Black Swan Events: Short-term Crisis, Long-term Opportunity
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Black Swan Events: Short-term Crisis, Long-term Opportunity

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This Markets in a Minute chart is available as a poster.

Black Swan Events and time to recovery

This Markets in a Minute chart is available as a poster.

Black Swans: Short-term Crisis, Long-term Opportunity

Few investors could have predicted that a viral outbreak would end the longest-running bull market in U.S. history. Now, the COVID-19 pandemic has pushed stocks far into bear market territory. From its peak on February 19th, the S&P 500 has fallen almost 30%.

While this volatility can cause investors to panic, it’s helpful to keep a long-term perspective. Black swan events, which are defined as rare and unexpected events with severe consequences, have come and gone throughout history.

In today’s Markets in a Minute chart from New York Life Investments, we explore the sell-off size and recovery length for some of these events.

Wars, Viruses, and Excessive Valuations

With sell-offs ranging from -5% to -50%, black swan events have all impacted the S&P 500 differently. Here’s a look at select events over the last half-century:

EventStart of Sell-off/Previous PeakSize of Sell-offDuration of Sell-off (Trading Days)Duration of Recovery (Trading Days)
Israel Arab War/Oil EmbargoOctober 29, 1973-17.1%271475
Iranian Hostage CrisisOctober 5, 1979-10.2%2451
Black MondayOctober 13, 1987-28.5%5398
First Gulf WarJanuary 1, 1991-5.7%68
9/11 AttacksSeptember 10, 2001-11.6%615
SARSJanuary 14, 2003-14.1%3940
Global Financial CrisisOctober 9, 2007-56.8%3561022
Intervention in LibyaFebruary 18, 2011-6.4%1829
Brexit VoteJune 8, 2016-5.6%149
COVID-19*February 19, 2020-29.5%19N/A (ongoing)

* Figure as of market close on March 18, 2020. The sell-off measures from the market high to the market low.

While the declines can be severe, most have been short-lived. Markets typically returned to previous peak levels in no more than a couple of months. The Oil Embargo, Black Monday, and the Global Financial Crisis are notable outliers, with the recovery spanning a year or more.

After Black Monday, the Federal Reserve reaffirmed its readiness to provide liquidity, and the market recovered in about 400 trading days. Both the 1973 Oil Embargo and 2007 Global Financial Crisis led to U.S. recessions, lengthening the recovery over multiple years.

COVID-19: How Long Will it Last?

It’s difficult to predict how long COVID-19 will impact markets, as its societal and financial disruption is unprecedented. In fact, the S&P 500 reached a bear market in just 16 days, the fastest time period on record.

Time for bear market to occur

Some Wall Street strategists believe that the market will only begin to recover when COVID-19’s daily infection rate peaks. In the meantime, governments have begun announcing rate cuts and fiscal stimulus in order to help stabilize the economy.

Considering the high levels of uncertainty, what should investors do?

Buy on Fear, Sell on Greed?

Legendary investor Warren Buffet is a big proponent of this strategy. When others are greedy—typically when prices are boiling over—assets may be overpriced. On the flipside, there may be good buying opportunities when others are fearful.

Most importantly, investors need to remain disciplined with their investment process throughout the volatility. History has shown that markets will eventually recover, and may reward patient investors.

Note: This post originally came from our Advisor Channel, a partnership with New York Life Investments that aims to create a go-to resource for financial advisors and their clients to navigate market trends.

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News Explainer: The Economic Crisis in Sri Lanka

Sri Lanka is currently in an economic crisis with over $50 billion in debt and consumer inflation at 39%. So how did they get here?

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sri lanka economic crisis

Explained: the Economic Crisis in Sri Lanka

Sri Lanka is currently in an economic and political crisis of mass proportions, recently culminating in a default on its debt payments. The country is also nearly at empty on their foreign currency reserves, decreasing the ability to purchase imports and driving up domestic prices for goods.

There are several reasons for this crisis and the economic turmoil has sparked mass protests and violence across the country. This visual breaks down some of the elements that led to Sri Lanka’s current situation.

A Timeline of Events

The ongoing problems in Sri Lanka have bubbled up after years of economic mismanagement. Here’s a brief timeline looking at just some of the recent factors.

