In case you missed it, the proverbial hit the fan in overseas markets last night.
Let’s run through the scorecard, shall we…
Dow Jones Industrials: Down 3.5%.
S&P 500: Down 3.3%.
NASDAQ: Down 3.7%.
Germany’s DAX Index: Down 4%.
Gold: Traded as high as US$1,690 overnight. At 6.20am Melbourne time, it was US$1,660.
Oil: Down around 3.5%.
Shanghai Composite Index: Down 0.3%.
The only outlier there is China! Clearly, the authorities are in there propping prices up to maintain the illusion of calm.
Good luck with that…
Let’s leave China’s head in the sand for now, and try and work out what’s going on.
Overnight panic in markets
The overnight panic in markets (and yesterday’s large falls in Australia) was in response to the spread of the coronavirus, notably in South Korea and Italy.
The thing to understand here is that it is the fear of contagion that is the biggest risk. Fear stops people travelling. Fear stops people (especially in China right now) from going to work. Fear stops people from going out for dinner, shopping, and doing all the things that create economic activity.
That’s why oil prices are down sharply. That’s why airlines and travel companies are down too. It’s kinda obvious, so I won’t belabour the point.
Up until a few days ago, the equity market chose to ignore all this. The bond and gold markets told you something was going on. But the equity market continued to party.
Because the market is an irrational beast. When it gets up a head of steam, all the contrary facts in the world won’t change its mind.
In fact, a few weeks ago, my mate and co-editor Vern Gowdie issued a warning to get out of the market. The general response was scorn and derision. I said at the time it was a good contrarian indicator.
If you ignored all that and listened to what Vern had to say, you’re feeling pretty good right now. It’s not too late to heed his advice. Vern reckons there’s a long way to go. Down, that is.
The point I wanted to make though is that the psychology of the market was blindly bullish just a few days ago. It sounds crazy. But that’s what happens in a melt-up. Investors lose their minds.
The return of uncertainty
There are two ways things could go from here.
There will be a ‘buy the dip’ mentality as investors believe there will be no long lasting impact from the virus. Yes, economic growth will be terrible in the first quarter, but investors will ‘look through it’.
The Financial Review reports on one such investor today. It mentions the expected slowdown in global growth, but…
‘…wise investors know the drop in economic activity will not be permanent, says Leonardo Drago, co-founder at Singapore’s AL Wealth, which provides investment and fund management services to a select group of institutional investors and family offices.
‘From his office high in Millennia Tower, Mr Drago has a commanding view of the container ships queuing up in Singapore’s harbour, but it’s a logarithmic chart plotting out the rate of new infections and the case-fatality rate of COVID-19 that anchors his read on the crisis.
‘The rate of virus progression has slowed in recent weeks, notwithstanding new clusters in South Korea, Italy and Iran, and the fatality rate outside China is now 0.8 per cent. Together, these two factors suggest that, like previous pandemics such as SARS, COVID-19 is likely to fizzle out.
‘“My projection is it will be all over by the northern summer. There are still risks of course, but it becoming less and less of an unknown,” Mr Drago said.’
The problem here is that Mr Drago seems to believe the government statistics on the virus’ rate of progression. That’s crazy.
The buy the dip crowd will no doubt have some central bank announcements to celebrate soon. These central planners believe they can fix climate change, so why not have a crack at sorting out a global pandemic too?
That will be more short term noise though.
The biggest issue in all this is the potential for fundamental change in the global supply chain. If nothing else, the spread of the virus across China has exposed industries and countries as over-reliant on China’s manufacturing and distribution system.
Whether this turns out to be a short-term scare or something that drags on for a long time, no one knows. The point is, it will see many countries reassess their trading relationship with China.
The US already has. That’s what the long running trade war was all about. Much of its military hardware, for example, came with a ‘made in China’ sticker.
The ramifications of a fundamental re-working of the global supply chain cannot be overstated. No one knows how it will play out.
And that’s the point isn’t it?
No one knows how any of this will play out.
The problem for the stock market though, is that it had a massive ‘certainty premium’ priced in. It still does, to be honest.
What I mean by that is that up until a few days ago, investors were certain that tech stocks would keep heading higher. They were certain that profits would keep growing. And they were certain the Fed would sort out any problems along the way.
Certainty equals high prices.
Certainly equals a low margin of safety.
But certainty is an illusion. The future is inherently uncertain.
After a long time of ignoring this truth, the market looks like it’s changing its tune. It will be painful in the short term. But for genuine investors looking for well-priced long-term opportunities, the return of uncertainty is a beautiful thing.