Coronavirus: Four big unknowns for investors

The stock market just had more variance in three weeks than in the previous four years combined. PHOTO: AFP

There is an old joke about a trader who hears a talk about the horrors of heroin addiction, covering areas from how many addicts there are to how desperate they are to get the drug and how difficult it is to discourage them, either by treatment or punishment.

The trader raises his hand and asks: "Who makes the needles?"

This is a who-makes-the-needles column. Your main concern about the coronavirus should be its effect on human lives.

But there is a good chance you may survive the pandemic, in which case you will care about your finances. So it is worth taking some time to think about what to do about them from a risk management point of view.

My usual advice is not to watch the markets every minute. Pick a sensible long-term strategy that has a good chance of meeting your goals and track it for possible adjustment every three to 12 months.

But the stock market just had more variance in three weeks than in the previous four years combined.

If your allocation was 60 per cent to stocks and 40 per cent to bonds at the beginning of the year, you now probably have more money in bonds than stocks.

There are four big unknowns for investors. First, how long and deep will be the reduction in economic activity from social isolation?

Second, how much money will the government spend during that period, and how will it deal with the increased debt afterwards?

Third, what will be the long-term public health impact? Fourth, what permanent changes will result?

The first unknown is not really an issue for most investments. The total amount of toilet paper people are going to use over the next five years does not depend crucially on either the virus or the economy. This is true for many things.

If people are buying more now, they will buy less later. If they are buying less now, they will buy more later. Our economy has the capacity and flexibility to supply demand.

Total wages are falling due to lay-offs and furloughs, but when demand comes back, the lost wages will be restored.

Cruise ships may take a long time to recover, if ever. There could be long-lasting effects on travel and hospitality. People who are streaming movies today instead of going to theatres are probably not going to make up for the missed evenings out.

While sales of clothes and cosmetics will likely pick up, there is probably a permanent loss from the weeks or months people spent without much need to dress up.

Therefore, it makes sense to look at your portfolio with an eye towards what may suffer permanent losses from worse-than-expected pandemic severity, what is likely to make up any losses, and what might stand to gain.

In terms of the second question, government action is two-sided.

Lots of spending on relief payments to individuals and bailouts to industries will soften short-term investment losses and stimulate demand. But it will cost at least US$1 trillion (S$1.43 trillion) in the best case for the United States, possibly several times more that amount.

That brings up spectres such as inflation, defaults or massive tax increases likely targeted at businesses, Wall Street or wealthy people.

Any of these could weigh heavily on investment returns.

So, think about what happens to your portfolio if there is a massive, short-term drop in spending with government response capped at US$1 trillion, and what happens if the government spends US$3 trillion and either pretends it did not or tries to get it back.

The third question of long-term public health impact is not a concern. It seems unlikely that the coronavirus will have a significant impact on overall life expectancy.

But if it does, either through a very high death toll, or surviving in high fatality form either in periodic outbreaks or endemic survival, it will change economic calculations about insurance, pensions, healthcare and taxes as well as how people live their lives.

Since this is a who-makes-the-needles column, I will point out that bad humanitarian news is good news for the investors who survive.

Finally, what are the likely permanent changes? Expect an acceleration of a number of trends.

More of life will move to the Internet. Traffic is up 30 per cent as a result of the virus, and that is likely to prove a permanent bump.

Work-from-home and the gig economy will expand. It was happening anyway, and lots of people will adopt it by choice. Education, especially college, will never be the same.

Supply chains will shorten and get more robust, making the economy a bit less global. There will be more support for, and acceptance of, government planning.

The world has changed. We do not yet know exactly how or how much, but we do know it is enough that a portfolio that was optimal last year is unlikely to be optimal today.

I do not recommend guessing the future, but it is wise to ask if the bets you have today are the ones you would make if you were building a portfolio from scratch.

My guess is the answer is "no".


• The writer is a former managing director and head of financial market research at AQR Capital Management.

Join ST's Telegram channel and get the latest breaking news delivered to you.

A version of this article appeared in the print edition of The Sunday Times on April 05, 2020, with the headline Coronavirus: Four big unknowns for investors. Subscribe