Market Update
April 24, 2020

First the Hammer, now the dance

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While stock markets have been looking forward to a much brighter future, Investors have been watching economic data fall off a cliff this week.

Imagine a thought experiment where you knew for sure that company earnings would ultimately return to trend growth in 2022 after an earnings disaster this year. In such a scenario markets would most likely be higher than today. So the difference between that higher number and today’s market level can be seen as the risk premium embedded in equities with respect to a successful going back to work programme.

If going back to work leads to non-isolated mass reinfections of the populations with the virus, you would expect markets to fall from here. However, if governments are successful in getting people back to work without a significant reoccurrence of infections then you would expect the gap between the market levels in our thought experiment and today’s market levels to close over time.

This week’s piece borrows heavily from an influential paper published by Tomas Pueyo recently, titled The Hammer and the Dance. What does he mean?

Well so far, governments around the world have been using a hammer – lock-down measures – to batter the virus into submission and they have largely been successful. Rates of growth in new infections globally stood at only 3% this morning and, more importantly, in many countries the healthcare systems have not been overwhelmed as feared. However, these impressive results have come at a massive cost to the economy.

Going back to work

It is clear that before too long economies will have to get back to work. To borrow Pueyo’s phrase, the world has to start to dance again. How this happens is a matter for fierce debate across the western world, but it is likely that a successful reopening strategy will involve a sharp ramp up in testing and contact tracing, as well as low-cost public hygiene measures, including campaigns for handwashing, masks, gloves and so forth.

This dance becomes the dance of R. R is the transmission rate of the disease; if R is above 1, infections grow exponentially into an epidemic but if R is below 1 the disease dies down. The key thing to monitor over the coming months will be R and in particular R in the largest economy in the world – namely the US and ideally state-by-state.

One website worth watching closely in the coming months will be Rt Live. This is a new website created by the co-creators of Instagram, Kevin Systrom and Mike Krieger. It lists the R-value by state across the US. Naturally, as with anything, it will attract its fair share of detractors and some scientists will debate its methodology, but it is really the rate of change that matters.

Of course, it cannot be predicted if economies will be able to get back to work without R racing above 1. However, one can hope that Western economies will have learnt lessons from South Korea, Taiwan and China and, over time, be able to close the gap between market levels today and market levels in the afore mentioned thought experiment.

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