Is the Corona Virus the Black Swan Event that causes the next recession?
A Black Swan Event from a financial perspective is an event that occurs unexpectedly and with significant and unknown consequences.
The term itself originates from the belief that all swans are white and this is because up until 1697, the western world had only ever seen white swans. The subsequent discovery of black swans in Australia by Dutch explorer Willem de Vlamingh was an unexpected event in scientific history and profoundly changed zoology.
Some investment commentators believe that the Corona Virus could be a black swan event for the world economy and therefore for investment markets.
Until the Corona Virus infection stories started to emerge in early 2020, market sentiment was fairly bullish. The US stock market was hitting new highs, progress in the trade war discussions between China and the USA was being made and, in the UK, Boris Johnson’s Tory party were basking in the glory of a landslide election victory and an 80 seat majority.
As we moved into February, the Corona Virus was seen as only a China problem, very much like the SARS outbreak in 2002, however as cases in Italy, Iran and other countries around the world started to appear, sentiment started to change and nervousness started to creep into markets. As this unease started to gather pace, Monday the 9th of March saw the biggest falls in stock markets since the financial crisis.
Although the US stock market staged a recovery on Tuesday, Wednesday has been another down day as news has emerged that Corona Virus infection rates have spiked dramatically in western countries.
It now looks very likely that the virus will infect many people all over the world and unfortunately some people, hopefully only a small percentage, will die as a result.
It seems that the only way to halt the rate of infection is to lock down and quarantine whole regions or countries as in the case of Italy. If this only happens in a few countries, then the consequences shouldn’t be too severe. Unfortunately though, this doesn’t appear to be the case and with infection rates rising across the world, it looks as if every country will face some form of lockdown.
That lockdown process means that businesses, schools, colleges and factories will shut down for a while, people will stop going out and normal life will be put on hold until the disease is either cured with a vaccine or until we build up some immunity by catching the disease and hopefully surviving.
The worry that some have is that the economic shock to the world economy of the slow down could tip the world into recession and a period of economic contraction. On average, recessions happen every 8 years or so, but as the last recession was 12 years ago, perhaps we are overdue one.
If the world does go into recession, we can expect to significantly more volatility in stock markets and the value of shares, particularly in the USA, but throughout the world will fall.
All things pass however, and at some point markets will bottom out and share prices will start to bounce back. Correctly calling the bottom of the market is tricky though and I expect that we will see several false dawns before the markets finally turn. John Authers, Senior Editor at Bloomberg believes that we won’t reach the bottom until investors have lost all hope. To put it another way things are likely to get a lot worse before they start to get better.
Every cloud has a silver lining though, historically in the 5 years after a recession, markets tend to do very well. Between March 2009 and March 2014 the FTSE100 index made returns of 88%.