With 200% Leverage, no Wonder Stocks are Falling

Dear Reader,

It’s been another rough night on global stocks markets. US markets are still trading as I type, but let’s take a look at the scorecard so far…

Dow Jones Industrials: Down 2.6%

S&P 500: Down 2.4%

NASDAQ: Down 2.1%

German Dax: Down 1.9%

Gold: Down 0.7%

Brent crude: Down 3.1%

When business cycles turn, it is usually slow. Central banks can see it coming. They can manipulate it.

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But when a black swan event like a deadly virus spreads throughout the world, the impact on economic growth is much more severe. It stops, dead in its tracks. At least it does for those countries where the fear of contagion is greatest.

That’s China, obviously. But the virus is now in South Korea, Iran and Italy. The Australian reports:

European countries have upped their coronavirus preparations as a further four elderly Northern Italians died overnight and confirmed cases of the virus have now been detected in Croatia, Austria and Switzerland.

In Iran, the deputy health minister Iraj Harirchi tested positive for coronavirus, hours after he appeared on television wiping away sweat and coughing, to insist the Iranian government had the outbreak under control. Another Iranian parliamentarian, Mahmoud Sadeghi, is also suffering from the virus and said on Twitter: ‘My corona test is positive…I don’t have a lot of hope of continuing life in this world.’’

As I said yesterday, it’s not the virus itself leading to this rapid slowdown. It’s the fear of contagion. People stop travelling, moving about, eating out etc.

Less movement of people = less movement of goods and services = lower economic growth.

Stock markets are particularly vulnerable right now

Before I explain why stock markets are particularly vulnerable right now, let me give you a health tip. This may or may not be useful. All I can say is that I haven’t (touch wood) had a cold of any decent severity for years. And rightly or wrongly, I put it down to…

Cold showers!

By that I mean finishing a shower with a few minutes of cold water. It’s hard at first. Start with 10 seconds. The next day do 20 seconds. They day after do 30 seconds. Then it becomes easy. And invigorating.

What’s the point? It strengthens your immune system. The idea is to put your body under a small amount of stress each day. It makes it stronger.

Look it up. The health benefits are immense.

Right then, let’s get back to the markets…

There are a few reasons stocks are reacting so negatively to the spreading virus. Obviously, the expected hit to growth and earnings means there is a fundamental change to valuation models.

This pullback is a buying opportunity

The odds suggest that — as bad as it seems now — the virus will eventually be contained. Therefore, the earnings dip will be short lived. That means this pullback is a buying opportunity!

But wait…

This is happening at the tail end of the business cycle. It’s already been the longest expansion in US history. The bull market is also the longest in history.

But this time, central bankers can’t avert a cyclical slowdown. They will try, but the impact on earnings from this virus fear will be real and perhaps much larger than expected.

The other point to note is that the global economy is now more highly leveraged than it has ever been before.

As at 30 June, 2019, total global debt totalled US$250 million, according to the International Institute of Finance. Meanwhile, the value of global equity markets was around US$85 trillion at the end of 2019, according to research from Deutsche Bank.

That represents a leverage, or gearing ratio of 200%.

During an upswing, that type of leverage works wonders on equity values. But leverage works both ways. Watch it go into reverse as company earnings come under pressure.

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Does this mean you should panic and get out of stocks altogether?

The answer to that depends on your individual circumstances. I certainly know what Vern Gowdie’s answer is. Vern was urging you to panic weeks ago. It’s looking like a great call.

It’s not an easy question to answer. I have a detailed report on it going out to subscribers of my advisory, Crisis & Opportunity, today. So I’m not going to divulge too much.

But in short, I think the market does have a fair bit more downside to go in the months ahead. It won’t happen in a straight line though. There will be hope-fuelled rallies along the way.

And there is always the chance that the spread of the virus slows and then stops. That will put a stop to the selling very quickly.

In short, understand that you’re operating with very little certainty right now. While that’s always true in the markets, it is particularly true today. This virus could decimate the global economy, or it could be all over in a matter of months.

This uncertainty is manifesting in lower stock prices, as it should. There will be rallies here and there, but investors will use them to get out of positions.

I think you’re seeing the overall trend of the market starting to change. The top of this great bull market is in.

Regards,


Signature
Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own. Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts. At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates. Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.


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