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How Coronovirus impacts Fintech, Financial Markets, and the global Economy
Hi Fintech futurists --
In the long take this week, I look at how the news about the spread of the coronovirus are cracking the global economic machine. Some may argue that the number of people effected is still low -- but that misses the entire point. The shock of a global pandemic has revealed weakness in the financial machine, sending the stock markets falling 10% year-to-date. Gross domestic product growth is expected to slow by billions of dollars, governments and central banks are unable to implement policy to compensate with rates at historic lows and borrowing at historic highs, public market valuations will tumble arithmetically, and private Fintech companies will lose a path to exit. At least that's what the conspiracy theorists want you to think!
These opinions are personal and do not reflect any views of ConsenSys or other parties. Still, you should check out ConsenSys Codefi for software powering digital assets, financial enterprise blockchains, decentralized finance, and crypto payments here.
Thanks for reading and let me know your thoughts here!
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The thing about Twitter bots is that eventually we figure things out. Eventually, we know it's a Twitter bot, recycling memes from a software propaganda factory. Sometimes it takes a long time for the artifice to crack, and we go on believing that something the machine says is really true, valuable, and honest. As artificial intelligence gets smarter about us, it takes longer and longer to uncover such emotional manipulations. But it's not just AI in 2020, it is written into the very fabric of human nature. We build social constructs and machines to tell stories, to echo-chamber those stories in tribal communities, and then splash them around with hormones like cortisol and dopamine.
Let's take our myths apart one at a time.
There are two stories going about coronovirus. The first one is sovereign denial. You've read the arguments -- (1) China, the US, Italy, Iran, etc., have everything under control with quarantines and flight restrictions and health preparations, (2) the virus is no worse than the flu and only effects the infirm, (3) even if it does become a pandemic, so what. Ben Hunt at Epsilon Theory rages fantastically against this narrative here. Clearly, not everything is OK, and the time for pretending that we know the unknown unknowns is over.
The other side of the story, one that is now being articulated by smart researchers, conspiracy theorists, and the global stock market, is that this will be a global pandemic with a 2% mortality rate. A back of the envelope on 1 billion people looks pretty horrific. I've plotted the current known data above, which likely overstates the mortality rate but understates exposure. We know that influenza mortality is somewhere around 6 per 100,000 people, or 0.006%. That's about 300x less lethal than the current coronovirus trend.
But maybe it will be contained by warm weather! Or maybe it won't spread further! Or maybe we just live in a dangerous world -- 100 people die every day in the US in an automobile accident. Anyway, I don't mean to prognosticate about the coronovirus. That's not why you're here. What I am more focused on is the effect this shock has on the economy, the financial services, and frontier technology. In particular, what strikes me is just how un-modelled and un-modellable this particular black swan was to our markets.
Everybody in the markets was complaining about pricing in the geopolitical risks of Brexit, or the weakness of the Italian economy and its effect on the Euro, or Boris Johnson's reckless gamesmanship, or Donald Trump's charming personality, or the trade war with China and the capture of a Huawei executive. Investors complained about risk that was included in their models, but had fuzzy upside and downside. It wasn't a precise number, but some wobbly uncertain variable that moved around according to new developments. It was uncertainty about the levels of our "fundamentals", not about which fundamentals should be included in the model. Well, surprise!
So do we think that the S&P 500 fell by nearly 10% because hedge fund managers think that we are all going to die of respiratory failure. Of course not.
What you are seeing is equivalent to the global Twitter bot machine coming under stress (metaphorically). The causal events are as follows. In China, thousands of people are being forced to stay at home. Globally, air travel is slowing down and tourism is under pressure. People and companies are choosing to avoid contact with others. International travel is being seen in a suspicious light, and conferences are being cancelled across industries. Whether you work in real estate or video games, or if you just want to run the marathon in Japan, your industry get-togethers have been postponed. As a result, global demand for goods and services is going down, with OECD projecting 0.50%-1.50% negative GDP impact by geography.
On the other side, given that China is the world's manufacturer, companies that rely on China to make things (i.e., 29% globally) will end up making less things, selling even fewer things, and going bankrupt. This impacts not just the goods themselves, but everyone along the supply chain. That includes your supply chain management software, banking and trade finance providers, insurance companies, and all sorts of other technology and services. Fewer companies will be able to pay software-as-a-service fees and pay off interest. It is probably good news for lawyers and consultants, as are most disasters and change.
