A Stock Market Sale is Underway

Dear Reader,

As you can see from the announcement above, we’re doing something different this week. It’s a company-wide initiative. The incredible moves in the market you’ve seen over the past few days demand it.

So please, make sure you tune in each day for updates.

For now, let’s try and make some sense of this market.

As you probably know, yesterday a new threat hit the market: plunging oil prices. On Sunday night US time, oil futures dropped an incredible 30%-plus during the trading session. Brent crude closed down 24% to US$34.36 a barrel.

Actions by Saudi Arabia were the catalyst for the fall. As the Wall Street Journal reported yesterday:

Oil prices crashed to their lowest levels since 2016 after Saudi Arabian state oil giant Aramco said it plans to cut prices, a move that escalates the kingdom’s clash with Russia and threatens to unleash a torrent of crude into well-supplied energy markets.

The Saudi gambit is part of an aggressive campaign to snatch some of Moscow’s market share, according to delegates from the Organization of the Petroleum Exporting Countries and Saudi officials.

With demand for oil already plunging due to the coronavirus, this move by Saudi Arabia looks like madness. But there is a method to it. Saudi Arabia is the largest and lowest cost producer in the world. It can afford, for a short time at least, to start a price war and knock out some higher cost producers.

Amongst those higher cost producers are the US shale oil players. This has been a boom sector for the US over the past decade. It’s why the US regained energy independence.

But this plunge in prices will be a problem for the sector. And for the wider market. That’s because borrowers in the US energy sector make up around 11% of the high yield bond index.

There will be bankruptcies in this sector. There will be defaults. Which raises the dreaded question of ‘contagion’. Who holds the debt?

Along with the oil price plunge itself, that’s probably a big reason why US stocks had a massive fall overnight. At the close of trade, the Dow Jones Index and the S&P 500 were down 7.8%. The NASDAQ fell 7.3%.

Sell everything that isn’t cash

Banks were hit hard on this contagion fear. What is their exposure to the US oil sector? JPMorgan, for example, sank 13.5%.

The gold price held steady. But the miners were not spared. The HUI Gold Bugs Index plunged 8%.

In other words, it’s a case of sell everything that isn’t cash or cash-like. The market sees gold and government bonds as cash-like, which is why they continue to do well. The yield on the US 10-year Treasury bond dropped sharply again overnight to around 0.33% — another all-time low. When yields fall, prices rise.

So you’re seeing capital flee the equity market and surge into the US sovereign bond market.

At some point, the panic will subside. Rational investors will see a big difference between bond and equity valuations. The pendulum will swing the other way.

The problem at the moment is on the equity (or stock) side of the equation. The uncertainty around the coronavirus means that the short-term hit to profits and profitability is unknown. It could be short and sharp, or deep and prolonged.

But history does tell us that these are the times you should be thinking about buying, not selling in a panic. True, it might take another 6–12 months to vindicate your decision. You might have to endure losses and look like an idiot for some time.

But the price of an asset is the sum total of its lifetime of expected cashflows, discounted back to the present day using an appropriate interest rate. If share prices plunge because of fears of recession (leading to a short-term drop in earnings) then it presents an opportunity for the rational investor.

Having said that, prior to the panic kicking in, market valuations were very stretched. So you’d have to question whether a 20% fall has restored value.

On the other hand, the alternative asset class to equities, government bonds, are now even more expensive. I just mentioned that you value shares by discounting future cashflows using an appropriate interest rate. The US 10-year treasury is the basis for that rate.

In other words, the discount rate analysts use to value equities is lower than it’s ever been. Theoretically, that should provide support to equity prices. But right now, during the panic phase, that’s simply not happening.

To use a bit more financial jargon, it means the ‘equity risk premium’ is now quite high. In plainer English, it means the long-term reward for investing in equities is higher than it’s been for some time.

But we’re in the midst of an all-out panic. There are few thinking rationally at this point. No one wants to know about ‘equity risk premiums’, or the relative value of stocks over bonds.

It’s all about survival.

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Fear is prevalent in the market

Which is why fear is so prevalent in the market right now.

To give you an idea of this fear, check out the Aussie VIX (an index of volatility, also known as the ‘fear gauge’). This is what it looked like after yesterday’s session.

The data only goes back to 2013. But as you can see in the chart below, it’s a panic reading:


The Rum Rebellion

Source: Optuma

[Click to open in a new window]

Once again, history tells us that during these times, those with the stomach to buy are usually rewarded over the long term.

So as far as I’m concerned, it’s time to start looking at companies and valuations rationally. A stock market sale is underway.

Regards,


Signature
Greg Canavan,
Editor, The Rum Rebellion

PS: FREE report reveals that both bitcoin and gold could soon soar. To find out what’s set to kick-start this ‘Wealth War’…claim your FREE report now.


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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