible.
While I do not pretend to have any more knowledge of medical issues than the next person, I am a mathematician by background, having obtained a PhD in Mathematical Logic. While this is by no means essential in understanding the overall risks from covid-19, it has been useful in getting to grips with the modelling aspects, as mathematics underpins much of the science of the spread of an epidemic. It did not take me long to appreciate that what some financial analysts were saying was incorrect, and contradictory to the science.
In epidemiology, the basic reproduction number (denoted R0) of an infection is the expected number of cases directly generated by one case in a population where all individuals are susceptible to infection. In a simplified model, R0 depends on three factors: the probability you will infect someone if there is social contact; how many contacts you have; and the probability those contacts are susceptible to the virus because they have no immunity. If R0's value is above 1, the virus will spread; the higher is the value, the harder it will be to control.
One of the first articles I read was a blog on the LSHTM website. The author said while there was a lot of uncertainty as the outbreak was still in its infancy, there was already strong evidence to suggest it was unlikely to be contained and would turn out to be a pandemic. This was markedly different to the prevailing view in the market and prompted me to look into why viruses such as MERS and SARS, both of which had very high mortality rates, peaked and eventually stopped.
Since in the early stages of an outbreak, 100% of the population is susceptible as there is no immunity, the first two factors - the probability you will infect someone if there is social contact and how many contacts you have - are what determine the ability to control the spread of the disease. In the cases of SARS and MERS, transmission was proportional to symptoms. People were only highly infectious when they were very ill, which enabled authorities to trace contacts before they became contagious and get on top of the reproductive number. Effectively they were able to reduce the number of social contacts for those who were infected to zero.
Unfortunately, in the case of covid-19 there is plenty of evidence to suggest it can be transmitted by people who are either asymptomatic or have very mild symptoms. As a result, it is almost impossible to identify those infected before they become contagious. This means that the ability to reduce social contact with the infected, as seen with SARS and MERS, is not repeatable. Social distancing at a total population level is therefore required.
However, since this is hard to achieve for the whole population, most experts currently believe that while such measures can slow the disease's spread, as with the Spanish flu it is likely to come back in waves as and when those measures are relaxed.
Desperate to slow the disease's rate of progression so as to prevent their health systems from being swamped, governments have resorted to increasingly draconian lockdowns. That is crushing economic activity, which has in turn led to the financial market meltdown.
As we became increasingly concerned, we took steps to reduce risks in our portfolios. With the benefit of hindsight, we perhaps could have been even more aggressive in cutting risk but these steps have helped. What we didn't quite expect was the extent to which Western governments would look to suppress rather than simply mitigate the spread of the virus.
Given the pace and severity of the sell-off, plenty of investors are now trying to call the bottom of the market, perhaps concluding the medical experts are systematically biased to fear the worst. However, if the events of recent weeks ought to have taught investors one thing, it is that going with your instincts and betting against the opinion of the experts is a very dangerous game to play.
With the news getting progressively worse in many countries, and little end in sight to the pandemic, rather than trying to call the bottom of the market, investors might do better to reduce the overall risk of their portfolios.
Having said that, the speed of the response of both governments and central banks has been large and rapid. While this makes assessing the likely direction of financial markets no less difficult, and although concentrating on relative value trades might make sense for now, investors also need to ensure they remain alert to opportunities to add risk when it seems appropriate over a two-to-three-year horizon.
One thing seems certain: in the coming weeks, more and more investors should scour the medical literature for better insight into COVID-19's progression before making big investment calls.
Ian Pizer heads the investment strategy team at Aviva Investors.