"The four most dangerous words in investing are: 'this time it's different.'"
-Sir John Templeton
The Black Swan is either the most overused term in financial risk management, or it’s the most under appreciated. When volatility is low and the stock market is ticking higher at a measured rate, the Black Swan is basically extinct and rarely mentioned. Conversely, in periods like last week, we see Black Swans everywhere.
While the idea of the Black Swan goes way back in literature, the term itself was recently made popular by Nassim Taleb in the book of the same name. In his book, Taleb asserts that black swans can be defined as following:
“First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme 'impact'. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.”
Currently, the market is faced with two key challenges, which to some extent are being characterized as Black Swans. The first is the COVID-19, or coronavirus. The second is the emergence of Socialist Democratic Bernie Sanders as the likely nominee from the Democratic Party for President.
Both events were somewhat predictable, but they carry extreme impacts that are likely to be rationalized with hindsight well after the fact. The question, as always, for us stock market operators is what do we do from here?
Back to the Global Macro Grind…
While we are hardly contagious disease experts, we have been tracking the data around COVID-19 closely. In fact, to the extent you are interested in being added to our daily COVID-19 update note please email .
The challenge with COVID-19 is that we have no idea whether we should believe the data. But as a starting point, we’ll assume it is at least directionally correct, even if probably understating the real impact. Currently, the dynamic is as follows:
- China is improving – On almost all key metrics, the outbreak in China appears to be improving. In the last two days, total active cases of COVID-19 have declined over 9% to 43,041. In fact, total healed to new diagnosis has been tracking at about 7:1 over the last few days. So while China is not out of the woods, the data, as presented, is positive;
- International getting worse – The key global hot spots for COVID-19 at the moment are South Korea and Italy. In the last six days, South Korea infections have grown from 204 → 1,766 and Italian infections have grown from 3 → 453. In the last 24 hours, bout countries added their most new cases since the start of the epidemic.
While the recent warnings from WHO, CDC, and other public health agencies sound dire, the acceleration of the outbreaks in South Korea and Italy suggest that idea of a global pandemic, and its associated impact on commerce and travel is not an improbably event. In the Chart of the Day, we highlight a graphic from WHO that shows the alarming fact that many of the new cases have had no direct contact with China.
→ What to watch from here: Growth (or decline) of cases in Italy and South Korea and/or emergence of other outbreaks globally.
Now that we’ve discussed diseases, we’ll flip over to the much more positive topic of socialism. Any discussion of politics in general usually offends someone, but as stock market operators we need to be aware of the reality that Senator Bernie Sanders would, as President, implement (or try to implement) a very different economic system than we’ve seen in the modern U.S. His recent proposal of a $4.35 trillion wealth tax over 10-years to pay for childcare is but one example.
To become President though he must win both the Democratic primary and then the general election, which doesn’t seem implausible when we consider the following:
- Primary – Currently in national polls for the Democratic nomination, Sanders is polling at 29.2% and Biden, his closest competitor, is sitting at 18.0%. Meanwhile, most betting markets have Sanders at about 57% odds, versus Biden at 22%, and Bloomberg at 13%. In all likelihood, we are probably setting up for a contested convention for the Democrats.
- General election – In the Real Clear Politics poll aggregate, Sanders currently polls ahead of Trump by +4.4 points and has led him consistently since these polls started. The betting markets tell a more favorable story for Trump and suggest he has about a 56% change of being re-elected and Sanders is about 33% chance of becoming President.
To simplify, currently Sanders has about the same odds of becoming President as calling heads on two coin flips in a row and getting them right. Maybe the market has that priced, or maybe it doesn’t . . .
→ What to watch from here: The South Carolina primary is February 29th and is a must win for Biden. Up next is Super Tuesday on March 3rd with 15 states voting.
Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 1.26-1.49% (bearish)
SPX 3070-3223 (bearish)
RUT 1 (bearish)
NASDAQ 8 (bearish)
Utilities (XLU) 67.00-71.90 (bullish)
REITS (VNQ) 93.91-100.55 (bullish)
Consumer Staples (XLP) 61.40-65.88 (bullish)
Tech (XLK) 90.08-97.68 (bearish)
Shanghai Comp 2 (neutral)
Nikkei 212 (bearish)
VIX 18.80-32.33 (bullish)
USD 98.49-100.08 (bullish)
Oil (WTI) 47.02-52.83 (bearish)
Nat Gas 1.70-1.95 (bearish)
Gold 1 (bullish)
Copper 2.52-2.60 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
