Pandemics & Crashes - Investor Amnesia

4/5/2020 Pandemics & Crashes — Investor Amnesia
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Sunday Reads
Pandemics &
Crashes
By Jamie Catherwood March 29, 2020
https://investoramnesia.com/2020/03/29/pandemics-crashes/ 1/19
Visualizing History
Source: A Century of Evidence on Trend Following
From the Archives
The Rationale of Market Fluctuations (1876)
Sunday Reads
History is not a road-map, but a compass.
Reading all the nancial history in the world will not allow you to accurately
predict everything that will unfold in markets over the near term. There is no
historical road-map outlining the speci c events that will occur today simply
because of what’s happened in the past. However, history acts an invaluable
compass for steering investors in the right direction in challenging times. By
recognizing the patterns that repeat themselves over the course of centuries,
we can better position ourselves for whatever lies ahead. I hope that this
week’s edition of Sunday Reads acts as a useful ‘calibration’ of this historical
compass.
Without going into too much detail, these are some of the largest events and
themes that have occurred since the Pandemics & Markets post I shared on
March 1st.
The S&P 500, Dow Jones Industrial Average, and NASDAQ indices all
entered bear markets.
For the S&P 500, this was the fastest bear market entry on record, taking
just 16 trading sessions to fall 20% from its peak.
The largest stimulus package in history was passed on March 27th,
totaling $2 Trillion.
The airline industry received a $50 billion bailout as part of the stimulus
package.
Regulation was passed banning buybacks for companies that received
government aid.
As a result, the links below dive into:
Long run consequences of pandemics.

The political rami cations of nancial crashes and crises.
What three centuries of data tells us about what to expect after market
crashes. Home Articles Sunday Reads Meet Ups About
The potential of new securities regulation as a result of recent events.
Before we get to this week’s links, I wanted to share an inspiring story from a
previous American crisis (1906 San Francisco Earthquake) that I came across
while researching a new article.
The story is of A. P. Giannini, a.k.a. the founder of Bank of America (which was
actually named The Bank of Italy until 1930). As this article tells it, Amadeo
Peter Giannini was the son of Italian immigrants, and founded a small bank in
an Italian neighborhood of San Francisco in 1904. While most banks at the
time were strictly focused on servicing the wealthy, Giannini focused on
convincing the ‘unbanked’ (mostly immigrants) to put the money under their
mattresses into a bank account, where it would be safer and accrue interest.
Great guy, right? Well, it gets even better.
“On the morning of April 18, 1906, a massive earthquake hit San Francisco.
The ensuing res burned down the large banks. Their superheated metal
vaults could not be opened for weeks- lest the cash and paper records
catch re when oxygen rushed in.
As ames threatened his one room bank, Giannini spiritied $80,000 in

coins out of town. He hid the precious metal under crates of oranges and
steered his wagons past gangs of thugs and looters in the streets.
As other banks struggled to recover, Giannini made headlines by setting up

a makeshift bank on a North Beach wharf. He extended loans to
beleagured residents “on a handshake” and helped revive the city. The
innovative bank welcomed small borrowers who might otherwise have to
use high-cost loan sharks. Most banks at the time regarded people with
modest incomes as credit risks not worth the paperwork. But experience
had taught Giannini otherwise: that working class people were no less
likely to pay their debts than the wealthy….
On November 1, 1930, the Bank of Italy in San Francisco changed its name
to Bank of America. The bank today has the same national bank charter
number as Giannini’s old bank – #13044. When A.P. Giannini died in 1949,
the former single-teller of ce in North Beach claimed more than 500
branches and $6 billion in assets. It was then the largest bank in the world.”
I still can’t get over how incredible a story this is, and how perfectly it
encapsulates the American spirit. Amazingly, the story gets even better! In
addition to being a literal hero during the San Francisco earthquake
aftermath by providing loans to those in need, he also:
Providing nancing for the Golden Gate Bridge.

Financed Walt Disney’s rst rst full-length feature: Snow White and the
Seven Dwarves.
What a guy.
Now let’s get into this week’s links!
Longer-Run Economic Consequences of Pandemics

This is the article that many of you have been searching for since the
coronavirus pandemic rst broke out. This article looks at the return on assets
over 12 major Home
pandemicsArticles
since the 14th century.Reads
Sunday Meet Ups About
“How do major pandemics affect economic activity in the medium to longer

term?… We study rates of return on assets using a dataset
stretching back to the 14th century, focusing on 12 major
pandemics where more than 100,000 people died… Signi cant
macroeconomic after-effects of the pandemics persist for about 40 years,
with real rates of return substantially depressed… Using more sparse data,
we nd real wages somewhat elevated following pandemics. The ndings
are consistent with pandemics inducing labor scarcity and/or a shift to
greater precautionary savings.”
Speci cally, the authors look at the “natural rate of interest”, which is ‘the level
of real returns on safe assets which equilibrates savings supply and investment
demand—while keeping prices stable—in an economy.’ Their ndings are

