The Affect Heuristic
The dominance of conclusions over arguments is most pronounced where emotions are involved. The psychologist Paul Slovic has proposed an affect heuristic in which people let their likes and dislikes determine their beliefs about the world. Your political preference determines the arguments that you find compelling. If you like the current health policy, you believe its benefits are substantial and its costs more manageable than the costs of alternatives. If you are a hawk in your attitude toward other nations, you probably think they are relatively weak and likely to submit to your country’s will. If you are a dove, you probably think they are strong and will not be easily coerced. Your emotional attitude to such things as irradiated food, red meat, nuclear power, tattoos, or motorcycles drives your beliefs about their benefits and their risks. If you dislike any of these things, you probably believe that its risks are high and its benefits negligible. The primacy of conclusions does not mean that your mind is completely closed and that your opinions are wholly immune to information and sensible reasoning. Your beliefs, and even your emotional attitude, may change (at least a little) when you learn that the risk of an activity you disliked is smaller than you thought. However, the information about lower risks will also change your view of the benefits (for the better) even if nothing was said about benefits in the information you received.
Kahneman, Daniel. Thinking, Fast and Slow (p. 103). Farrar, Straus and Giroux. Kindle Edition.
The dominance of conclusions over arguments is most pronounced where emotions are involved. The Public’s emotional attitude guided by the affect heuristic has turned to despair. Could it be that the world is forever altered? That is how many people seem to be reacting to the current crisis.
Investors are not to be confused with traders. If you are a long-term investor, the urge to “take action” may benefit from the recognition that staying invested is a courageous action. To bolster resolve, it may be helpful to ask where all the money generated by selling goes…This may be the same money that will come back and buy when the news becomes less negative or actual breakthroughs are announced. Take note that in order to trade and avoid the declines of a negative market, you need to be correct multiple times. First, you need to anticipate and avoid the initial downturn and then, when the fear is at the maximum, you need to see the light and buy back in. There is little evidence that this can be done.
Mortgage rates are at all-time lows. Gas prices are dropping. The US Treasury is sending everyone free money. Oh, and one other thing. You need to “shelter in place”. We are living in a surreal world where a highly contagious, “novel” virus known as COVID-19 has spread globally at an escalating pace.
It is strange to imagine life as it was just a month ago. Every morning is a news-check with depressing updates of infection rates and new “hotspots”. It is rational to think that this contagion will have a finite life span, yet that does not feel reassuring in the moment.
One of the longest US bull markets on record began on 3-9-2009. In that near 11-year run, there had been corrections (5-10%) but no bear market (20%+) declines. That came to a dramatic end in February with COVID-19 crisis of 2020.
The market had been positive without significant downswings for an extended period. The ease with which gains accumulated created more drama once the long-term uptrend reversed and became a rapid decline. The longer the bull market, the more volatile the ultimate bear market can be.
This virus has spawned a global health care crisis that has sent markets into rapid downswings. The US and global markets have endured a historic sell-off resulting in one of the worst quarters on record. This slide has been followed by volatile upswings of a magnitude rarely seen. The uncertainty of the virus timeline has investors and traders guessing as to when signs of normal economic activity will begin to emerge. Markets may see buying before concrete evidence of recovery is prevalent.
The playbook for a global health crisis is to stay inside and avoid contact with the viral threat. That could be said for investors that own quality companies. Doing nothing and avoiding the trading frenzy may be the best course of action. The timeline for this downswing is impossible to predict, yet it is likely to be marked by a reopening of commerce that could spark surging economic activity.
Ultra-rare events are sometimes referred to as a “Black Swan”. These moments cannot be anticipated. The invisible spread of germs has pervaded the public consciousness triggering an unprecedented response. The notion of public quarantine on a mass scale was a very unlikely scenario for investors to plan for.
We are witness to a convergence of additional factors that have made the downturn uniquely dramatic.
Market levels that had been rising vigorously for an extended segment of time
There was a prolonged period where the markets had not experienced any cleansing corrections. The dynamic of smooth and persistently rising markets inevitably runs into negative events. Global pandemic is what has arrived. This previous “Goldie-locks” market was particularly vulnerable to an unprecedented challenge as the elevated prices of assets globally induced vigorous selling to attempt to book gains.
Demand for all types of market-based investments had been so high that the condition known as “overbought” was prevalent. Pent up gains unleashed a torrent of selling as few buyers were available to temper the downdraft. The supply of buyers had been exhausted to a high degree in 2019 and that presented a huge reservoir of ready sellers.