2009

In 2009, a decades-long civil war in the country ended and the government’s focus turned inward towards domestic production. However, a stress on local production and sales, instead of exports, increased the reliance on foreign goods.

2019

Unprompted cuts were introduced on income tax in 2019, leading to significant losses in government revenue, draining an already cash-strapped country.

2020

The COVID-19 pandemic hit the world causing border closures globally and stifling one of Sri Lanka’s most lucrative industries. Prior to the pandemic, in 2018, tourism contributed nearly 5% of the country’s GDP and generated over 388,000 jobs. In 2020, tourism’s share of GDP had dropped to 0.8%, with over 40,000 jobs lost to that point.

2021

Recently, the Sri Lankan government introduced a ban on foreign-made chemical fertilizers. The ban was meant to counter the depletion of the country’s foreign currency reserves.

However, with only local, organic fertilizers available to farmers, a massive crop failure occurred and Sri Lankans were subsequently forced to rely even more heavily on imports, further depleting reserves.

April 2022

In early April this year, massive protests calling for President Gotabaya Rajapaksa’s resignation, sparked in Sri Lanka’s capital city, Colombo.

May 2022

In May, pro-government supporters brutally attacked protesters. Subsequently, Prime Minister Mahinda Rajapaksa, brother of President Rajapaksa, stepped down and was replaced with former PM, Ranil Wickremesinghe.

June 2022

Recently, the government approved a four-day work week to allow citizens an extra day to grow food, as prices continue to shoot up. Food inflation increased over 57% in May.

Additionally, the increasing prices on grain caused by the war in Ukraine and rising fuel prices globally have played into an already dire situation in Sri Lanka.

The Key Information

“Our economy has completely collapsed.”
Prime minister Ranil Wickremesinghe to Parliament last week.

One of the main causes of the economic crisis in Sri Lanka is the reliance on imports and the amount spent on them. Let’s take a look at the numbers:

  • 2021 total imports = $20.6 billion USD
  • 2022 total imports (to March) = $5.7 billion USD

In contrast, the most recent reported foreign currency reserve levels in the country were at an abysmal $50 million, having plummeted an astounding 99%, from $7.6 billion in 2019.

Some of the top imports in 2021, according to the country’s central bank were:

  • Refined petroleum = $2.8 billion
  • Textiles = $3.1 billion
  • Chemical products = $1.1 billion
  • Food & beverage = $1.7 billion

Of course, without the cash to purchase these goods from abroad, Sri Lankans face an increasingly drastic situation.

Additionally, the debt Sri Lanka has incurred is huge, further hampering their ability to boost their reserves. Recently, they defaulted on a $78 million loan from international creditors, and in total, they’ve borrowed $50.7 billion.

The largest source of their debt is by far due to market borrowings, followed closely by loans taken from the Asian Development Bank, China, and Japan, among others.

What it Means

Sri Lanka is home to more than 22 million people who are rapidly losing the ability to purchase everyday goods. Consumer inflation reached 39% at the end of May.

Due to power outages meant to save energy and fuel, schools are currently shuttered and children have nowhere to go during the day. Protesters calling for the president’s resignation have been camped in the capital for months, facing tear gas from police and backlash from president Rajapaksa’s supporters, but many have also responded violently to pushback.

India and China have agreed to send help to the country and the the International Monetary Fund recently arrived in the country to discuss a bailout. Additionally, the government has sent ministers to Russia to discuss a deal for discounted oil imports.

A Foreshadowing for Low Income Countries

Governments need foreign currency in order to purchase goods from abroad. Without the ability to purchase or borrow foreign currency, the Sri Lankan government cannot buy desperately needed imports, including food staples and fuel, causing domestic prices to rise.

Furthermore, defaults on loan payments discourage foreign direct investment and devalue the national currency, making future borrowing more difficult.

What’s happening in Sri Lanka may be an ominous preview of what’s to come in other low and middle-income countries, as the risk of debt distress continues to rise globally.

The Debt Service Suspension Initiative (DSSI) was implemented by G20 countries, suspending nearly $13 billion in debt from the start of the pandemic until late 2021.

Sri Lanka Economic Crisis - countries by level of debt distress

Some DSSI and LIC countries facing a high risk of debt distress include Zambia, Ethiopia, and Tajikistan, to name a few.

Going forward, Sri Lanka’s next steps in managing this situation will either serve as a useful example for other countries at risk or a warning worth heeding.

