Friday, 03 April 2020

Money & Markets: Market noise reflects coronavirus concerns but logic will prevail

While traders react emotionally to the spread of the virus, causing price volatility, Bitcoin is the new digital equivalent of gold.

The market is meant to be a perfect judge of all information so that the price of any instrument is right all the time, every time.

Industry professionals rebel against this idea because you can’t add value for customers if this is true. A cynic might say the industry can’t fleece the customer if this is true, and history is definitely on the side of the cynical.

If you crunch the statistics, then the market is very random from moment to moment, and this randomness spreads across all the timeframes. It aligns with near perfect pricing because the randomness is just noise in a communication channel which must always carry some element of noise along with the signal. Randomness and near perfection in pricing don’t leave much, if any, room for stock-picking managers to outperform the general market. This doesn’t stop the industry spinning a fine tale but it also doesn’t stop the growth of passive index trackers slowly but surely eating away at the active managers who claim they know best.

It gets non-random when things break, such as a bit of engineering key to the operation of the market, or when time is limited, for example at open or close of trading, or when the number of traders falls because it’s a holiday. It also becomes non-random when an unknown hits.

Unknowables can’t be priced in efficiently because they are not understood; it is these unexpected moves that can be non-random.

With the developing coronavirus outbreak we are currently in such a state now.

Coronavirus is an unknown on many levels, and the markets will have a hard time pricing it in.

Most people in the modern world have little understanding of a pandemic. I’m sensitised to this possibility, having written a thriller based around plague, ‘The First Horseman’. As soon as the first news hit, I lightened my stock market position, because plague is one of the few forces that can level the modern world and if/when it hits it will come from China and be novel.

As an investor it already seems likely to me that this is not the ‘end of the world’ outbreak so beloved of horror movies. At the time I’m writing, the situation perhaps has another 10 days to ‘peak virus’ and its lack of significant spread to Europe and the US, and even more importantly Hong Kong, suggests fewer people will die from it than will die of flu in the US this year (under 50,000 people).

These losses are very sad but not world-changing. Bubonic plague took out 25-40 per cent of Europe’s population. The Roman Empire was likely felled by a plague, probably smallpox. Whole populations in North America were eradicated by the diseases brought by the settlers. Thankfully, this is the modern era and our societies understand the science of these disasters and seem proactively on top of this emergence.

The markets seem to reflect this, but many individual investors appear to be behind the power curve and are only now waking up to the possibilities. The participants will take time to wake up to R0 numbers (how rapidly the virus spreads) and lethality predictions, but a few more days of containment will see the markets heaving a collective sigh of relief.

Markets are a great pricing mechanism, but in the short term they are driven by emotion. This emotion is the noise in the market. When the unknown strikes, emotion spikes and so does volatility. Market action is only moderated by logic over a longer time frame. In the circumstances we are in now, the noise will grow until there is enough information about what is happening and how bad it will get for the markets’ signal to take over from the noise.

There are markets, however, that give a view on the current situation that cannot be garnered at a distance and those are Bitcoin and gold. Bitcoin, in particular, is a sensitive indicator of the situation on the ground in China. The higher Bitcoin rises, the more worrisome the situation is likely to be. This is because Bitcoin is the best flight capital for those in a hurry to flee. If there becomes a situation where we should be worried for humanity, Bitcoin will have sent the signal in advance because it is exactly the instrument anyone would pick if they were heading for the airport to escape.

Inside information like this will always flow straight into the market and it will flow into Bitcoin, which once again is proving itself as digital gold. Right now Bitcoin is in the low $9,000s. If it were to jump into the mid-$10,000, I would start to fear the worst. If it continues to drift around, creeping up, then I will take that as a comforting sign of containment.

As I write I’m ‘risk off’ but not out of the market, because the signals from the market are of concern not panic. Let’s hope the market is right.


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