Annus horribilis

Christopher Joye

Coolabah Capital

In the AFR today I write that as difficult as 2020’s annus horrbilis has been—a year in which we’ve all lost-out, one way or another—the winners have been human ingenuity, those who can predict policy endogeneity, and perhaps, ultimately, democratic capitalism as a business model relative to the ascendant alternative of autocracy, which is being forced into autarky. Excerpt enclosed:

When SARS-CoV-2 first emerged, almost all the experts were convinced there was no hope of finding vaccines that could be approved and distributed in 2020. This consensus, which projected a best-case scenario for vaccine distribution in mid-to-late 2021, was surprising insofar as it was predicated on historical vaccine development processes.

Yet there has never been any precedent for the vast medical research funding and public-private collaboration that emerged to combat SARS-CoV-2 at “warp speed”. Once you acknowledged this, past vaccine timetables were redundant. And this was one insight that informed our view that tractable vaccines would be approved and distributed in 2020.

It sounds like a cliché, but this year has again proven that when we choose to band together, united by a common purpose, and work as hard as we can, it is remarkable what our species can accomplish. In the world’s largest and most creative economy, the United States, Operation Warp Speed was truly a 21st century successor to the Manhattan Project without the collateral damage of atomic weapons.

A second lesson from 2020 has been how vitally important it is for investors to anticipate derivative consequences in the policy domain. We told clients in March that this crisis was not about winning that month, but rather the next six-to-twelve. Most investors who profited in March suffered badly over the remainder of the year. They fell into the trap of overweighting the initial external shock, a common pit-fall for perma-bears, and not acknowledging the just-as-significant public response to that perturbation.

In March the prevailing elite opinion asserted that markets would suffer an enduring downturn. There was, however, a credible case that this claim was flawed because of the far-reaching ramifications of policy intervention.

What was clear to some by late February was that markets would not be able to handicap the extraordinarily complex array of contingencies flowing from the global pandemic. The view that the one-in-100 year information asymmetries wrought by this pathogen would drive catastrophic “market failures”, necessitating extreme liquidity support and quantitative easing (disputed by current and former central bankers in February and early March), was, in my opinion, a novel insight.

(With the World Health Organisation advising that there was no evidence of human-to-human transmission of the disease in mid January, I don’t think it was possible to arrive at the conclusion that it would inevitably lead to a pandemic at that juncture.)

One you understood the second-order policy reaction function, and synthesised the economic relationships linking reductions in interest rates, liquidity injections, central bank asset purchases and fiscal stimulus with valuations and household and business behaviours, you were in a position to anticipate a rich range of contrarian events.

Most obviously in Australia, you could have predicted that house prices would only fall by a trivial margin over a six month period, and that they would then start climbing again. This would have led you to dismiss the universally-held consensus calls for 10 to 30 per cent price falls amongst analysts and fund managers.

You would have also forecast that the jobless rate would not leap to anywhere near 10 to 12 per cent, as every economist claimed, instead projecting a more benign 6 to 7 per cent outcome, which is where it resides today.

And you would have intuited that the main legacy of March would be a massive financial melt-up, as record-low discount rates across the yield curve and central bank liquidity guarantees encouraged investors to accept that there was a policy bridge back to normality. This would require investors to remove the impact of the March mayhem via correspondingly large asset price appreciation.

Given this, you would have bought everything you could in March with your ears pinned back. And because 99 per cent of investors did the opposite, rushing for the exits in extreme fear, you would have benefited from exceptional liquidity: you could have bought as much as you wanted as the “offer” was seemingly limitless.

You would have also been emboldened to buy in March if you had ignored the epidemiologists’ theoretical projections and instead built empirical, data-driven forecasting models that were based on the observed effects of social distancing and disciplined lock-downs in China and South Korea.

This would have led you to the finding that the first COVID-19 wave in Australia, the US and Europe would crest in early April, giving markets confidence that it was possible to control the pandemic. But these models would not have enabled you to predict policy errors in the form of US, UK and European failures to manage borders and implement lockdowns to eliminate the virus following outbreaks. Put differently, they were not much value in divining second and third waves deriving from decision-making mistakes.

Care of the counter-factuals in Australia, China, New Zealand and Singapore, we know that these national second and third waves were not a fait accompli.

Somewhat paradoxically, and perhaps optimistically, another winner in 2020 could well be democracy and the open, transparent and market-orientated business model it espouses to maximise prosperity and safeguard liberty. Highly motivated private companies, Moderna, Pfizer and AstraZeneca, working with researchers around the world, have delivered us three effective and safe vaccines in record time.

There has never been a more galvanizing event that has brought more people together through the power of instant digital communications to cooperate without fetters to better understand and seek to defeat what has been (incorrectly) perceived as an existential threat to our species.

In this context, the greatest legacy of COVID-19 may be an unexpected one. It has united a once conflicted and dispersed liberal-democratic order in recognition that there is, in fact, a potential existential threat: namely, the underappreciated ascension of an autocratic superpower that appears to want to bend capitalism to its will through any means necessary, kinetic or otherwise.

It is committed to doing so with an ideological fervour because it regards democracy, and its companion capitalism, as threats to its own longevity. To this lens, all adversaries must be eliminated or subordinated if the autocracy is to survive.

After free-riding on an unwitting liberal-democratic world for decades, powering its own prosperity by the very vehicle it strives to overwhelm, COVID-19 has inadvertently revealed the autocracy for what it is. Counter-measures by democratic actors are now forcing it down the road of autarky, which will seal its demise unless it error-corrects into something resembling the Singaporean model.

Yet error-correction is something autocracies find difficult because debate, dissent and the ensuing self-learning are not tolerated. This is why they make ostensibly simple mistakes over-and-over again. And it is why they are doomed to fail or suffer irreversible decline.

Conversely, elastic error-correction is arguably capitalism’s greatest attribute. Trump was an example of this creative destruction in action. On the one hand, Trump was the disruptive shock Western foreign policy desperately needed to refocus its priorities. On the other, Trump’s unprofessional governance approach, incapable of managing the COVID-19 crisis, has been roundly rejected by the electoral system. In a Darwinian fashion, that system should embrace the foreign policy positives while avoiding a repeat of the organisational negatives.

Unfortunately, this brings us to a final legacy: a huge increase in uncertainty as a result of the fracturing of the geo-polity into the competing Western and Sino-led franchises. The risk of major power conflict has not been more elevated since the Cold War. As the Reserve Bank of Australia is wont to advise, the road ahead is likely to be a bumpy one. There are doubtless unusually fat tails on both the left- and right-hand-sides of the distribution of possible futures.

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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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