The Great Instability: this is the label we chose last year to describe the fragile nature of the global economy and wider society, looking at 2020. It’s a label inspired by the contrast with a very different period known as the Great Stability – a dim but not so distant past, in the years leading up to the Great Financial Crisis, when it appeared as if the economy had achieved its state of ‘nirvana’. A global pandemic was not exactly front of mind when we settled on ‘The Great Instability’; still, it fits quite neatly into the overarching concept. After all, the world was already, and will remain, a volatile place.
The COVID-19 outbreak, of course, poses a clear and present danger to humanity, and the immediate focus for the authorities is to protect human life while preventing an economic collapse. For professional investors, though, the focus is to monitor the evolution of the virus, understand the public policy response and calibrate the impact on markets, both from a high and low frequency perspective – that is, where markets will go in the next 24 hours, but also in the next 12-24 months as fundamentals reassert themselves.
This piece, in particular, focuses on the importance of not losing sight of the medium-term. Society will ultimately win the war against the virus and the system will remain fundamentally fragile. Understanding the sources of The Great Instability and what it means for societies, economies and markets will remain of paramount importance to investors.
On this point, we elaborate five lessons:
The risks that lurk in the left tail: the pandemic is not the exception to the rule, but the latest in a long line of shocks. These high impact tail risks threaten the stability of the system but are all too easily lost in an assessment of what is most likely to happen. The world is more volatile than we pretend.
A fragile ecosystem: today, a highly interconnected network of lean companies has outsourced multiple aspects of the production process, hold minimal inventory and are heavily reliant on technology. Globalisation, technological change and competition helped to foster a global economy that is efficient but vulnerable to large disruptive shocks.
A role for the state: the state is the only actor able to mobilise resources to build resilience against the left tail risks before they strike, and to manage the crisis in the aftermath. The forceful response to the pandemic proves it: where there is a will, there is a way. Although, that requires technical competence, a functioning political system and the trust of the electorate.
The only game in town is over: both investors and politicians had become reliant on central banks to do “whatever it takes” to tackle any shock and insulate the economy and markets from left tail risks. Unfortunately, the capacity of central banks to support the economy has progressively waned, leaving the system more vulnerable. Whatever monetary space existed before the virus has been largely exhausted in recent weeks.
The day after tomorrow: the outbreak may change society in profound ways and act as a teachable moment – particularly about the need to tackle the left tail risk seriously, prompt a more forceful response to the climate crisis, and rethink the state’s role in society. New habits learned during social distancing could lead to persistent shifts in behaviour, including the way we work and consume.
While speculative, we feel each of these lessons is important for a long-term investor to consider in their analysis. At BNP Paribas Asset Management, we’re used to investigating before investing, and looking at things from different angles.