So is this explanation enough? Projected global GDP slows down due to unforeseen disaster, on a one time basis. Nope!
What sticks out at me is that the financial levers in the global banking Twitter bot toolbox are pretty much exchausted. Normally, you would maybe lower some interest rates to make it easier for companies to borrow money, invest in growth, and take on more risk. Guess what -- nearly a quarter of bonds in the world, or $14 trillion of paper, trade at negative interest rates. Similarly, US Treasuries rates are at historic lows of around 2% after a decade of quantitative easing. That's about the same as the current rate of inflation, meaning that real interest rates are 0%.
Or maybe you'd want to try some Keynesian spending to replace the demand consumers are foregoing. Let's put aside our xenophopia for a second (why would the US spend to help with the Chinese slowdown, etc., etc.). It just so happens that even with "conservative" government at the helm, the US has been spending on tax cuts and other various initiatives that have expanded the budget deficit and led to increased leverage and borrowing. Remember how that borrowing is at a historically cheap rate now? Yeah.
And it's not like only the US is doing the dance. The US simply happens to be more systemically important and not subject to austerity and berating like Greece, Italy, and Portugal. It can always lever up some more to launch healthcare programs -- what about the rest of the world?
Ok. So is this enough of a narrative? Coronovirus created an unexpected, unpriced shock to economic activity, which led to pressure on GDP on both supply and demand, which highlighted the inability of governments across the world to equilibrate their economies? Nope, not yet.
The stock markets are math machines, driven by human hands. If you have a company that generates $100 per year in profit forever, and an investor discounts next year's cashflow by 1%, then the value of the company could be $100/1%, or $10,000. Now let's say your discount rate changes to 10% -- then the value of the company is $100/10%, or $1,000. Oops, we just lost 90% of the stock price due to opportunity cost and perception of risk. Let's say now that our bonds priced at 1% actually start defaulting as governments have trouble collecting tax revenue to pay ongoing interest (or some other post-apocalyptic scenario). Let's say that investors start needing to get paid 5% or 10% to hold the same "risk free" debt. Or they stop lending altogether. Given that the stock market has been at historic highs for over a decade, people will start to do the math.
And if you do the math on the public markets, someone will eventually do the math on the private markets. The $150 billion of Fintech unicorn valuation out there looks fantastic on paper. But we know that many Fintech companies, in particular digital lenders (and most likely neobanks and digital investing firms), tend to lose 80% of their stock price after a few months of being public. WeWork and Uber narratives do not help at the moment. So if the public markets are down, that suggests that IPO windows (i.e., a good time to go public and sell venture-backed stock) will close and VC investors will get stuck holding the bag even longer.
And there you have it -- anti-fragility at its finest. It was never about coronovirus. It is about an exogenous shock that could not be modeled, having a real effect on the underlying economy. No amount of propaganda Twitter botting changes the ground truth of a person catching a disease. And then that effect is rippled and amplified across all the weak points of the narrative financial construct that has been calcified over the last decade. Nobody really likes or wants this. But if you think the melting of Deutsche Bank or HSBC is unique and unusual, or that Fintech startups won't fritz out once their economics are revealed on 10-Ks, you are in for a rude awakening.
Look, there's still lots of great news! Plaid exited at $5 billion to Visa. Credit Karma just had a fantastic $7 billion sale to Mint, I mean Intuit. Video-conferencing provider Zoom (ZM in the chart) added more users in early 2020 than in all of 2019 due to people's self quarantine, and its stock price is 50% up year to date. Innovation and technology will continue to be more secularly important than human services and outdated business models.
Apocalypse hedge assets are holding better value this year -- with Gold (GLD in the chart) increasing 3% and Bitcoin (BTC-USD in the chart) up 25%. But these flashing numbers are in large part noise that should be addressed with proper portfolio construction. For example, what should be happening with insurance companies? Or healthcare companies? Or cloud software companies? No clear answers will emerge from our market. The broader picture is a soup of complexity.
Don't fret and sell -- just implement a rigorous asset allocation, get enough canned goods and Coca Cola, hug your family, and stay healthy.