Dow Drops

This is the first time that the stock market dropped the most in a week (down more than 12%) since the financial crisis in 2008. Did this move surprise you? If it did, I would recommend checking out my previous post on the Coronavirus, where I laid out some indicators and strategies that allowed me to prepare my portfolio for this correction in equities.

Should you buy stocks right now?

The S&P 500 index has seen a lot of volatility in the past few days. Due to the speed of the sell-off during last week, any short-term market rallies from now on may be met with heavy selling pressure from those investors that didn’t get a chance to sell yet.

SPX spx-e1583432732683

In times like these, it’s helpful to look at past market corrections and get a gauge on how long it really takes for the market to shakeout all the fear. As you can see from the chart above, large recessions such as the 2008 financial crises can last up to roughly 73 weeks (each bar is one week), and shorter market corrections without recessions can last around 13 weeks.

Now I’m not recommending you to use the past examples as an exact rule of when this current market correction will end, however these past corrections does provide us with a rough timeline of when it might be safe to start deploying cash back into equities. Following that logic, I would recommend holding your cash for now and resist against buying stocks too early. Keep in mind that the market will have multiple fake rallies before reversing momentum, this period of finding the bottom is often called the “Consolidation” phase. Don’t try and catch the falling knife!

 

Will the Coronavirus cause a global recession?

The simple answer to that questions is no one knows. One core reason why the market is suddenly seeing so much volatility is due to the uncertainty regarding the effects of this virus. We know that the virus has already caused immense economic pain for China, proven by the recent dismal manufacturing PMI data for China.

Chinese PMI

China’s economy has been steadily slowing in terms of growth rates, with the most recent full year growth hitting only 6.1%, which was a three decade low for them. However, even with the slowing domestic growth, China’s global supply chains and the massive Chinese consumer buying power had contributed to over 40% of the global growth last year. The bad news is that China’s GDP growth this year is projected to be only around 4.1% (down from 6% forecasts) due to the virus effects, leading to a much smaller boost to global growth. This should decrease global growth by roughly 0.8-1%.

The increased risks that comes with the last two decades of globalization is a powerful exogenous disruption to supply chains, which is what we’re facing currently. Companies around the world have become heavily reliant on China’s factories to supply both critical raw materials and finished products, so when the entire manufacturing sector in the country is operating at 33% capacity, companies around the globe will feel the disruption. Compounding on the negative supply side shock, we will likely start seeing the negative demand side effects as well. The Chinese consumer has increased their wealth dramatically over the past decade, and they’re a major consumer of the world’s products, everything from imported luxury goods to tourism spending. With the entire country on high alert and travel restrictions being enforced, we just lost a major portion of global tourism and spending.

However, there is hope for a recovery in global growth. First, we can expect the Chinese government to do everything possible to juice their economy. Their strategies could include monetary policies such as slashing lending rates and encouraging banks to boost lending, and fiscal policies such as subsidies and tax cuts for large and small businesses. One thing is for sure, it’s generally unwise to bet against the Chinese government’s ability to stimulate their economy using whatever means necessary.

On the global front, Europe and Japan is restrained in terms of monetary stimulus since they’ve already lowered their interest rates below 0%. Any further decrease in rates will likely have minimal stimulus effects. The US has lagged other developed countries in cutting rates, however just today they announced a surprise cut by 0.5%, bringing the Fed rate down to 1% – 1.25%. They also announced today that more cuts may be on its way depending on the severity of Coronavirus, so if situations get worse, we can expect to be in an increasingly easy monetary environment. The big risk is that the marginal benefit of each cut decreases dramatically as the rates become closer to 0%, and this is due to having easy access to money is no longer the issue for the economy, it’s something else that needs to change.

Fed Rate Cut

 

The next tool that governments have is fiscal policy, such as tax cuts and incentives to invest. Trump recently announced tax cut 2.0, which will mainly focus on cutting taxes for the largest consumer base in the US, the middle-class.

Tax Cut

 

Conclusion:

So given the risks ahead with Coronavirus, and the possible stimulating policy changes that governments will likely impose, how should you position your investments to take advantage?

At the end of the day, no fiscal or monetary policy will work if the virus is impacting consumer behavior. As a nation, the US is heavily dependent on its consumers and their desire to go out and spend. If the virus continues to scare people, that spending will not come back. However, the good news is that there is a high probability, in my opinion, that the economy can outlast the virus. With the technology we have now, I believe we will be able to find a vaccine and the sensational fear regarding the virus will calm down after a couple of months. When the fear does eventually die down, we will be left with ultra-low interest rates and a favorable fiscal environment. That combination of stimulus I believe will allow the economy to bounce back substantially and therefore be a strong boost to the stock markets.

In summary, I would recommend holding onto your cash for now, and look for opportunities to buy stocks after a few weeks have passed. Obviously, I will be closely monitoring the situation and will update you guys if I decide to starting buying sooner or later than expected.