The year from hell

You do not need me to tell you that 2020 was the year from hell. It will go down in history as the year of the pandemic – the biggest black swan event of our lifetimes. Even prior to the financial crash of 2008 we had some warning that problems were building up in the banking sector. But a year ago, apart from a few well-connected health professionals, the general public had not even heard of the coronavirus. Google search data reveal that it was only in the week commencing 19 January that there was a huge spike in interest in China. However, the rest of the world took another seven weeks to cotton on (chart above).

At the time of writing, almost 83 million people worldwide have tested positive for Covid-19 which has claimed the lives of more than 1.8 million. To put this into context, US deaths from Covid number almost 6 times those who lost their lives in Vietnam. In the UK, there are only 130 towns with a population higher than 72,657 – the current number of registered deaths in Britain. It became clear early on that this was a humanitarian disaster and until the vaccine is widely deployed, these numbers will unfortunately continue to rise. In this context, everything we thought might happen in 2020 was blown away by the ultimate in random events.

If we learned anything in the course of 2020 it was the distinction between risk and uncertainty. As the economist Frank Knight wrote in 1921, “there is a fundamental distinction between the reward for taking a known risk and that for assuming a risk whose value itself is not known.” The idea that risk is something that can be priced but uncertainty cannot is something that I have been pushing for many years. We learned in 2008 that we had been pricing risk incorrectly when the risks in the far tail of the distribution came to define the central case. But as much as we might have adjusted our subjective assessment of risks in the following decade, nothing could have prepared us for the events of 2020.

Starting with the economics, forecasts are conditional on the information set available at the time. Since we had no information on Covid in January, the economic forecasts made at the start of the year were quickly rendered meaningless. However, once governments began to implement their lockdown plans, forecasts adjusted very quickly and projections produced in the spring gave us a very decent guide as to how events turned out in 2020. For example, the consensus projection for this year’s UK GDP growth was 1.1% in January 2020. By May this had been slashed to -8.6% with the projections made by financial institutions averaging -9.3%. At that point we only had GDP data through to March and we were flying blind with regard to much of the data and I would regard this as an acceptable outcome. One thing that surprised me with regard to European economies was the extent to which unemployment remained relatively contained despite the massive collapse in output. This was a result of schemes put in place by governments to place a safety net under the economy, and very welcome it was too.

The downside is that there was a huge deterioration in government finances. Government borrowing across the EU, for example, is predicted by the European Commission to expand from 0.5% of GDP in 2019 to over 8% in 2020 (it will be even higher in the UK). In the euro zone, the debt-to-GDP ratio is projected to rise from 86% in 2019 to over 101% in 2020 and to rise further over the next couple of years. To put this into context, in the seven years following the crash of 2008 the debt ratio rose by 30 percentage points of GDP to 95%. High levels of debt are a legacy of the corona-induced recession that will be with us for years to come and will undoubtedly have a big influence on fiscal thinking in future. That said, the role of the state in providing support to the economy very much came back into fashion in 2020. I rather suspect that electorates will not take kindly to fiscal austerity in the near future, having endured it for much of the past decade.

It was certainly a dramatic year in equities. A year ago my view was that “equity markets would appear to be due a correction” but “unless we experience some form of major random shock, it might be too pessimistic to expect a bearish correction.” In early February I questioned why markets were ignoring the risks posed by the coronavirus. By March, we got the long-awaited correction as investors understandably panicked as liquidity dried up in much the same way as it did in 2008. This time, however, the authorities were prepared and pumped in liquidity as if it were going out of fashion. The surprise was just how quickly markets rallied thereafter with US markets rallying to record highs late in the year (chart below). This was in part driven by FAANG stocks as the likes of Amazon and Netflix had a “good” crisis but most sectors benefited to a greater or lesser degree. For all the concerns regarding excessive valuations my year-ahead call that “equities remain the asset class of choice” means that so long as an expansionary monetary policy depresses returns on other assets, it is hard to see why investors will dump them.

On the politics front, the UK left the EU as expected and did so with a trade deal that at various stages throughout the year appeared very elusive. The year also marked the end of Donald Trump’s tenure in the White House. A year ago I was unsure how the US election would pan out: The polls suggested Trump would lose but it was never certain that the Democratic challenger would be able to pull off a win. Now that Joe Biden is about to move into 1600 Pennsylvania Avenue this will likely mean an end to the Twitter-based policy environment that has characterised the last four years. It is unclear whether this will be bad news for Twitter Inc. On the one hand they have lost one of their highest profile brand ambassadors. On the other, it may take some heat out of the fake news allegations that have dogged the company thanks to the President’s unfiltered use of social media. 

There are now just a matter of hours to go until we can say goodbye to 2020. I am sure I speak for everyone when I say the end can’t come soon enough. Here’s wishing us all a happier new year.