As the markets would tell it, the swine flu epidemic is little more than a tempest in a teacup. But, sad to say, the danger here remains far greater than it seems…

Before we begin, a word in honor of Monday’s stage-five rocket launch of a rally. Or should I say, rally on top of rally.

As a caveat, these words are being written some two hours and change before market close. Regardless of where that close may be, however, it simply must be said – watching what seemed to be nearly every risk-related asset in the world catch a gigantic bid simultaneously was, in a word, awesome.

(Your humble editor was so transfixed by the sight, he felt verbally transported back to his seventh-grade skateboarding days.)

The world, it seems, is pounding the table for a V-shaped recovery. Maybe even a slightly leftward-tilting V, to make more room for a right-side trajectory of almost straight up.

So what is this? Is it the mother of all short squeezes, as such to slay the mightiest of caught-out quant funds, making all past squeezes look positively Lilliputian in comparison?

Is it the blowoff top-of-tops, as every long-only fund manager on the planet loses his mind with fear that the great new bull market is leaving him behind, thus forcing him (or her) to buy with a frenzy reminiscent of Duke and Duke watching their fortunes evaporate in the frozen orange juice pit?

Or could it be, just might it be, the unexpectedly early beginnings of a great new inflationary phase – a paper wind-tunnel destined for the heavens, in which the trillions upon paper trillions pumped into the global economy’s backside result in worldwide equity markets that look Zimbabwe’s?

If the latter, then one might expect the Dow Jones to double – and gold to more than triple and silver to quintuple.

But anyhow, I digress. My intent today was to usurp the “grumpy old man” role from my professorial colleague Adam Lass, and in that guise sound an unpleasant (but necessary) note on swine flu.

Should We Pooh-Pooh the Flu?

The cool kid move, for now, is dismissing swine flu (or type A H1N1 influenza to be precise) as an overblown hoax.

The WHO – as in World Health Organization, not Pete Townshend & Co. – has faced a blast of snarky criticism from those who felt that the raising of the alarm to threat level 5, one notch below full-blown pandemic, was an irresponsible act of overkill.

“After all,” the critics scoff, “the plain old brown bag flu kills tens of thousands of Americans every year, and no one has bothered to sound the alarm about that. Surely a mere handful of deaths is little more than an excuse for the media to gin up panic.”

Nor has the credibility of the swine flu threat been helped by ridiculous actions from panicked governments, like Egypt’s 100% useless decree to slaughter every pig in sight – or Iraq’s plan to kill the wild boars in the Baghdad Zoo. (Wait… Baghdad has a zoo?)

It’s clear what global equity markets think of swine flu. (Not worth a Kleenex.) But, nonetheless, WHO was right to sound the alarm. And we are not yet out of the woods.

To understand why, first think of black swans.

The Implications of Black Swan Theory

I almost hesitate to bring up black swans, because the phrase has been so routinely butchered by the media. (And the phrase’s author, Nassim Nicholas Taleb, is gleefully vicious in taking apart anyone who misquotes him.)

Quoting Wikipedia (in the hopes of dodging a bullet), Taleb’s Black Swan theory “refers to a large-impact, hard-to-predict, and rare event beyond the realm of normal expectations.”

The unnerving aspect of swine flu is that if nothing much happens, then we all turn out fine because, well, nothing much happened.

But if the virus mutates in its travels, and comes back in a “second wave” as some far more deadly form, then we could have one hell of a black swan on our hands – with tragic loss implications far bigger and nastier than any event in living memory.

This is why the authorities are so cautious, and so willing to ratchet up the pandemic alarm even if the present iteration of swine flu seems “mild.” Viruses are strange opportunistic beings, by some classifications neither living nor dead, and they are known to get a leg up on their hosts whenever they can.

So the trouble with even a “mild” version of swine flu is, the farther the flu spreads and the more humans it comes into contact with, the greater the chance that, somewhere down along the line, one particular substrain of the virus wins the genetic equivalent of the mutation lotto and turns into a swift and silent killer overnight.