US Federal leadership render inept response
On 2-25-20 National Economic Council Director Larry Kudlow stated “We have contained this. I won’t say [it’s] airtight, but it’s pretty close to airtight”. This is the same Larry Kudlow who in December 2007, the month the Great Recession started, boldly told viewers, “There’s no recession coming.”
Hesitating to invoke the war powers act in order to fortify the medical supply shortages and hospital capacity weakness set back the FEMA response capabilities. There is evidence that the administration was lobbied by entities worried about the heavy hand of government with federal production mandates. There has also been stark concern expressed regarding the involvement of FEMA versus HHS as the lead agency. These are perplexing problems that would challenge even the most experienced leadership team.
The federal messaging for this crisis has been improvised and unbalanced. Conflict driven political messages about how terrible the opposition party is ring hollow now that we need bipartisan federal action to address this challenge. It seems ironic to recall that the government was shut down over funding for a “wall” and then we were attacked by an invisible virus.
The initial response maintained that the problem was being exaggerated. Then, the gravity of the spread globally demanded broad policy response which was met by numerous “travel bans” when the efficacy of those tactics was likened to closing the barn door after the exit of the livestock. Recently we have been witnessing daily briefings by the President himself. This has led to confrontations with reporters and confusion regarding vaccine, treatment and hospital capacity.
The strategy of the President seeking to speak daily may diminish the power of the office when bolstering confidence is the aim. The bully pulpit needs to choose its words carefully and make sure that they have maximum impact. Professional spokespeople that could handle daily briefings are conspicuously absent.
There is an ongoing chorus of praise and proclamation of how well the administration is performing in the briefings. Celebrating what a great job you are doing while you are doing it is not generally regarded as a trait of quality leadership. This has not been reassuring to the markets or the general public. This daunting invisible menace would be a monumental challenge to any president.
Messaging is crucial but policy is ultimately what will matter. Making the trains run on time is an impossible task. Crisis makes many scapegoats and few heroes. This is a very difficult challenge and it is likely that our messy system of checks and balances will render what can help, albeit slowly and with little grace.
Federal deficit spending high going into the downswing
When the economy is hit with an external shock, the federal government can assist by increasing spending and assistance to buffer the downswing. This ability to act as lender and program funder when other elements of the economy are pulling back can have significant impact as to how long and deep the economic contraction may be.
There is a history for spending hawks in the US to be concerned about Federal spending and debt. When conservatives gained full control in 2016, there was no interest in practicing fiscal responsibility. This unleashed both parties on a recent spending binge as the system incentivizes individual congress reps to bring home the bacon (or plant-based protein if that is what they prefer, haha). The recent corporate tax cut was all candy and no (cuts) courage as the leadership fantasized about how the economy could grow at a rate that would magically add Federal revenues to make up for the cut. This “deficits don’t matter” mentality began in the 1980’s.
Now the need for massive deficit spending is upon us. This emergency funding will be piled on top of the existing mountain of debt that already existed. Both parties in our binary system will blame the other for the debt, but actual spending cuts that are necessary may never arrive. This is likely to diminish the nominal value of money as the quantities of “stimulus” and Federal Reserve actions flood the banking system with newly created money.
Interest rates were historically low prior to this crisis.
The supportive impact of cutting interest rates and assisting the economy is having limited impact as rates had been held low by inertia of the 2008 financial crisis and market reactions that held off each effort to elevate or “normalize” the cost of money. In December 2018 The Federal Reserve was on a course to raise rates. Higher borrowing costs may have disciplined the relentless rise in markets that turned out to be vulnerable. This is all irrelevant now as massive sums of cheap money are going to be deployed to try to buffer the downturn.
QE is the acronym for Quantitative Easing. QE is an expansion of the money that seeks to foster stability and seek to reduce downswings as interest rates fall to zero and further cuts are not available. The Federal Reserve has the magical ability to purchase bonds by effectively creating money. As disturbing as that may sound, it is a feature of modern “flexible” monetary policy that ultimately can buffer the downswing in a crisis. Effectively the dollar is being gradually devalued. Inflating the US currency may support asset prices which may allow long term investors to keep pace with the falling real value of the dollar.
The Federal Reserve has responded to this pandemic with open ended QE. Open ended means unlimited. The efficacy of QE in 2008 has now galvanized the belief that our central bank is the backstop of the global financial system. It may be possible that these monetary tools can reduce the economic harm of unanticipated shocks to the global financial system.
Saudis decide to start an oil price war
The demise of OPEC as the world’s most powerful energy cartel has led to perplexing strategies of former oil powers, particularly the House of Saud. The sheikdom increasingly flails at a world awash in energy. The rise of US domestic production as a huge global supplier has shifted the balance of energy power from kleptocracies like the Saudis and Putin’s Russia. The Saudi vision is bizarrely centered on a price cutting strategy that further rocked the markets during the COVID-19 crisis.
