As we predicted on the 19th January 2020, it has been a bumpy start to the year for equities and the Coronavirus is chiefly to blame for the volatility.
- Our last post covered why markets were over-valued
- Stock markets were not prepared for the Coronavirus spreading
- Developed markets are down between -3% and -4%
- Chinese markets like the Hang Seng down nearly -10%
- There may be a buying opportunity in early- to mid- February 2020
Rather than trying to accurately predict equity markets, instead, we want to protect ourselves from downside and be prepared to be fearful when others are greedy and greedy when others are fearful.
We will cover the performance of major equity markets and the Coronavirus data in general, then discuss where the Market Timing Model indicators sit and what that says about the investment case for stocks.
Performance of Major Equity Markets
|Index||Value 17th Jan (Friday)||Value 31st Jan (Friday)||Difference|
|FTSE All Share (UK)||4257.93||4057.47||-4.7%|
|S&P 500 Index (US)||3329.62||3225.52||-3.1%|
|Nikkei 225 Index (JPN)||24,041.26||23,205.18||-3.5%|
|Hang Seng Index (HK)||29,056.42||26,312.63||-9.4%|
|German DAX Index||13,526.13||12,981.97||-4.0%|
Simply put, stocks have had a rough start to February. The main UK stock index – the FTSE All-Share – is down nearly 5%. That may have to do with the fact that nearly two-thirds of FTSE 100 businesses make their earnings abroad, and household brands like Diageo (think Johnnie Walker, Guinness) and Unilever (think Axe, Lipton, Hellmann’s) get significant portions of their earnings from Asia Pac and emerging markets.
The question remains: is this sell-off justified?
Coronavirus and the Global Pandemic
As of today the virus has spread quickly: the pandemic has been declared a global public health emergency by the WHO, and massively disrupted the Chinese economy and celebrations over Chinese New Year. It’s a tragic event that has left tens of millions of people effectively locked up in their cities and unable to properly travel and function until the end of this week (7th February) at the earliest. The death toll has surpassed 250 and there are 12,000 confirmed cases as of the 1st of February 2020.
Australia, the US and Taiwan have decided to ban foreign nationals from traveling into their respective countries if they come from China or have very recently visited the affected areas. There is no denying that this is an incredibly tragic and un-timely event for the world, and for the people of China in particular.
Likely Impact on the Economy
The fact that flights have been suspended and production lines completely shut down has sent shock-waves through financial markets. The reason being is simple: you can quantify how much one day’s productivity is worth (hint: it’s a lot!) Take the entire country – or the vast majority of its productive capacity – out for an entire week and that could be a significant dent to GDP and economic growth. The impact on the US economy (as a product of a potential slowdown in China) could be 0.4% of GDP.
Doesn’t sound like much? That’s $77.56 billion dollars.
That being said I don’t think that this has much bearing on the stock market and whether equities are well priced or not. A LOT of investors miss this point. After all, when you buy shares in Diageo or Unilever, you’re buying the future growth of those companies over many years, even decades. So a minor slowdown that may last for 2020 or 2021 shouldn’t have a significant impact provided the companies recover and return to growth.
Medical Transmission Rates
The news media is really not helping to present the facts fairly and in a considered way. I can see articles bearing titles like “The Wuhan Virus is increasingly looking like the plague of our time,” and “Coronavirus: Death toll rises as virus spreads to every region.” It is no wonder that people in the developed world, who are largely outside of this and fairly protected from the immediate spread of the disease, are starting to worry.
In fact when you consider the medical side of the virus the facts suggest that the outbreak is not as bad as the media is portraying it to be. Here are a few outbreaks in order of severity:
- The seasonal flu (Influenza) kills between 291,000 – 646,000 people per year with a mortality rate of approximately 0.13%.
- For Coronavirus there are 12,024 cases and 259 total deaths, so far, with 287 people having recovered (Data provided by Johns Hopkins). That equates to a fatality rate of 2.15%.
- The 2002-2003 SARS outbreak infected 8096 people and resulted in 774 deaths, working out to a mortality rate of 9.5%.
- The 2012 MERS outbreak infected 2494 people and resulted in 858 deaths, working out to a morality rate of 34.5%
- The 2014 Ebola outbreak in West Africa infected over 28,000 people and resulted in 11,000 deaths. The mortality rate of Ebola is estimated to be between 25%-90% depending on region.