Vaccines Not a Help

Another problem with just brushing off the swine flu scare is the threat of over-reliance on common vaccines. The more we rely on existing vaccines to kill the currently existing version of the swine flu virus, the greater the odds we give said virus of mutating its way into a vaccine-resistant strain – in much the same way many hospital bugs grow hardier and nastier after surviving a barrage of chemical attacks.

So, again, the problem is not just the visible mortality rate. The problem is the scope and scale of the spread. The farther and wider swine flu travels, the greater the odds that something very, very bad happens.

And now that I may have gone and ruined your pleasant Tuesday, what are the odds that something terrible will happen – that the Dr. Jekyll version of swine flu (sorry, H1N1) turns into Mr. Hyde?

It’s tough to say, of course – in terms of a mutation threat, specific numbers are very hard to come by. Needless to say the odds are probably pretty low.

But given the potential scope of the threat, the authorities are right to take this threat quite seriously. Even if the threat of a lethal worldwide pandemic were, say, one chance in 50, a 2% chance of millions dying in the midst of global economic shutdown is, to say the least, a nontrivial matter.

The perhaps aptly named Larry Brilliant, chairman of the National Biosurveillance Advisory Subcommittee and chief “philanthrophy evangelist” at Google, writes the following in The Wall Street Journal:

No one knows if the 2009 swine flu will behave like the 1918 Spanish flu that killed 50 million to 100 million world-wide, or like the 1957 Asian flu and 1968 Hong Kong flu that killed far fewer. This 2009 flu may weaken and lose its virulence, or strengthen and gain virulence – we just do not know.

After totting up further bits of good and bad news – mostly on the bad side – Mr. Brilliant frighteningly adds this:

The 2009 swine flu will not be the last and may not be the worst pandemic that we will face in the coming years. Indeed, we might be entering an Age of Pandemics. In our lifetimes, or our children’s lifetimes, we will face a broad array of dangerous emerging 21st-century diseases, man-made or natural, brand-new or old, newly resistant to our current vaccines and antiviral drugs. You can bet on it.

Flu-Proof Your Portfolio

So what to do? Buy a face mask and a survival plot of land? Hide under the bed until the whole thing blows over?

Unfortunately, it’s not going to blow over any time soon. The 1918 Spanish flu also gave the appearance of being “mild” at first, seemingly going into remission before returning with a deadly vengeance.

Margaret Chan, the director general of the World Health Organization, warns onlookers not to feel too warm and fuzzy about an apparent trend of declining mortality rates in Mexico.

“We hope the virus fizzles out, because if it doesn’t we are heading for a big outbreak,” Chan said. “I’m not predicting the pandemic will blow up,” she added, “but if I miss it and we don’t prepare, I fail. I’d rather over-prepare than not prepare.”

Your humble editor will be catching a plane in a few weeks’ time – given the likely-to-subside nature of this threat, which will probably fizzle out after all, we have to go on living our lives. It doesn’t make sense to quake in fear.

But at the same time, it would be wise to avoid the lolling lull of complacency. If the lazy hazy days of summer produce nothing extraordinary on the epidemic front, that doesn’t mean we are home free – just as a stage-five rocket ride doesn’t mean the bulls are free and clear to celebrate the end of the late great bear market.

Stay calm, but stay vigilant, and perhaps consider some long-dated put option protection for your portfolio. If you aren’t sure what to buy to protect yourself, I’m sure the Taipan Publishing Group team of eagle-eyed trading editors – including Zach Scheidt, Adam Lass, Sara Nunnally, Christian DeHaemer and me – can help you come up with something.

To close, a quote from a Winston Churchill speech to The Commons – delivered May 2, 1935 – that feels doubly appropriate in this gloriously (insanely?) bullish afterglow:

When the situation was manageable it was neglected, and now that it is thoroughly out of hand we apply too late the remedies which then might have effected a cure. There is nothing new in the story. It is as old as the sybilline books. It falls into that long, dismal catalogue of the fruitlessness of experience and the confirmed unteachability of mankind. Want of foresight, unwillingness to act when action would be simple and effective, lack of clear thinking, confusion of counsel until the emergency comes, until self-preservation strikes its jarring gong, these are the features which constitute the endless repetition of history.

Source: Black Swans and Dead Pigs – Why Swine Flu Is No Joke