The Middle East oil powers seem to be as delusional as an American dreaming of the glory days of the 1950s. In the context of the current crisis, the flooding of international oil markets was a significant destabilizing force. The oil kingdom sees a production increase as a tactic that will be beneficial to its position as the world leader and dictator of pricing. This is 180 degrees from the Financial Crisis of 1973-74 when OPEC was so powerful it was able to cut off supply to the United States. Ultimately this plentiful supply is likely to be another positive that will power the modern global economy with oceans of cheap oil.
The narrative since mid-February has been relentlessly negative. What could possibly go right?
Science
In the daily grind of the surreal “shelter in place” tactic to battle the contagious spread of the virus, it is difficult to perceive the relentless march of human innovation that is being brought to bear against this problem. Gene sequencing technologies, treatment testing and vaccine development are all likely to produce breakthroughs. The pace of these efforts will be driven by new tools and techniques that were unimaginable in the battles of past public health challenges.
An astonishing number of efforts are underway to develop treatments and vaccine. See https://milkeninstitute.org/covid-19-tracker
Asia recovery model
Chinese power plants have doubled coal burning since February
Source: China Coal Transport and Distribution Association
China is burning more coal in yet another sign that the first country hit by a coronavirus outbreak is returning to a level of normalcy. Daily coal burn at select coastal plants has doubled from early February, at the height of the country’s lockdown to stop the spread of Covid-19. The plants are responding to resurgent electricity demand as factories restart in the world’s second-largest economy.
Dan Murtaugh and Jing Yang, Bloomberg
March 30, 2020, 9:08 PM PDT
There are strong signs in China, Japan, and Korea that this is a finite event. Quarantine, distancing and ultimately herd immunity will hopefully put a cap on the spread. This threat will likely have a time frame that is less than any worst-case scenarios that are being circulated.
Baby Boom
One of the economic stories of this crisis is likely to be that of a significant uptick in the birthrate of many western countries. The western world’s long term fertility decline is unlikely to be reversed, but the unprecedented togetherness of sheltering in place is likely to impact birth rates in a positive way.
It is probable that the economic challenges of the future are going to demand a growing population. The fertility rate in many aging countries will be an important piece of this puzzle.
The need for infrastructure development and expansion has been a sad federal policy failure for decades. This crisis could lead to massive economic activity in health care infrastructure along with a viable strategy for transport, electrical grid and even national rail development. These areas may well be sources of future growth.
Leadership action becomes more effective and better articulated. Let’s call in The Marines
The crisis seems to be creating its own learning curve for federal and state leadership. The layered nature of State government offers a powerful resource for societal reaction at the local level.
Governors are responding to unique and regional needs of their state. State level actions may be more informed and efficient as the need for policy decisions demands aggressive action.
Monetary Federal fiscal action takes time but ultimately creates a bridge to a point in the timeline where the virus plateaus and begins to decline
The Federal Reserve has responded to this crisis early and vigorously. It is likely that the economic damage currently being done will be significantly impacted by activist central banks around the world.
The monetary system has always evolved to meet challenges and needs of humanity. This process is messy and filled with unknowns. Like the impacts of food production, industry and technology, monetary techniques will have broad impacts. The history of these changes, led by the Federal Reserve have had many positive results, with gut wrenching swings along the way as markets adjust.
The narrative has been relentlessly negative since early February when the first cases began to appear in the USA. Daily, the information flow was centered on rapid spread and calamitous outcomes as hospital systems in Wuhan, Italy and other global hotspots suffered terrible supply and treatment shortages.
This has been a trial and test of society as we struggle against a nasty bug and the vulnerability of our modern world. Public confidence has fallen so far that the resilience, innovation and long track record of success in medicine, vaccine and treatment has been greatly discounted.
Mother nature periodically challenges humans and the history of these battles in one of innovation, invention and breakthrough. Numerous threats of the not too distant past have been mitigated or overcome. Polio, smallpox and so many other challenges have been destroyed. Medical techniques, biotech and invention yet imagined will solve so much of what we face, as so much of human history has shown.
Prediction as always is impossible. The only approach to the perpetual uncertainty is to remain courageous and committed to the philosophy that owning a diversified portfolio will be effective in harnessing and growing wealth. Terrible challenges will lurk around the turn of a calendar page and then be overcome as a few more months tick by. By remaining disciplined and calm, long term holdings should appreciate and reward over time.
Investors are not traders. The urge to take cover and then re-enter the market after things look better is not a strategy. Timing the ebbs and flows of trial and resolution is unlikely to produce a better outcome than buy and hold.