The market is in retreat! Is it from the economic impacts of the coronavirus or speculative selling and is it a good time to buy?

Welcome to Finance and Fury

What a week last week was for markets – ASX lost value of just under 10% - All around news of the Coronavirus and speculation on Government responses – So Aus and international markets have dropped heavily – might be thinking that it is solely out of expectation that companies will lose money from the Virus outbreak.

Well – the overall Market has tanked which companies most affected? - almost every one Medical companies dropped, banks dropped, A2 Milk – which has large sales to china went up over the week In the US - FANG stocks went down heavily – Google, FB, Amazon – down 14% - understand Amazon if cant ship goods – but why FB? If anything – people may be spending more time inside online What does this all say? Could the Selloff probably have less to do with the coronavirus than what is being reported on? – let's have a look at this further to see – or if it is just speculative selling/profit-taking – and if it is a good time to buy? Before we get into it – Nobody has asked the question – why has the Chinese Government which from observation – doesn’t really have a high value of life on its population – shut down their economy through extreme quarantine measures for 80,000 sick people and around 2,700 dead? Are the numbers more? Or is something else going on China has a population of 1.4bn –80k = 0.0057% of pop - In Australia that would be 1,400 people with the illness – 50 of those would pass away based around the estimated death rates – those who are immunocompromised or over the age of 60 Even if it is 50 times larger – there would be 135,000 dead – historically for China this is a good weekend on a collectivised farm – I know they are past those practices – but even in modern times: They aren’t without their human atrocities – Falun Gong practitioners being imprisoned and tortured, reports of organ harvesting, treatment of the million Uyghur Muslims in “re-education camps” – but all of a sudden, they really care about their people? I find it hard to believe – might be the case Now - Not saying this is related, or implying anything – but two interesting things I noticed around the timing of the quarantines - Wuhan was having mass protests last year – same with HK – not much happening with those now? Also – China just lost the trade war and were about to sign an agreement with the USA – losing yet again They were dumping their US treasuries leading up to December last year – then the quarantines effectively are shutting down the global economy Nobody knows what is going on – all we do know is that the market is going down and Governments seem to be overreacting – resulting in panic selling and global fear occurring The responses from the media and Governments are creating the economic uncertainty – not the virus itself Perspective - Assumptions are that 5% to 20% of western populations will get the flu/mild or severe– each year – death rates in the west from the flu are lower than Coronavirus – but in China – flu deaths are around double already due to health care system – so every year 70m Chinese at a minimum will get the flu – working off the numbers - in the past week – more people in China have died from the flu than the coronavirus

 

Regardless of the rational for the selloff

– there has been a crash/correction – and a quick one at that – the volumes are huge – to the point it is one of the most coordinated sell offs in history – to break this down:

First – let's have a look at How crashes work – analogy to a movie theatre –

Anyone been to a movie theatre – people slowly arrive at different time – some go early to buy the best seats, some rock up later, some don’t like the ads to turn up just as the movie starts – people all get in slowly – Similar to buying patters of markets – buy orders come in over time – different institutions and individuals dribble in But now let's say that the room can fit 200 people – but the movie is very in demand – and this is the one cinema showing it – people will pay a lot for the tickets – prices start to go up and the room starts getting crowded Out of greed – and to make more money – the cinema allows 300 people to cram into the room – so it is packed – but the exits are the same size Now say someone cried out fire – and the room panics – everyone rushing for the exits – cinema clears a lot quicker than what it filled up This is similar to how markets behave – the bears take the window whilst the bulls take the stairs – markets go down in a panic faster than what they rise in a boom Markets don’t crash when they are overbought – but they crash when they are oversold through panic – like over the past week S&P 500 had its fastest movement from peak to correction on record – a matter of 6 days – next: Feb18 was 10 days, Oct55 about 15 days – Nov07 took 35 days Dow had its peak to correction at the fastest pace since the 1928 panic – right before the great depression Overall - US markets saw their worst week since Lehman (Oct 2008) – similar in Australia Need some historical context – what are the week-on-week changes in the S&P500 over the past 100 years – Worst is the 1928 great depression along with the GFC – losses of around 18% week on week Then Hitler invading France - in 1941 – about a 15% reduction in week on week Right now – we are the same as the 1987 black Monday, dot-com bubble – with around 10% Following the trend of the 2000 crash, 1928 crash – the Nasdaq and US markets (and maybe Australia) may be in for a potential dead cat bounce (small rebound through buying) and then declines over the next few months further from here – albeit at a slow rate compared to the last week But this all depends on the panic and fear in the market – nothing fundamentally has changed since last week – still in the same leveraged position with record low-interest rates – which may decline further in response to boost the markets Similar to these events - Investors are selling stocks first and asking questions later – the signs of panic Market over the past week was showing signs of pure liquidation - ‘Get me out at any cost’ (regardless of crystallising losses) - seems to be the prevailing mood – depending on Government responses to the coronavirus – the weigh on the global economy may increase - There is much that is unknown – and also premature to suggest the base case for a recession triggering event Important not to forget that asset prices have already diverged significantly from fundamentals over the past few years - in part because of central bank policy, share buybacks - but also because passive investment’s main signal is price action – becoming price taking and not price making – looking at the sell offs – large caps in indexes (like the FANGS in the US, and Banks as well) have been hit hard – for no fundamental reason Volumes of sales have been very high - Stock market volume has exploded higher as the crash has accelerated - notably higher volumes than during the mid-2018 crash Globally – shares lost over $5.1 trillion in market cap in the last 6 days - that is the biggest loss ever Global banks shares were also a bloodbath this week - The biggest 6-day collapse in bank stocks since the peak of the GFC – is lending going to be restricted from the coronavirus? Interestingly - What happened beyond the share market also shows some signs of panic instead of fundamentals – The US Dollar rose by the most since July 2019 in Feb (but the worst week since 2019) – whilst the AUD fell Silver suffered its worst monthly drop since May 2016 and on Friday - Gold's worst day today since June 2013 – Lots of questions about the crash in gold but the likely culprit was the BoJ putting in massive sales Oil also collapsed again in February for its worst start to a year since 1991 Central banks are now meant to save us – so what Comments from the Fed occurred? Fed speakers and Jay Powell issued statements which definitely didn't suggest that a Sunday night rescue was planned – but a possibility "Further policy rate cuts are a possibility if a global pandemic actually develops with health effects approaching the scale of ordinary influenza, but this is not the baseline case at this time” – so the Fed isn't even worried about this compared to the ordinary flu? “Longer-term U.S. interest rates have been driven lower by a global flight to safety, likely benefiting the U.S. economy. Even with the current stock market price drop, equities have been on a long upswing. We will use our tools and act as appropriate to support the economy." But The market implied rate cuts indicate that one cut is guaranteed soon – same in Australia over the next few months – probably won’t happen this week based around out implied rate curve – but who knows

