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Investors love a good metaphor to explain away what often appear to be unexplainable events in financial markets. So you hear about stocks taking the stairs up and the elevator down to describe how a slow march higher in prices can be followed by a sudden drop. Or “dead-cat bounce” will be offered as a dark explanation for a market that makes a small but ultimately futile rebound after a sharp loss, likening the price chart to the way a cat seems to spring off the ground following a fall from a tree—even though it was killed on impact.
In recent years the metaphor trotted out over and over has been that stocks are “climbing a wall of worry” as investors dismiss threat after threat, be it the European debt crisis, the trade war, or escalating tensions between the U.S. and Iran. Central banks such as the Federal Reserve, entrusted with the power to set interest rates and buy assets, are viewed as the Sherpas who help investors make this climb. The problem at the moment is how to view the potential damage from the novel coronavirus now that the illness isspreading to countries beyond China. Is this just another row of bricks in the wall of worry, just waiting to be scaled by intrepid financial rock climbers? Or are we confronted with an unforeseen layer of razor wire that’s insurmountable, even with the help of the strongest Sherpas?
As silly as they sound, these metaphors shape the narratives that influence markets and economics—a phenomenon catching a lot of interest because of Yale economist Robert Shiller’s latest book, Narrative Economics: How Stories Go Viral & Drive Major Economic Events. “Going viral” is yet another metaphor, but in this case it’s pretty spot on: Shiller shows how narratives often spread, and then dissipate, at similar rates of speed as epidemics—and how their importance is grossly underestimated in economics and finance.
Equity markets were jolted out of a sense of complacency as the original narrative surrounding the coronavirus—that it was largely contained to China and would be only a brief headwind to the global economy—went up in smoke. With the Tokyo Marathoncanceled and outbreaks reported in such places as Milan, the French Alps, and Spain’s Canary Islands, the random spread of the sickness from Wuhan’s open-air market to the holiday destinations of the global affluent has clearly alarmed the investor class. Meanwhile, the human toll on countries with weaker health-care infrastructure, such asIran andAfghanistan, could prove to be even more devastating.
The uncertainty surrounding the virus is creating an information vacuum for investors, as many global companies such asApple,Nike, andUnited Airlines warn that their previous financial forecasts won’t be met but they can’t yet offer a replacement. This adds a layer of fog on top of a dataset of health and economic statistics out of China that many investors view as untrustworthy. Reliable statistics are taking on greater significance, such as anIHS Markit survey of purchasing managers signaling that the U.S.’s dominant services industries had already begun to shrink in February because of the effects of the virus.
Whatever new narrative investors latch onto will be influential, given the shortage of more reliable data points.
Donald Trump, a master when it comes to the self-flattering narrative, has one he’d like to push. He’s staked his reelection campaign on taking credit for a strong economy and an elevated stock market—both of which wereat risk even before the virus began to spread in the U.S. With the Dow Jones Industrial Average down more than 1,000 points on Feb. 24, Trumptook to Twitter to push his chosen narrative: “The Coronavirus is very much under control in the USA,” he wrote. “We are in contact with everyone and all relevant countries. CDC & World Health have been working hard and very smart. Stock Market starting to look very good to me!”
Unlike his tweets about the trade war, however, this attempt to shift the narrativefailed to lift investors’ spirits. The next day the U.S. Centers for Disease Control and Preventionwarned that Americans should brace for the likelihood that the virus will spread in the U.S., and the secretary of health and human services, Alex Azar II, told a Senate committee, “This is an unprecedented, potentially severe health challenge globally.” The Dow fell more than 3% for a second day.
Meanwhile, investors and analysts, starved of hard data and conclusive estimates for the ultimate human and economic toll of the virus, are wondering if years of scaling the metaphorical wall of worry have left markets complacent to what ultimately could be the most serious risk to the global economy since the financial crisis. They’re passing around stories quoting experts such as Harvard epidemiology professor Marc Lipsitch, who says the likely outcome is thatthe virus won’t be contained and somewhere from 40% to 70% of the world’s population could be infected within the year.
What, then, can be expected of the market’s old friend and wall-of-worry Sherpa, the Federal Reserve? Theminutes of the latest Fed policy meeting and remarks from various policymakers signal they’retaking the threat of the virus seriously; futures traders are pricing in the probability of two to three 0.25-percentage-point rate cuts before the end of the year. Still, this has done nothing to stop the bleeding in the stock market, with the S&P 500 down 8% on Feb. 26 from a record just seven days earlier. After all, what can central bankers realistically do to stem simultaneous supply and demand shocks as factories close, cross-border trade dwindles, and consumers find themselves in either voluntary or involuntary quarantines?
Regardless of which path the narrative travels in coming weeks, it’s clear the reflexive instinct among investors over the past decade to buy stocks aggressively following periods of market weakness—to keep climbing that wall of worry—is being called into question in a big way.
There’s an old Wall Street metaphor that comes to mind to describe the inherent risk that such a strategy poses at the moment: trying to catch a falling knife.
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