Update: Just hours after writing the piece below, President Trump acknowledged on national television that COVID-19 is a global pandemic, outlining several steps in the US government’s response, and global stock markets fell to bear market levels.
As any semi-decent risk manager would tell you, the purpose of hedging now is to prevent having to panic later. Sound reasonable?
For months, certain media pundits and politicians have told you otherwise. In fact, many have gone so far as to pathologize fear.
People, the human species didn’t survive for as long as it has by shedding fear in favor of optimism. There’s a time for both.
As the author of Black Swan fame once tweeted, “When paranoid, you can be wrong 1000 times & you will survive.If non-paranoid; wrong once, and you, your genes, & the rest of your group are done.”
And this brings us to two factors that have caused our markets to crater: coronavirus and the oil price war.
The Coronavirus’ Numerous Secondary Effects Are Far Worse Than First-Order Effects
In a brilliant Medium post by Brian Stoffel titled Coronavirus Won’t Kill You — THAT Is What Makes It So Dangerous, he points out the public’s myopic view toward the virus’ potential for wreaking havoc on our communities via an over-stressed healthcare system.
First, coronavirus infections are not easily detectable, at least not right away. That much we know.
It has a 3.4% fatality rate. Though much higher than any regular flu strain, it’s still relatively low. But that’s the direct first-order effect. It may not impact you if you’re young and healthy.
But the second-order effects will. What might happen if a larger number of Americans are infected with the coronavirus? Do we even have enough hospital beds (or respirators) to serve them?
The fact is that we don’t. But what will that mean for other patients needing services for non-coronavirus conditions (accidents, heart attacks, surgeries, birth complications, etc.).
Where are they supposed to stay? Certainly not with the quarantined patients. But again, we don’t have enough beds. So, the fatality rate may be greater than 3.4% including those who aren’t infected by the coronavirus.
Another second-order effect will also likely happen: many healthcare workers will get infected. So now, not only do we have enough facilities, beds, and resources, we are now going to see a drop in available professional services.
As of late last week, WHO has officially announced that coronavirus has now met all the criteria for a global pandemic.
Italy is in 100% lockdown. We’re beginning to see more quarantine scenarios here in the US, including self-imposed limits by individuals, businesses, and government.
Global banks are beginning to evacuate their offices, according to a CNN Business report.
Among the bigger banks, this includes the likes of JPMorgan, Bank of America, Deutsche Bank, Goldman Sachs, and HSBC.
The point is to split their workforce so as to not have too many people in the same room, and have a number of their workers work remotely.
Of course, we know that among the regular (non-banking) workforce, this pandemic is already causing an impending mess--what if people fall ill? Not only will that affect their employer, there’s no certainty with regard to the sufficiency of their paid sick leave.
The banking industry is just one among others that face these same issues. But it’s close to the only industry handling your money.
The banking industry is no less fragile than others that are vulnerable to this pandemic. The truth is that the country is ill-prepared for this Black Swan.
As the CNN authors write:
“Operating large dealing rooms, where employees crowd to trade stocks, bonds, currencies and commodities, is looking increasingly untenable as the number of confirmed cases of coronavirus in New York and London climb.”
The Securities Industry and Financial Markets Association’s head of technology, Tom Price, told CNN, "We may need some guidance or temporary relief if the goal is to keep markets moving."
And that’s the big question. Can COVID-19’s impact on financial institutions and banks cause a shutdown of the markets? Can it cause certain banking operations to freeze or collapse?
If so, how might this impact investors, retirees, and depositors?
Suppose bank employees were able to work from home. What does that mean for data security, considering that most banking operations will take place in a more open, and less secure, virtual space.
CNN says, “As with banks, remote working poses unique challenges around security and data protection.” In other words, the full force of a bank’s data security will now be vulnerable to cyber breaches.
Bear in mind we’re talking only about the banking industry. COVID-19 will have ramifications in every industry across the globe.
It;’s potential impact overall? It remains a big unknown.
The Oil Price War
Last Monday, oil prices crashed 26%, its worst one-day plummet since 1991, after Saudi Arabia initiated a price war with its shaky OPEC ally, Russia, over disagreements to cut production to buoy the commodity’s price.
Russia refused to go along with production cuts, and so Saudi Arabia retaliated.
Although this may be good for consumers on the purchasing side of the commodity, one of the biggest industries most vulnerable to this price crash is comprised of American shale companies; frackers.
The American energy sector is completely saturated in debt, and Vladimir Putin knows this.
As research firm ClipperData’s director of commodity research said, "This is a response to try to cripple the US shale industry.”
“Russia's strategy seems to be targeting not simply US shale companies -- but the coercive sanctions policy that American energy abundance has enabled," according to RBC Capital’s Helima Croft.
A large amount of energy sector debt is “high yield.” High yield debt is risky.
And a good portion of this risky high yield debt is held by big banks.
What will happen if losses begin to mount in the energy sector? You get defaults--credit market defaults--as big banks end up paying for their high risk speculations.
See our Bank Failure Survival Guide for more information on how to hedge such a potential crisis.
What might happen to the US economy if the credit cycle “cracks”?
Given everything that’s going on in the world today, one thing we can expect is more monetary policy. And you know what happens to the value of your wealth when yet more fiscal stimulus is needed to boost (or in this case uphold) the economy.
The Time to Hedge Is Still Now
Investors’ flight to safety is evident in the sinking sovereign yields across the globe. But if monetary stimulus only serves to weaken the purchasing power of paper money, in our case, the US dollar, is it truly wise to bet your wealth on dollar-based assets?
Obviously, we think not. We believe that a portion of your portfolio might best be served by physical gold and silver--in other words, “sound money.” But that’s a choice for you to make.
Remember, as we mentioned at the top of this piece, hedging is a choice you make in order not to panic when everything comes crashing down.
Everything is crashing down at this very moment.
But this might only be the beginning. Hence, there’s still time to hedge.