I have been looking back at my posts and re-reading my coverage of this global health crisis to get a sense of what I got wrong and why. I know this sounds perverse. But I think it's critical to actively seek non-confirming information and then to try not use it as an excuse for hardening one's pre-conceived view.
Most people look for confirming data, leading to so-called confirmation bias. And even to the degree, we look for non-confirming data, we generally incorporate it by finding ways to explain the data away and strengthen our pre-existing views, the so-called backfire effect. So I thought I would take stock here by genuinely looking for non-confirming information and having it alter my point of view. Let's see how this goes.
My first impressions of this pandemic
I woke up this morning to tweets from the amazing Lisa Abramowicz indicating a sizable move into risk-off territory for global markets on the back of coronavirus concerns. And because I talked about faulty market structure related to one of those tweets, I thought I’d riff on a framework that Eurasia Group CEO Maziar Minovi presented me in an interview released today on Real Vision.
I am still in my ‘cautiously optimistic’ guise here. So, I am still thinking of a recession or credit crisis only as a tail risk in 2020 versus a base case.
-A framework for thinking about tail risk, Credit Writedowns, January 28, 2020
That's the first mention of the coronavirus I can find in any of my writing. And from reading most of what I have written subsequently, what's clear is the framework I was using seems to work. Here's how.
In August 2019, I wrote why my base case for 2020 was a recession (link here). This was speculative though. I wrote:
"But, clearly, if I have recession for 2020 as a base case, I don’t think policy makers will make the right moves in time. So let me flesh out my speculative call here."
What I was saying then was that the US economy would slow and policy makers wouldn't recognize the danger soon enough to prevent recession. I didn't know this for sure but I believed that policy makers are generally reactive, not proactive.
Even so, eventually the data flow turned where recession was less likely, a tail risk. And so, I changed my view in mid-January to 'cautiously optimistic', with expansion in 2020 as a base case and recession as merely a tail risk - with coronavirus flagged as just one of many tail risks. And then I outlined how I thought about tail risks.
On January 31, I made clear that “I think the coronavirus is a serious event risk. But I don’t think it is yet to the point where we have to worry about recession.” But I wrote more on the coronavirus, tail risk and policy error on February 3.
The long and short is I correctly flagged the virus as a tail risk but was 'wedded' to my cautiously optimistic view (perhaps because I had just flipped away from recession as a base case and didn't want to reverse myself).
That was my first impression of the pandemic.
Switch to Alarm
None of the posts over the subsequent 15 days were specifically about Covid-19. So I would call this period the incubation period, if you will - a period during which I identified the risk but was unwilling to put it front and center. And if you think of how policy makers are acting now, it mirrors their response, albeit from a much earlier time frame.
My initial concern was supply chains because of the shutdown in China Feb 18 and Feb 21). Nothing I wrote talks about a pandemic until February 26 when I wrote about economic outcomes from a shift to the coronavirus as a pandemic. My view then:
The lockdown and quarantine approach is having a major impact on economies by shutting down supply and reducing demand. No manner of monetary intervention is going to counteract that. If left in place long enough, this approach will cause the world economy to buckle and break. At the same time, health officials would be hard-pressed not to take this approach, knowing that by not doing so, at least initially, they will be rightfully accused of putting many lives at risk. And if they allowed the virus to spread and infection rates soared, the fear this would cause would have even more dire economic and social consequences.
...But, at some point, we will move to a different approach. Whether that’s before or after a pandemic can become entrenched remains to be seen.
So, my predictions at that time were:
This was likely to become a pandemic
Governments everywhere would take the lockdown and quarantine approach
But, eventually the economic impact would be so severe that they would relax those restrictions
Where did I go wrong? I think I got the timing totally wrong. I got the pandemic call right and the fact that governments would eventually be forced into lockdown. But I also thought they might relax the lockdown before we knew it was a pandemic. To me, that suggests that, in late February, despite my having been early in recognizing the problem, I was not alarmed enough at the pace at which the virus would spread. I mean, we got to the pandemic phase even before lockdowns were in place.
