Coronavirus - The Black Swan of 2020

What is a black swan ?

Here is the investopedia definition : A black swan is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. Black swan events are characterized by their extreme rarity, their severe impact, and the practice of explaining widespread failure to predict them as simple folly in hindsight.

The concept was highly popularized by Nassim Taleb's book. 

On March 1st, I published a blog post predicting the massive outbreak in california and particularly the west coast. Washington has evolved as the epicenter of USA. That article looks very prescient now.

I stated in the article

The disease has a R0 of ~2.5, that means that 10 affected people will spread it to 25 people. R0 is a measure of how infectious a disease is and is heavily used for planning strategies to mitigate the spread(R0 calculation is an ongoing task here and it lies between 2 and 3.5). This is what makes it an exponential rate of increase

Paul Graham, VC investor and the co-founder of startup accelerator firm Y-combinator also tweeted yesterday

This is similar to catch a lightening in a bottle and indeed very hard to explain outside the startup world. Very few people understand the power of compounding.

This is what also explains why the government response has been bungled, our testing kits have lacked in numbers. In-spite of a headstart from china and other countries, our preparation and response has been tepid. This is what makes it a black swan.

Black swan events are characterized by their extreme rarity, their severe impact, and the practice of explaining widespread failure to predict them as simple folly in hindsight.

Before talking further, customary disclaimer and warning. I want to emphasize I dont know how good/bad it will get from here and how sharp/shallow the coming downturn will look like. This is not investment advice. Use your own judgement. The world is uncertain and I am just talking about some possibilities. I might be wrong.

Now that we have a blackswan event, how is the investment community(Venture Capital and Hedge Funds) reacting

Venture Capital

1. Sequoia capital, the legendary silicon valley VC firm published the blog post - coronavirus the black swan of 2020. This is eerily reminiscent of 2008 presentation that sequoia capital did before the depths of the housing and financial crisis, RIP Good times. Does that ring a bell ? Yes, this time it is different. 
2. Some of the key points from Sequoia's black swan presentation
• It will take considerable time — perhaps several quarters — before we can be confident that the virus has been contained. It will take even longer for the global economy to recover its footing. Some of you may experience softening demand; some of you may face supply challenges.

• Monetary policy will prove a blunt tool in front of a healthcare crisis
• Squeeze coming in capital spending, marketing, sales, headcount as we are already seeing in some industries like travel


• A distinctive feature of enduring companies is the way their leaders react to moments like these. Your employees are all aware of COVID-19 and are wondering how you will react and what it means for them. False optimism can easily lead you astray and prevent you from making contingency plans or taking bold action.
• Already, there is a thread on the private social network blind titled  - Anybody think differently about their employer after seeing the response to COVID-19

• It will take considerable time — perhaps several quarters — before we can be confident that the virus has been contained. It will take even longer for the global economy to recover its footing. Some of you may experience softening demand; some of you may face supply challenges.

• Monetary policy will prove a blunt tool in front of a healthcare crisis
• Squeeze coming in capital spending, marketing, sales, headcount as we are already seeing in some industries like travel


• A distinctive feature of enduring companies is the way their leaders react to moments like these. Your employees are all aware of COVID-19 and are wondering how you will react and what it means for them. False optimism can easily lead you astray and prevent you from making contingency plans or taking bold action.
• Already, there is a thread on the private social network blind titled  - Anybody think differently about their employer after seeing the response to COVID-19

Hedge Funds

Like with any downturn, some firms will be more impacted than others. The legendary hedge fund investor, Ray Dalio published the blog post : My thoughts on coronavirus. Ray Dalio has a net worth of ~$18.7 billion and is the founder and chairman of Bridgewater Associates with approximately $160 billion AUM. Here are his thoughts on the market impact section - 

The world is now leveraged long with a lot of cash still on the sidelines—i.e., most investors are long equities and other risky assets and the amount of leveraging that has taken place to support these positions has been large because low interest rates relative to expected returns on equities and the need to leverage up low returns to make them larger have led to this. The actions taken to curtail business activities will certainly cut revenues until the virus and business activity reverse which will lead to a rebound in revenue. That should (but won’t certainly) lead to V- or U-shaped financials for most companies.  However, during the drop, the market impact on leveraged companies in the most severely affected economies will probably be significant. We will show you what that looks like shortly. My guess is that the markets will probably not distinguish well between those which can and cannot withstand well the temporary shock and will focus more on their temporary hit to revenues than they should and underweight the credit impact—e.g., a company with plenty of cash and a big temporary economic hit will probably be exaggeratedly hit relative to one that is less economically hit but has a lot of short-term debt. 

Additionally, it seems to me that this is one of those once in 100 years catastrophic events that annihilates those who provide insurance against it and those who don’t take insurance to protect themselves against it because they treat it as the exposed bet that they can take because it virtually never happens.  These folks come in all sorts of forms, such as insurance companies who insured against the consequences that we are about to experience, those who sold deep-out-of-the-money options planning to earn the premiums and cover their exposures through dynamic hedging if and when the prices get near in the money, etc. The markets are being, and will continue to be, affected by these sorts of market players getting squeezed and forced to make market moves because of cash-flow issues rather than because of thoughtful fundamental analysis.  We are seeing this in very unusual and fundamentally unwarranted market action. Also, what’s interesting is how attractive some companies with good cash yields have become, especially as many market players have been shaken out. 

Ray Dalio doesnt say that this is a black swan but uses the words

it seems to me that this is one of those once in 100 years catastrophic events

Bill Gates 

Bill Gates is the founder of Microsoft and the second richest person in the world at the time of this writing. Rather than debate whether to allow WFH policies or not, he is spending his time helping the world become a better place. I highly recommend watching his TED talk from 4 years back where he states how the world is ill-prepared to fight the next outbreak.


If it is not clear why all the above is a problem, it is going to create huge pressure on the healthcare system, the health of the population, lost productivity, supply side pressure due to factory shutdowns, lost demand because of cancelled travel, vacations, business trips etc.

Conclusion

The goal of this blog is not to give investment/life advice, but to educate the community in terms of what is going on. Hope you are able to learn from some of the stalwarts of the VC and hedge fund industry and take the best of decisions in terms of health and investments for yourself and your family. 

References

1. Bill Gates ted talk : the next outbreak? We are not ready. shared 4 years ago.
2. Ray Dalio's thoughts on coronavirus shared on March 3
3. Sequoia capitals memo : coronavirus - the black swan of 2020
4. The Black Swan: Second Edition: The Impact of the Highly Improbable: With a new section: "On Robustness and Fragility" (Incerto)
5. Healthcare crisis : recession 2020