The unrelenting selloff continues. The Dow Jones Industrial Averages tanked 1190 points, or 4.4% yesterday. This is the largest one day point drop ever and the worst performing day since August 2011. However, it doesn’t even rank in the top 100 of worst percentage days ever. We are now in “correction” territory with major averages down greater than 10%. This happened just six days after new highs. The only other decline after making new highs that is comparable dates all the way back to 1928!
As Jim Meyer noted, there are a few items hitting the markets. The virus infections have expanded to 50 countries and are becoming more prevalent in major news headlines. The Governor of California stated 8,600 people are being monitored now. Fear mongering is expanding. On the political front, Bernie Sanders’ election hopes have been rising since the Nevada caucus win. As discussed over the past several weeks, stocks were overly extended to begin with; especially in the go-go technology sector. The dichotomy of new lows in yields, new highs in gold and defensive stocks, doesn’t coincide with new highs in growth and momentum stocks. The correction was inevitable, albeit 12% in under 2 weeks is faster than anyone expected.
One other item to note is leverage. A lot of aggressively managed funds became overly levered as the trade was quite easy to keep extending throughout 2019. Borrow or short just about anything and go long technology and momentum stocks. This adds more fuel on the downside when margin calls keep hitting the tape and managers are forced to sell stocks. You typically see this occur later in the trading session. Yesterday we had a 700 point positive swing in the morning until sellers exploded, leading to an 1,100 point drop over the final three hours of trading. We will learn later if anyone went belly up on this volatility.
Uncertainty and fear reign supreme right now. The stock market does not like that, hence the quick decline. From here, one has to gauge how much negative news is priced in. That is impossible to predict with any precision. However, if one believes the China data is somewhat accurate, you can paint a rough picture. China was the first country infected. There are now more new cases outside China than within. The worst has already passed them and looks relatively contained as citizens slowly go back to work. Their stock market was actually up on Thursday, although they succumbed to pressure today. Still, they are one of the best performing markets overall in 2020.
On a daily basis, the number of recovered patients exceeds the newly sick. Further, the number of critical cases and new deaths is declining worldwide. The fatality rate is clearly elevated by age, similar to the common flu. The recovery rate for those under 50 years of age is 99.7%, but those over 80 is closer to 85%. The over 80 cohort primarily came from areas that have low quality healthcare facilities and started with minimal knowledge of how to attack this. Those numbers keep improving as well. That is not to say this is not serious but the impact could be overestimated. Israeli scientists say they could have a vaccine in 90 days.
From a macro perspective, interest rates have never been lower. The Fed will likely have to act in order to get Fed Funds back below short-term Treasury rates. The market can’t handle an inverted yield curve so any positive comments before their March 17th meeting would be welcome news. One can debate the long-term effect of ultra-low interest rates but any inverted yield curve needs to be fixed. The long bond yield is not rising any time soon. All Global Central banks seem to be on the same page with easing measures.
Economic data prior to February was showing signs of life so any short term lull could see a V-shaped bounce. The market is now extremely oversold. Chinese factories are slowly reopening. Over $200B has been infused in China with many measures to help out small businesses. The picture is not as dire as it feels when looking at red screens and massive drops in a lot of world class companies over the past 6 trading sessions.
The chart below tells the story as well. Long-term trend lines are important. Get too far above or below the line and it leads to mispricing. We’ve corrected most of this decline as the DJIA approaches support at 24,000. It would not be surprising to dip below that but risk/reward has improved. Corrections of 5% are supposed to happen three times a year, along with one 10% correction. We’ve been spoiled this decade with minimal pullbacks relative to norms. This is quite ordinary aside from the speed of the drop.
That is not to say it is all clear to get overly aggressive. If you stuck to your discipline and sold some stocks after the 30% rally in 2019 that pushed your portfolio above desired ranges, nibbling on some high quality names over the coming weeks could prove worthwhile. This may not be the exact bottom, but solid long-term purchases are likely here.
Quick drops like this usually have a bounce, then a re-test. We can still drop another 5% – 10% as the number of cases in the US expands. Have a plan, nibble a bit and wait for confirmation of a bottom before committing more. Some great values will come from this. Taking a taxable loss and moving funds to a higher quality name also makes sense. You don’t have to wait until year-end to get some tax loss numbers in your favor. By all means, be steady in your discipline.
Former Flyer, Eric Lindros, turns 47 today.
James Vogt, 610-260-2214