summarized below:
‘Figure 2 contains our main result, and displays ˆt (h), the response of the
natural rate to a pandemic, 1 to 40 years into the future. Pandemics have
effects that last for decades. Following a pandemic, the natural rate of
interest declines for decades thereafter, reaching its nadir about 20 years
later, with the natural rate about 2% lower had the pandemic not taken
place. At about four decades later, the natural rate returns to the level it
would be expected to have had the pandemic not taken place. These
results are staggering and speak of the disproportionate effects on the
labor force relative to land (and later capital) that pandemics had
throughout centuries.’
The author’s then went a step further and compared the impact of pandemics
to another category of events that take many lives: war. The outcomes were
very di erent, as ‘wars tend to leave real interest rates elevated for 30–40 years
and in an economically (and statistically) signi cantly way.’
Going to Extremes: Politics After Financial Crises (1870 –

2014)
Uncle Sam wards o another set of ‘Hard Times’ (Panic of 1893),

adding to his collection in the background (Panic of 1873, 1857,
1837, 1819)
Many people are already starting to think about the political rami cations of
coronavirus, particularly following the $2 trillion stimulus package. In addition
to the existing partisanship rampant across America, which can a ect how
one views Trump’s response to the crisis, the bailout of industries like Airlines
have stirred some of the anti-executive / anti-Wall Street sentiments
prevalent in the Great Financial Crisis of 2008. The 2008 crisis spurred the
Occupy Wall Street movement, the rise of the Tea Party, and some would
argue global populism in general.
This article provides helpful context on the historical relationship between

political movements and nancial crises / market crashes. Across 20
developed countries, this paper assesses the political consequences of
nancial crises over the last 140 years through studying more than 800
general elections. Their analysis nds that ‘On average, far-right parties
increase their vote share by 30% after a nancial crisis.’
Equally interesting is their conclusion that only Financial Crises have this
large impact on the political process:
‘Financial crises are politically disruptive, even when compared to other

economic crises. Indeed, we nd no (or only slight) political effects of
normal recessions and different responses in severe crises not involving a
nancial crash. In the latter, right wing votes do not increase as strongly
and people rally behind the government. In the light of modern history,
political radicalization, declining government majorities and increasing
street protests appear to be the hallmark of nancial crises.’
In so far as people blame central banks for exacerbating inequality through

quantitative easing, the authors end their article by acknowledging this
argument:
‘As a consequence, regulators and central bankers carry a big

responsibility for political stability when overseeing nancial
markets. Preventing nancial crises also means reducing the
probability of a political disaster.’
Negative Bubbles: What Happens After a Crash
I shared this article in the March 1st post on Pandemics & Markets, and it has
only become more relevant since then. Since March 1st, the three leading US
stock market indices o cially entered bear markets, and US markets have
endured some of the most volatile periods since the Great Depression. All that
said, now that we’ve had a legitimate ‘crash’, this paper is an excellent guide
for what investors can broadly expect to occur in markets moving forward.
‘We identify 1,032 events for which a market declined by more than 50%
over a 12-month period. Conditioning on these events, and controlling for a
range of other factors, we nd that markets tend to rebound in the year

following the crash. We refer to this pattern of crash-and-rebound as a
“negative bubble.” Interestingly, the pattern only holds for large crashes –
declines of lesser magnitude exhibit persistence, not reversal. This non-
linearity presents a challenge to standard econometric forecasting
techniques and suggests that something more complex than mean-
reversion is at work.’
William Goetzmann and Dasol Kim’s research nds two patterns:
‘First, markets experiencing a large crash of -50% or more have a

high probability of a rebound, and the average return following
such a crash is nearly 14% higher than returns with a positive
return in the prior year.
Second, market declines of up to -40% are more likely to be followed

by another decline, and the magnitude of this decline is
approximately 6% to 9% in the following 12 months.
In short, above and beyond mean reversion patterns in stock returns, a

small decline in a market leads to a much larger drop, and a large
drop precedes a large rebound.’
The Economic Impact of the Black Death

This week we revisit the Black Death once more, because there is no other
outbreak of disease that compares. In this article, the authors leave readers
with a few key conclusions.
First, the primary post-plague winners were peasants:
‘In the countryside, a freer peasant derived greater material bene t from his
toil. Fixed rents if not outright ownership of land had largely displaced
customary dues and services and, despite low grain prices, the peasant
more readily fed himself and his family from his own land and
produced a surplus for the market. Yields improved as reduced
population permitted a greater focus on fertile lands and more
frequent fallowing, a bene cial phenomenon for the peasant. More
pronounced socioeconomic gradations developed among peasants
as some, especially more prosperous ones, exploited the changed
circumstances, especially the availability of land. The peasant’s gain
was the lord’s loss.’
The post-plague economy also bene ted European consumers:
‘In trade and manufacturing, the relative ease of success during the high
Middle Ages gave way to greater competition, which rewarded better
business practices and leaner, meaner, and more ef cient concerns. Greater
sensitivity to the market and the cutting of costs ultimately rewarded the
European consumer with a wider range of good at better prices.’
In general, the Black Death ‘fostered the possibility of new economic growth’.
While that came at a heavy price, it’s true nonetheless.
‘In the long term, the demographic restructuring caused by the Black Death
perhaps fostered the possibility of new economic growth. The pestilence
returned Europe’s population roughly its level c. 1100. As one scholar
notes, the Black Death, unlike other catastrophes, destroyed people but not
property and the attenuated population was left with the whole of Europe’s
resources to exploit, resources far more substantial by 1347 than they had
been two and a half centuries earlier, when they had been created from the
ground up. In this environment, survivors also bene ted from the
technological and commercial skills developed during the course of the high
Middle Ages. Viewed from another perspective, the Black Death was a
cataclysmic event and retrenchment was inevitable, but it ultimately
diminished economic impediments and opened new opportunity.’
What Causes New Securities Regulation? 300 Years of

