Contain-Delay-Mitigate (and Biden gets a cheque book)

Over the last few weeks, this update has been saying that markets would drift lower or sideways due to the virus but market swings have been quite violent. It may not feel like it but stocks are flat on the week whilst hedges, such as bonds and gold, are up.

There are two main short-term issues to focus on and the feedback loop between the two: the virus and the US election.

There is concern that the US has not conducted enough testing so many investors are expecting US cases to increase significantly from here. Finally, the observed death rate calculated by dividing the number of deaths by the known number of cases appears high at 3% and is scaring people.

However, one could paint a more sanguine picture. It is possible that many more people have the virus than has been reported, partly due to lack of testing and partly because some people just fight it off without seeing a doctor. So it is possible that the death rate is actually much lower than 3% and more like 0.3%-0.9%. For context, the flu is more like 0.1%.

The outbreak on the Diamond Princess cruise liner is a good real-life experiment to look at. 705 people contracted the disease but only six have died and all of them were over the age of seventy. This is a rate of 0.9%. In this context, it looks like governments in the western world are actually pursuing the correct policies of delaying the onset of the virus via public health notices, hand washing advice and so forth. Therefore, moving to mitigation and shutting down economies is not a given.

The reason investors are concerned about the virus is that should it take hold in a serious way, and should the western world more or less shut down, then there could be a demand shock as the main western economies hunker down in order to contain the virus. This is not the base case and remains unlikely. However, it is this tail risk which is troubling markets as investors are looking at the daily rates of change in infections outside of China and seeing numbers like 19% this morning and 20% two days ago.

How developments in the US affect the feedback loop to the US elections is an important question.

As mentioned last week, if the US response is not handled well and people start blaming Trump for that, the chances of a Democrat taking the White House should increase. Depending on how the Senate races go, this could be seen as bad for markets. This week Trump’s job got a lot harder as after Super Tuesday, Joe Biden has emerged as the Democratic front runner and Bloomberg dropped out. Furthermore, Bloomberg has now committed to backing Biden with his money, so this week Biden received a cheque book as well as electoral momentum.

What does this all mean?

Based on the above, it would not be surprising to see markets drop a further 5-10% from here. Such a drop could present investors with an attractive buying opportunity, assuming no new major news emerges. However, it is equally plausible for markets to build a bottom around current levels. During these periods, diversity is vitally important for investors. Holding a meaningful position in equities still makes sense but combining this with bonds, gold and risk off alternative funds will help dampen volatility.

© 2019 GWM