After Hysteria comes Hysteresis

Human inference is clearly imperfect, particularly when it comes to problems that require statistical or probabilistic knowledge. If, in addition, the situation carries some kind of life-threatening risk, our “lizard brain” quickly takes over and triggers a “fight or flight” response, rather than going for math books.


To complicate matters, the statistics look very different depending on the media coverage. A social phenomenon known as “News Values” makes a news story more shocking depending on the proximity of the event or the familiarity of the actors.


The coronavirus crisis has delved into all these mental prejudices to end up creating an unprecedented social crisis; evolving from a problem that only affected a remote region in China, to a pandemic that threatens our loved ones.


The perceived remoteness, wasted time, since many, including myself, miscalculated the transmission speed. And the low mortality statistics covered up the deficit of the healthcare system to face the emergency; so later draconian measures had to be implemented.


With all of these measures, the cost in human lives will likely be greatly limited, but the associated economic cost will skyrocket as exponentially as the virus has spread. Large sectors of the economy, such as the hospitality and travel industries, are literally shut down, while other sectors operate at low capacity, burdened by low demand and falling productivity.


This is the kind of sudden stop that is usually experienced during a war, but in this case very limited in time. Its short duration known in advance should help prevent the severity of the damage. After all, what is needed is for the affected industries to obtain a liquidity line from the government that allows them to weather the lack of income for a few months. In this way, jobs will be saved and, when the health crisis ends, the economy will be able to rebound strongly. There is no project that guarantees better returns to public money than saving jobs by keeping industries that are perfectly viable alive.


But as much as the solution is easy, it is expensive. As with war efforts, government debt needs to increase substantially (financing two quarters of pyrrhic economic activity may well cost 20-30% of GDP). It is therefore not surprising that we see paralysis in the EU, as the old dispute between north and south over risk syndication is preventing a joint response. In the US, by contrast, the problem seems to be how to divide the political dividends of such a large fiscal stimulus.


During this impasse, financial markets are in free fall, with the only – but insufficient – support provided by central banks. The longer this situation lasts, the greater the economic activity lost, and the longer it will take to recover. The economy, like an over-stretched spring, may show “hysteresis,” and we may come to a point where it is too late to return it to its previous state.


Political leaders are aware of this and therefore we expect a comprehensive tax package to be announced in the coming days. This should help stabilize financial markets and bring stock prices closer to valuations commensurate with their long-term earnings potential.


Meanwhile, with unprecedented levels of volatility and dislocated asset prices, we reiterate our call to keep calm and remain invested in high-quality assets. And remember, don’t fight the Fed, and don’t fight civilization.


Fernando de Frutos – Chief Investment Officer


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