While the markets closed with another one-day record high, it is important to think about the last few weeks, as well as place it in a historical context.
Within the last two weeks, we have witnessed multiple one-day record highs and lows. Simply looking at this past week, Monday started with a record one-day low, the worst drop since the crash of 1987, and then the markets set another record one-day high the Friday of this same week (Friday 13th, 2020). The week before last there had been days with record lows followed by record highs the very next day. This is market volatility on a different level.
For example, during the historic drop on Monday, the markets tripped the “circuit breaker,” a mechanism that automatically halts trading for a period of time when markets drop too sharply. This was the first time this mechanism was tripped since 1997; moreover, the circuit breaker was tripped two more times within this last week, due largely to the coronavirus fears.
It is well-established that the markets do not like uncertainty, however, that is exactly the situation that coronavirus is causing. During the 2008 financial crisis, the main issue was the popping of the housing market bubble that led the U.S. Federal Reserve to slash interest rates to zero and the government to approve the Emergency Economic Stabilization Act—a $700 billion bailout to buy mortgage-backed securities. Moreover, while the exact cause of the 1987 crash is subject to some debate, it involved investors’ growing concerns of an impending bear-market, the novelty of beginning to use computer systems on Wall Street, and issues surrounding the role the Chairman of Federal Reserve, Alan Greenspan, had in the matter. While both these cases resulted in significant economic effects and the loss of jobs for many, the current situation is quite different.
In general, people use the past as a model to predict the future and help inform decision-making. There is a slew of cognitive biases that effect this process; however, when it comes to Wall Street and the stock markets, it seems that there are some foundational assumptions that blind people from the notion that the future is novel. For example, The Black Swan Theory highlights the fact that people tend to have biases that blind them to the potential for rare and unexpected future events that may have significant effects. Nowhere is this more true than the stock market, which is literally based on decision theory—a fixed model of outcomes that ignores and/or minimizes the impact of events that are considered “outliers” or outcomes outside of the basic model.
Unfortunately, this is not how life unfolds, as we can look back on historic events that were quite rare, though having a significant impact. This is the reason for the recent headlines of articles featuring economists stating that “This time is different.” One notable economist sounding the alarm on this issue is Economist David Rosenberg. He was serving as the chief economist for Merrill Lynch during the 2008 financial crisis. However, in a recent article, he clearly delineates the 2008 crisis from the economic crisis currently happening when he states:
“In the financial crisis, air travel didn’t come to a halt, borders weren’t being closed, we weren’t talking about quarantines and self-isolation. In the financial crisis, people weren’t scared to leave their homes. We’re talking about palpable fear and when people get fearful, they withdraw from economic activity…. The reality is the financial crisis did not come with a mortality rate.”
The effects of the coronavirus have already led to unprecedented cancellations of events, activities, etc. These effects have already prompted The Federal Reserve to take action. Most recently, this action was in the form of $1.5 trillion in short-term loans to banks in order to “address [the] highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak,” The Federal Reserve remarked Thursday, March 12th. The response by the Federal Reserve is detailed and not limited to simply this one action. This plan will be implemented over the course of weeks, in addition to the possibility of cutting interest rates more (a move they already did a few weeks ago).
However, despite these moves by The Federal Reserve attempting to prevent an economic collapse, some like Christopher Whalen, investment banker and founder of Whalen Global Advisors, do not think The Federal Reserve will be able to stop what is coming. Whalen highlights the fact that the financial system was not healthy to begin with and states that “The virus was the catalyst but it’s not the cause. Both bonds and equities were inflated rather dramatically by our friends at the Fed. You’re seeing the end game for monetary policy here, which is at a certain point you have to stop. Otherwise you get grotesque asset bubbles like we saw, and the engine just runs out of fuel.” Whalen is pointing to a sickness in the symptoms that predated this coronavirus outbreak. Moreover, David Rosenberg wrote in detail about some of these issues in a Financial Post article dated February 7th, 2020. In this article, Rosenberg writes “Fed policy, the trajectory of GDP growth and global economic fundamentals in general all tell a cautionary tale. Both bonds and stocks can’t be right at this moment in time…the equity market no longer seems to trade off the economic fundamentals. Never before has there been such a loose relationship to economic growth.” He wrote this article before the coronavirus started having its significant effects; additionally, he never mentions the virus in the article. What Rosenberg was critiquing was the framework of the current economic system and the dysfunctions that existed, such as discrepancies between market values and asset values.
Taken in sum, these points that I have laid out indicate that the economic effects stemming from this virus were not limited to the coronavirus alone. Instead, the virus served as the catalyst that is now testing the economic foundation of the system itself. After all, this event is one that impacts all aspects of the economy, since it impacts daily life and social activities. This event has released a cascade of events that cannot be walked back; moreover, the temporal extent and the economic/societal impact of this outbreak are entirely uncertain. The only certainty is that the coupling of a pandemic—that has not reached its peak yet—with an economy that has been built using the most advanced technologies in human history and relies on mass, sustained and fast-paced consumerism, will produce an outcome that is entirely novel from the status quo we are accustomed to.