What does that mean? I think it means that the situation is likely much worse than we think. The future exponential rate of infection increase is beyond what we are even now expecting. And so then, the next question goes to how bad it can get. What's the reasonable worst case scenario? I'm not an epidemiologist. So I won't hazard a guess. But I can hazard a guess regarding policy response and economic impact. And the answer is total lockdowns across the northern hemisphere and a major global recession.
Moving to recession as a base case again
I've been thinking this way for some time now. Here, we're talking about a severe global recession as a reasonable worst case outcome. But, again, I was wedded to the cautiously optimistic view and didn't want to switch tack until I was reasonably sure at least a mild recession was a base case.
For example, I wrote this on February 28:
I think a recession is a foregone conclusion for Europe and Japan, and probably for the global economy as well. For the US, the clock is ticking. Tightening financial conditions could soon mean defaults and bankruptcies that amplify the economic slowdown. Let’s see what kind of policy response we get today and at the weekend.
Earlier today, I saw US Treasury Secretary Steve Mnuchin is still pushing this view some 16 days later - that the US can avoid a U- or L-shaped recovery. I don't see it. And here's the post where I made that transition:
So, my view here is that we have to look at the past two weeks as sort of a break point. Before that time period, the coronavirus pandemic wasn’t acute enough outside China to matter. After that point it was. And so, all of the metrics before that period are largely meaningless except to the degree they tell you how susceptible an economy is to recession or crisis.
The US was sitting good as the coronavirus went global. But the US is not well prepared for what’s about to come. And I believe the economic fallout will be severe and long-lasting. Increasingly, we have to think about recession. And if we do have a recession, we are already in it right now.
That would mean a 40% down move in equities, base rates at zero and a 10-year yield approaching UK levels under 25 basis points. Moreover, we have simply not put the safeguards in place to prevent a liquidity crisis from worsening the outlook. And to the degree we get bankruptcies, the rush for dollar funding is going to be huge.
The days for happy talk are now over. This thing is getting serious. And over the next several weeks, the coronavirus will be all that matters for health, in the economy and for markets.
-Are we in recession already?, March 6, 2020
What was I getting wrong? It's too early to say. I think the Mnuchin view is premised on a temporary slowdown that is met with huge pent-up demand in the second half of the year. And massive policy stimulus will be instrumental in overcoming that.
My view is that a more likely scenario is that we remain in lockdown for weeks, if not months, with a reactive and late policy response followed by a weak rebound in demand. And there are two assumptions underlying that.
My inability to understand how quickly the Covid-19 case count could increase despite mooting the lockdown approach more than 3 weeks ago suggests that we are well into the pandemic phase now. Even now, many people in the US are acting like they can congregate in intimate settings in bars and restaurants shoulder to shoulder to people they don't know, when all evidence suggests doing so will cause coronavirus case counts to explode.
The slow fiscal and monetary policy reaction in the US and Europe suggests that policy makers are loath to take preventive measures. They would prefer to react and hope their reaction is quick enough to prevent the worst.
The combination of these two factors leads me to believe that a major recession is more likely than no recession, and that a mild recession is a base case at a minimum, both for the US and the global economy.
I am mostly happy with how quickly I recognized the downside risks of this pandemic. But I think it's clear that I wasn't quick enough. I simply didn't recognize the magnitude of the threat. So, if I had to learn from that, I would ask myself today what reasonable worse case outcomes look like. And, unfortunately, the answers I come up with are pretty frightening. So, actually, I'm not going to answer that question here so as not to spread panic. Instead let me focus on likely outcomes.
I continue to believe that most people - including policy makers - are reactive, and for exactly the reason I am not talking about reasonable worst case scenarios; people simply don't want to prepare for the worst because they fear looking foolish if the worst doesn't actually come to pass. And, given that reactive nature and the likelihood of a true overwhelming epidemic, I fully expect Western healthcare systems to be absolutely overwhelmed in the next two weeks - and for a massive but reactive policy response to result.
The questions are these: how far are policy makers willing to go in this next salvo? Are there key break points in our financial architecture that this response cannot address? If those break points fail, what are the consequences?
I don't have the answers to these questions, of course. But I do think the worst is yet to come in terms of this pandemic and the health crisis it will create. We are facing a serious global crisis, not just in healthcare but for the economy and in the financial system. I'll leave it at that.