Coronavirus: A Black Swan Event

Disclaimer: this blog post was put together for informational purposes only based on my review and analysis. This should not be construed as a solicitation, offer, or recommendation to acquire or dispose of any investment, engage in any transaction.

By Nassim Olive, CFA — Partner at Eterna Capital

The past few weeks have been nothing but eventful. As COVID-19 continues spreading around the world at a rapid pace, governments are being forced to take extraordinary contingency measures to slow down the pandemic outbreak (At the time of writing, WHO has announced it classifies the coronavirus as a global pandemic).

Without downplaying how serious the new coronavirus is, it is fair to say that we see a pandemic of fear fuelled by global media and witnessed everywhere from your local supermarket to Wall Street trading floors. In a globalised world, it is very challenging to contain the shock spreading to traditional supply chain rails and the drop in global demand — a domino effect driven by a black swan event. While we see short-term repercussions move from the healthcare sphere into politics and economics, we are optimistic over the medium term as medical experts find ways to contain and defeat the virus and most importantly, we remain focused on long term trends.

A short-term shock

As investors, the short-term impact on traditional markets caused by the COVID-19 outbreak has been a rollercoaster with a general feeling of risk-off across the board as investors around the world demonstrate a flight to safety approach. Some of the moves witnessed go all the way to stress the functionality of financial markets with a dramatic pickup in volatility and the beginning of what looks like a potential oil war between Saudi Arabia and Russia. We have seen government bond yields reaching all time low levels, equities diving across the board and oil prices taking a dramatic hit not seen since the first Gulf war in 1991.

While the situation remains uncertain, it should be temporary as the virus outbreak will eventually dissipate. Governments around the world are working on implementing stimulus plans to deal with the short-term shock to the global economy in order to prevent a possible recession. This time, we believe that to ensure an efficient impact that prevents cash flow issues, initiatives need to be quick and coordinated between central banks and their local governments to implement both monetary and fiscal policies but also between nations to revive the global economy.

The odds of a medium-term V-shaped recovery are increasing

When the SARS pandemic was identified back in 2003, China represented around 3% of global GDP, today its role in the global economy is undeniable — it represents close to a fifth of global GDP. The strong control and quarantine measures imposed by the Chinese government seem to be paying off [1]. Over the recent weeks, the number of daily cases diagnosed has decreased and China has recently announced that 70% of its infected nationals have recovered — this is reassuring news when it comes from the global manufacturing powerhouse.

It is important to put COVID-19 into the economical context. Before the virus outbreak, various data points coming out of the US and China were showing strong fundamentals — while businesses were showing signs of reduced confidence and spending, consumers data points have been very strong. A survey conducted by Bloomberg earlier this year (and measured by the Bloomberg Consumer Comfort Index) shows that confidence among Americans has surged to levels not seen since late 2000 [2] — driven by record low unemployment rates and an accelerating wage growth. On the other hand, US Purchasing Manager Index (PMI) experienced a drop late last year to four-year low levels [3] — driven by continuous trade conflicts uncertainty and a flat to inverted yield curve. In China, the overall sentiment picture is very similar [4].

Historically, inverted yield curves have been indicators of a recession, but with business confidence and spending lagging behind consumer optimism, we believe the recipe for a V-shaped recovery is in play. As recently announced by the IMF [5], we expect a short-term hit on real GDP (though we don’t know yet the magnitude) due to a slowdown in business activities but as governments put in place coordinated monetary and fiscal policies, as the virus outbreak dissipates, and as the focus moves to the US 2020 presidential election, we could be positively surprised by the recovery later this year and into next year.

Shocks put innovation at the forefront

Innovation is what drives society to evolve. DNA sequencing and artificial intelligence are innovative solutions that enabled medical researchers to successfully sequence COVID-19 in 48 hours compared to several months for the SARS virus in 2003 — this will enable the first vaccine to likely be commercialised in a few months rather than years — such a fast discovery has a direct impact on saving thousands if not millions of lives around the world.

As shocks and crisis shake the economy, innovation gains traction. We have witnessed this during the past financial crisis with a flourishing number of start-ups and more established technology companies offering innovative products and services that are cheaper, faster and more cost efficient. During the last global financial crisis, online retailers, web applications and Software-as-a-Service (SaaS) companies significantly increased their market shares propelling new innovative business models to become the new normal.

Innovative technologies will gain traction

We believe that the current shock caused by the COVID-19 outbreak is giving innovation another opportunity to reshape the current world order. This is where we see innovative technologies (e.g. artificial intelligence, robotics, blockchain) offering long term solutions to the problem.

As companies’ balance sheets suffer and supply/demand dynamics get shocked, we anticipate a pick-up in investments and speed of deployment in innovative solutions to close the output gap. Blockchain is part of this innovation and can help companies get closer to their customers and streamline supply chains — this could help reduce timelines to commercialisation and facilitate financial transactions — improving the efficiency of current business processes.

Blockchain tops the list of most in-demand “hard skills” for 2020 according to a report compiled earlier this year by LinkedIn [6]. Indeed, we are seeing a significant influx of talent working on building blockchain solutions.

The current environment provides even more reasons for businesses to seek innovative solutions as they look to reinvent their business models to remain competitive over the long term.

What is next?

The COVID-19 pandemic is putting pressure on the world economy, countries are in lockdown, people are forced to work from home, conferences around the world are being cancelled and travel is being dramatically reduced. As inventories and capital spending fall over the coming months, we should see more governments around the world respond with contingency and stimulus plans to revive the short-term demand squeeze — a catalyst for the V-shaped global recovery.

While short-term shocks to liquid investment portfolios are jaw-dropping and calling the bottom is always a crystal ball exercise, we see current levels as an opportunity for investors to get exposure to markets at attractive valuations. The revised valuations are likely to create a pipeline of early stage opportunities for the coming years.

Conclusion

As investors remain cautious about how to approach investments, we think it is even more essential to keep a cool head, stick to the fundamentals, implement a thorough investment selection process and build long term focused diversified portfolios.

During periods of turbulence, businesses and consumers are open to think differently, adapt and change their behaviour. As both look for cheaper, more productive, or more creative ways to meet their needs, we believe that disruptive innovative solutions will develop and gain significant revenue market share.

Investment company focused exclusively on blockchain technology. www.eternacapital.com

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