Will coronavirus turn out to be a Black Swan?

Is coronavirus, otherwise known as Covid-19, the next big Black Swan?

The Black Swan thesis – that you cannot rule out a black swan just because you haven’t seen one – was made famous by the great Nassim Nicholas Taleb. The former options trader turned philosopher and best-selling author says that humans never see a Black Swan event coming their way even though they created the environments in which such extreme events are likely. His own examples of what he calls proper Black Swans are religion, the two World Wars and the advent of the computer: events which were hard to predict and where humans underestimated their probability.

Yet Taleb also says that these were all events which humans should have seen coming. Should we have seen this latest outbreak of a new virus which originated in a Wuhan wet food market two months ago coming? And will it be the trigger to another market meltdown on the scale of 2008? The background is already fragile: a slowdown in world growth, trade wars between Trump and China, stasis across most of the eurozone and the upcoming talks between the UK and the EU over trade which are bound to be vexatious. Not a great picture.

Millions of people are now in quarantine in nearly every part of the world, towns across China and Italy have been closed, some schools have shut down in the UK, airlines have been grounded and flights cancelled, people have cut down on their travelling. Many have stopped going to everyday events such as conferences or concerts while others are now putting themselves in “self-isolation.”

You can tell how serious things are when even the bankers clip their own wings. Both Goldman Sachs and Standard Chartered, whose staff travel for much of their work in Asia, have been told to stay at home and “self-isolate” if they are returning from China and Hong Kong. Consultants EY have banned travelling to China and the near region.

In Japan, politicians are considering halting the Olympics while Six Nations rugby matches may be postponed.

Two months after the first reported case, which was traced back to a seafood and poultry market in Wuhan on December 31st, this Covid-9 virus has travelled fast and deep. The numbers are chilling; in two months there have been 1,000 deaths, there are around 78,000 cases in China alone and the virus has spread to 24 countries. At this rate hundreds of millions could be infected.

So far, the death rate is not evenly spread. In Wuhan, for example, nearly 5% of those infected have died and the number is also higher than expected in Iran. Elsewhere, the rate is much smaller.

According to the online real time statistics site, Worldometer, estimates based on the rate of death by dividing the numbers infected with those who have died are not accurate and experts say it’s too early to make forecasts. Epidemiologists reckon that a mortality rate of 2% of those who are sick is probably as good a forecast as possible. While the World Health Organisation has declared a global health emergency, it has not yet classified the illness as a pandemic.

Whether the virus turns out to be of Taleb’s Cygnus family or not, financial markets are treating the epidemic as though it were. Over the last few days alone, stock markets around the world have been in freefall, with shares losing around $1 trillion in value.

Here in the UK the FTSE 100 is now down by 5% on the week, having fallen to below 7,000, the first time in more than a year. European markets are also several percentage points lower.

By contrast, gold is soaring as are sales of hand gels and masks. Oil prices are lower, with traders fearing a serious downturn in world economic output. These rises and falls in asset values are neither an over-the-top nor a knee-jerk reaction to events. You could even say Western stock markets have been slow to react. The warning signs were there when the Shanghai Composite fell 10% on February 3, the first day of trading after the Chinese New Year. Every stock was down, apart from those in healthcare and pharmaceuticals.

Since then, the Chinese stock markets have recovered but analysts reckon that the climb-back will be short-lived as the impact feeds through into corporate profits. Yet in Western Europe and the US investors are right to be spooked because they are seeing for the first time the first hand effect that the virus outbreak has had over the last two months on global economies and companies.

Shares in airline companies are already down around the world. Airlines such as Lufthansa have cancelled all flights to China until the end of March. The German airline has announced a hiring freeze to help cushion the expected loss of income. Drinks giant, Diageo, predicts that profits will be hit by up to £200m from lost sales in Asia. The UK travel catering group, SSP, which runs restaurants and bars in travel hot spots like airports and railway stations, forecasts a 50% fall in sales.

Shares in luxury goods makers such as LVMH and Burberry, with big sales in Asia, are down, as is the French beauty group, L’Oreal. All three companies make about a third of their sales from Asia.

Travel, leisure and holiday firms including Carnival and Disney have been badly hit. Sea tankers have been grounded while lorries have been impounded. Chips and spare auto parts are not moving to where they should.

France’s Danone, the yoghurt to Evian water giant, predicts it may have lost up to E100m of sales from its Waters China business, and is revising growth targets down to between 2% and 4% from 5%.

Crucially, these are not sales that can be retrieved but are lost forever. As one analyst commenting on Diageo’s results said: “Once the consumption picks up again in the infected regions in China and beyond, you don’t then go and buy two bottles of Scotch instead of your normal one.”

Well, not most people anyway. What Covid-19 shows us is how quick humans are to adapt to new environments: they stop unnecessary travelling, whether work or pleasure, they panic buy, as the empty shelves in shops across Northern Italy have shown, and they hunker down in the safety of their homes if they can.

More pertinently, the outbreak also demonstrates how interconnected our lives have become: the saver or pensioner who owns shares in Diageo or Danone depends for his or her income on how many bottles of whisky or Evian water the Chinese buy.

This is the butterfly effect of chaos theory: that tiny changes of the butterfly wings can have huge consequences elsewhere. In China, tourism represents about 10% of economic growth with around 140 million trips made to the country every year by foreigners. In return, there are 134 million trips by Chinese tourists every year around the world, bringing their spending power with them.

That’s gone for the next few months, if not the next year. It’s not so much the impact of the virus on Chinese – or indeed world growth – but how marked the effect will be on human behaviour. That is the lasting lesson of this terrible illness. Other than splashing out on gold bars or shares in hand gel companies, what should investors be doing to mitigate the impact of the virus?

For most of us, the best advice is to hang on. Trading on big events – Black Swan or not – can lead to panic selling. The old adage, selling at the top and buying at the bottom, is still the best.

I’ve tried to contact Taleb to find out whether he thinks this is another Black Swan in the making. We met a few years ago to talk about another of his brilliant books, Antifragile: Things that Gain from Disorder, and if he gets back to me I’ll give you an update. It’s bound to be fascinating.

But I can make a bet: when we met, he told me how most of us live in direct contradiction to how the world works; that we should love “variability and embrace risk and resist forecasting if we don’t want to be turkeys.”