Pro Perspectives 2/24/20

February 24, 2020

On Friday we talked about the drivers of the move in gold.  Among the scenarios, we talked about the low probability scenario of the coronavirus turning into a global pandemic. 

Today, that scenario continued to fuel gold and global government bond prices.  And the fears of the low probability scenario becoming a higher probability scenario hit the equity markets today. 

Now, a thousand point decline on the Dow doesn’t carry the significance that it would have ten years ago, given the value of the index (near 30k a week ago).  But it’s still an eye opener and a headline event. 

The last time we had a 1,000 point decline in the Dow was a little more than two years ago.  For perspective, the concern at that time was inflation!  In fact, it was fear that the bond market was telling us that inflation and interest rates were about to reset (higher!).  The 10-year bond yield was trading at 2.88% at that time.  

Conversely, today we have a 10-year bond yield that is testing the all-time lows

As you can see in the chart above, the last two times we’ve been here in yields, it was on the fear of the unknown outcome (for the global economy). 

In each of the prior cases, global central banks responded.  Draghi effectively said, the ECB won’t let Italy and Spain default — he did the unimaginable by becoming the buyer of Spanish and Italian government bonds of last resort. And all major central banks were standing “ready to act” when the surprise Brexit vote hit in June of 2016. 

The interesting thing about both the European sovereign debt crisis and Brexit is that the biggest risk that was being priced into markets was contagion (i.e. a spread of defaults, or a spread of countries opting out of the EU).  

What is the risk of the coronavirus?  Contagion. 

With that, we have an unknown outcome from a human welfare perspective. And if we listen to those with the information and expertise, all we can do is trust that global pandemic is low risk.  In a couple of weeks, we’ll know if global cases are growing by the same multiple as they’ve grown in the first month in China. 

But we have a known outcome for the economy and markets.  That is, global policymakers, in coordination, will throw anything and everything at it, if necessary, to keep the confidence intact, to keep markets afloat and to keep the global economy moving.