Note: The debt breakdown in the main visualization represents total outstanding external debt owed to foreign creditors rather total debt.

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Interest Rate Hikes vs. Inflation Rate, by Country

Inflation rates are reaching multi-decade highs in some countries. How aggressive have central banks been with interest rate hikes?

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Interest Rate Hikes vs. Inflation Rate, by Country

Imagine today’s high inflation like a car speeding down a hill. In order to slow it down, you need to hit the brakes. In this case, the “brakes” are interest rate hikes intended to slow spending. However, some central banks are hitting the brakes faster than others.

This graphic uses data from central banks and government websites to show how policy interest rates and inflation rates have changed since the start of the year. It was inspired by a chart created by Macrobond.

How Do Interest Rate Hikes Combat Inflation?

To understand how interest rates influence inflation, we need to understand how inflation works. Inflation is the result of too much money chasing too few goods. Over the last several months, this has occurred amid a surge in demand and supply chain disruptions worsened by Russia’s invasion of Ukraine.

In an effort to combat inflation, central banks will raise their policy rate. This is the rate they charge commercial banks for loans or pay commercial banks for deposits. Commercial banks pass on a portion of these higher rates to their customers, which reduces the purchasing power of businesses and consumers. For example, it becomes more expensive to borrow money for a house or car.

Ultimately, interest rate hikes act to slow spending and encourage saving. This motivates companies to increase prices at a slower rate, or lower prices, to stimulate demand.

Rising Interest Rates and Inflation

With inflation rates hitting multi-decade highs in some countries, many central banks have announced interest rate hikes. Below, we show how the inflation rate and policy interest rate have changed for select countries and regions since January 2022. The jurisdictions are ordered from highest to lowest current inflation rate.

JurisdictionJan 2022 InflationMay 2022 InflationJan 2022 Policy RateJun 2022 Policy Rate
UK5.50%9.10%0.25%1.25%
U.S.7.50%8.60%0.00%-0.25%1.50%-1.75%
Euro Area5.10%8.10%0.00%0.00%
Canada5.10%7.70%0.25%1.50%
Sweden3.90%7.20%0.00%0.25%
New Zealand5.90%6.90%0.75%2.00%
Norway3.20%5.70%0.50%1.25%
Australia3.50%5.10%0.10%0.85%
Switzerland1.60%2.90%-0.75%-0.25%
Japan0.50%2.50%-0.10%-0.10%

The Euro area has 3 policy rates; the data above represents the main refinancing operations rate. Inflation data is as of May 2022 except for New Zealand and Australia, where the latest quarterly data is as of March 2022.

The U.S. Federal Reserve has been the most aggressive with its interest rate hikes. It has raised its policy rate by 1.5% since January, with half of that increase occurring at the June 2022 meeting. Jerome Powell, the Federal Reserve chair, said the committee would like to “do a little more front-end loading” to bring policy rates to normal levels. The action comes as the U.S. faces its highest inflation rate in 40 years.

On the other hand, the European Union is experiencing inflation of 8.1% but has not yet raised its policy rate. The European Central Bank has, however, provided clear forward guidance. It intends to raise rates by 0.25% in July, by a possibly larger increment in September, and with gradual but sustained increases thereafter. Clear forward guidance is intended to help people make spending and investment decisions, and avoid surprises that could disrupt markets.

Pacing Interest Rate Hikes

Raising interest rates is a fine balancing act. If central banks raise rates too quickly, it’s like slamming the brakes on that car speeding downhill: the economy could come to a standstill. This occurred in the U.S. in the 1980’s when the Federal Reserve, led by Chair Paul Volcker, raised the policy rate to 20%. The economy went into a recession, though the aggressive monetary policy did eventually tame double digit inflation.

However, if rates are raised too slowly, inflation could gather enough momentum that it becomes difficult to stop. The longer high price increases linger, the more future inflation expectations build. This can result in people buying more in anticipation of prices rising further, perpetuating high demand.

“There’s always a risk of going too far or not going far enough, and it’s going to be a very difficult judgment to make.” — Jerome Powell, U.S. Federal Reserve Chair

It’s worth noting that while central banks can influence demand through policy rates, this is only one side of the equation. Inflation is also being caused by supply chain issues, a problem that is more or less outside of the control of central banks.

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