Evidence
According to the research of this article, investors should prepare themselves
for increased regulation:
‘If new technology doesn’t cause new securities regulation, what does? In a
nutshell, crashes. All of the 18th-century English regulation, and
even all of the 18th-century proposed regulation, came
immediately after sustained price declines. The rst signi cant
American securities regulation, passed in 1792 in New York, followed the
big crash of that year. And of course the federal securities acts of the early
1930s came soon after the crash of 1929. This is just a general trend,
not an absolute rule. There have been sharp price declines without
subsequent regulation, and of course there has been regulation
without immediately preceding price declines. But most of the
major instances of new securities regulation in the past three
hundred years of English and American history have come right
after crashes.‘
Much of what the author outlines in this article is relevant to the narratives
we hear today surrounding negative public sentiment towards nanciers and
corporate executives. For example, picture everything you’ve heard/read on
the recent controversy and outrage surrounding airline buybacks. Now read
this:
‘The political power of speculators-their incentive and perceived

ability to nudge public policy in the direction that will push
securities prices up or down-has been a constant source of public
concern. The belief that securities trading is a nonproductive
sphere of the economy, one that drains resources from more
fruitful activities, has been ever present. These strands of thought
were pervasive in England in the 1690s, and they are still pervasive
in the United States today.’
Right or wrong, this is a pretty accurate description of the narrative today.

The author also points out that this push-back against speculating and
nanciers often comes after a crash. This is similar to the Kindleberger-
Minsky model, which suggests that fraud lags the market cycle, meaning
frauds are discovered after a market crash because people exercise greater
scrutiny over their investments when losing money.
‘As long as the market has been rising or at least holding steady, however,
these strands of thought have been kept in check by the simple fact that
too many people have been making too much money to favor regulation
restricting trading. But when prices drop, much of that opposition to
regulation is removed. People who were proponents of securities trading in
good times become critics in bad. The result, more often than not, is that
new legislation gets introduced, and often that legislation gets passed.
New securities regulation thus tends to follow crashes.’

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4/5/2020 Pandemics & Crashes — Investor Amnesia

Home Articles Sunday Reads Meet Ups About

Home Articles Sunday Reads Meet Ups About

Source: A Century of Evidence on Trend Following

The Rationale of Market Fluctuations (1876)

History is not a road-map, but a compass.

As a result, the links below dive into:

Long run consequences of pandemics.

As ames threatened his one room bank, Giannini spiritied $80,000 in

As other banks struggled to recover, Giannini made headlines by setting up

Providing nancing for the Golden Gate Bridge.

Now let’s get into this week’s links!

Longer-Run Economic Consequences of Pandemics

“How do major pandemics affect economic activity in the medium to longer

demand—while keeping prices stable—in an economy.’ Their ndings are

Home Articles Sunday Reads Meet Ups About

Home Articles Sunday Reads Meet Ups About

Going to Extremes: Politics After Financial Crises (1870 –

Home Articles Sunday Reads Meet Ups About

Uncle Sam wards o another set of ‘Hard Times’ (Panic of 1893),

This article provides helpful context on the historical relationship between

‘Financial crises are politically disruptive, even when compared to other

In so far as people blame central banks for exacerbating inequality through

‘As a consequence, regulators and central bankers carry a big

Negative Bubbles: What Happens After a Crash

Home Articles Sunday Reads Meet Ups About

range of other factors, we nd that markets tend to rebound in the year

William Goetzmann and Dasol Kim’s research nds two patterns:

‘First, markets experiencing a large crash of -50% or more have a

Second, market declines of up to -40% are more likely to be followed

In short, above and beyond mean reversion patterns in stock returns, a

The Economic Impact of the Black Death

First, the primary post-plague winners were peasants:

The post-plague economy also bene ted European consumers:

What Causes New Securities Regulation? 300 Years of

‘The political power of speculators-their incentive and perceived

Right or wrong, this is a pretty accurate description of the narrative today.

Home Articles Sunday Reads Meet Ups About

MISS LAST WEEK’S SUNDAY READS? CATCH UP HERE

Your email address

Twitter – LinkedIn – Disclaimer – Website by Adam Collins

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