 

From here – is likely that another wave of selling will likely occur before a stronger bottom is finally reached in markets  The composite technical overbought/oversold gauge is also trending for more extreme oversold conditions soon - but these are typical of a short-term oversold condition In plain English – in 2019 everyone was piling into the theatre creating overcrowding – but now large amounts of people are running for the doors – guess they didn’t like the movie So - What to do from here? – Remember - We were not this oversold even during the 2015-2016 decline, much less the two declines in 2018 from September to December

 

Was having a look at historical patterns and what actually defines a market crash – On average the market rises by about 0.04% per day – with Standard deviation – average daily volatility is around the 1% range At this stage – the ASX is below the 50,100,200,300 DMA – shows a very quick decline and very volatile Volumes as well point to an overselling phenomenon – but doesn’t mean that is it overdue to one factor Market crashes occur when shares are already oversold – looking at the data – for the days where the market goes down by 5% or more - it happened 22 times in the US – 82% of those occurred once shares were already oversold – Interestingly - 12 of those days occurred in the GFC time period Mathematically speaking - the bulk of the recent decline is already priced into the market out of future fears That is where the odds of a 5-standard deviation move (which we have gone through) are about 1 in 3.5 million But since 1958 (15,647 trading days) there have been a total of 39 days with +5% moves: 17 positive and 22 negative – so whilst statistically this should be very very rare – does happen a bit in markets – or about 8,700 times more than would be statistically predictable Therefore - technically and statistically - equity returns have more “fat tails” rather than those defined by a normal distribution – so this is really nothing outside of what is possible in markets The bottom line is that a 5% decline in a given day is a good definition of a “Crash” – Over a month – 20% and over a few months – 30-40% Outside of the 2008 – 2009 Financial Crisis, if you bought the close of a down 5% day you made an average of 8.46% over the next 3 calendar months with 90% of those instances yielding positive returns. The only exception, but still notable, was October 16th 1987 Looking just at the 2008 – 2009 experience, buying the first down 5% move on September 29th was not a great idea, but if you had the fortitude to stick with it you were at least breaking even within a year. Looking at this present-day event: what if we get a 5% crash day as a result of concerns about the coronavirus' effect on the global economy?  History says buy that these types of crashes are opportunities to make solid 3-month returns with little risk of further cataclysmic drawdowns. However - If you think the COVID-19 bears closer resemblance to the 2008 Financial Crisis than a “garden variety” crash - then history says to buy the first down 5% close in a small size and wait for more to add to positions – essentially a dollar cost averaging approach – nobody knows when it will bottom out – but if the market tanks from here this week – some shares may start to appear fair valued

 

Bottom line:

At the time of recording this - we’re going into a Friday-Monday sequence – with large one-week losses in previous crash events – like in 1987 and 2008 – 2009 – there was the possibility for markets to have a down 5% day - From here there are two scenarios –

We are going to get a bounce over the next few weeks – but may be a dead cat bounce Or this shows the cracks in the economy

Either way – I am holding off before moving funds back into the market – but it is important to Be Ready To Execute

Whatever further drop we get from here will likely be short-lived when viewed in a timeframe of years - So have your game plan together before-hand as the opportunity to buy in may be coming soon - Bottom line: markets right now are vulnerable to a crash – due to structural issues - so Be ready to at least stick a toe in the water if that happens.

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