- For those of you who are hypochondriacs, the 1918 Spanish Flu pandemic killed 50-100 million people and had a mortality rate of between 10% and 20% (but at a time when medicine wasn’t as advanced)
If you believe the claims that China has underreported the number of cases, then actually the mortality rate for Coronavirus is less than 2.15%. Unless they are drastically under-reporting the number of deaths, it would mean that many more people carry the virus without resulting in a mortality.
From the perspective of the figures that are currently available, SARS was 4.42 times more potent than Coronavirus, and MERS was 16 times more potent.
The Coronavirus is a tragedy and we all should sincerely hope that governments continue to work together to halt its spread. At the same time – in order to keep a cool head – we should view facts that we read in the news with a bit more scrutiny.
Market Timing Model
The reality is that financial markets have and will probably continue to over-react into next week. Billions of pounds of value have been wiped off of developing stock markets and emerging markets.
Overall Summary: Neutral Rating
When it comes to investing, to be successful long-term you need to train yourself to understand what is happening in the world and to apply logical reasoning to the situation. If you react to headlines constantly, you’ll never manage to be invested for the long-term!
The Market Timing Model suggests we’ve gone from highly over-valued to a cautious and neutral rating for stocks. Now is not the time to get excited (yet).
Here is where the Market Timing Model sits as of February 1st 2020. What a difference two weeks makes:
The New York Stock Exchange new highs-new lows index measures the proportional amount of stocks that have reached all-time highs and then compares it to a 200 day moving average. At 77.0 this is a neutral rating, neither a buy, nor a sell. Look at the steep dip in December 2018 (that was a strong buy).
The NYSE Bullish Percent Index measures where sentiment sits and suggests that 62.37% of market participants are bullish (positive) on the overall direction of stocks. Note how quickly readings between 75-80% have corrected, at times within several months. We’re looking for readings around 20%-45%. Neutral rating.
The CBOE put/call ratio measures derivatives activity for traders who bet on the direction of the market. High readings suggest traders have a high degree of negative or bearish sentiment towards the market. Low readings (well below 1) or ultra-low readings (Jan 20th: 0.48) suggest an excessive amount of positive or bullish sentiment. One way to view this is as a contrarian: excessive positive exuberance tends to lead to a correction or event that brings prices down closer to their average
At a reading of 0.74 this is verging on suggesting a weak buy, because it means day traders (who are often wrong) are betting on further market falls. When it hits 0.8-1.0 that would be a strong buy.
One of the classical measures of the market – the VIX – measures volatility. At 18.84 the reading is starting to suggest that a reversal in the market is well under-way. Ideally we’d like to see figures spike above 22-24 and sort of hold there. When volatility starts to return back to earth that would signal a strong buy (but not before). Neutral.
What do you do?
In general stocks have gone from a cautious sell (20th January) to a neutral or hold rating (1st February). With the unfortunate spread of the Coronavirus in China and the mass-hysteria that is happening in the markets, on the balance of things, we expect further volatility next week.
There is a good chance that when the Chinese stock indexes open after a prolonged pause in the markets they will fall further. The Shanghai Composite index will likely face a further and potentially intensified sell-off on Monday. That could quickly lead the Nikkei (Japan), Hang Seng (Hong Kong) and other equity markets out in Asia lower.
The figures above suggest to me that there is room for more volatility, further investor betting against equity markets (short positions and put options), and more stocks hitting lower lows rather than higher highs.
Sit tight and start to look for stronger signals that investors are getting worried about the market. Watch what happens with major reserves – does the Federal Reserve start to pump more cash into the system? What does the bank of China do? How does Coronavirus progress?
Remember where you are in the world has an impact on how long you wait before investing more of your hard-earned cash into equities.
European and UK stocks offer rewarding dividend yields and trade at lower multiples. As a result you may consider (as a UK-based investor) starting to invest as early as next week, especially if we see the FTSE All-Share hitting new lows and trading between 5%-8% off recent highs. If you reduced equity exposure earlier in January (as this Frugalist Investor did!) then you’re on track at this stage to beat the market by about 4.7% by the end of the year depending on when you re-invest.
US based investors with significant exposure to the domestic market would be prudent to wait. The US market is extremely over-valued and was due for a correction. It would seem prudent to wait for a further fall in the S&P 500 index and then buy into that weakness. Dr. Yardeni, the famed economist and Fed Chairman turned market guru, predicts that the S&P 500 will ultimately hit 3500 by year end. He’s well worth following for his views on the market.
Look out for more updates here at Frugal Investors!