A month ago we would have been looking forward to a bit of a fall in markets – it’s healthy, and creates opportunities to buy a bit more cheaply. It was early days for the coronavirus, and we said “history suggests using market weakness as a short term buying opportunity.” It assumed the virus would be largely contained in China, only sporadic outbreaks elsewhere, and an eventual V-shaped economic recovery once most Chinese companies returned to full capacity. Those assumptions have proven to be wrong.
On Friday 21st February the news emerged of serious outbreaks in Italy and Iran, and more outbreaks in new locations daily. No longer was there simply an economic supply chain problem (e.g. Apple can’t access iPhone parts manufactured in China) which would be solved with a V-shaped recovery in China. This was now a global health emergency, not a moderate recession risk for a few months.
Stock markets began to respond quickly from that Friday. This accelerated not just with the newsflow but with the reaction of Donald Trump and “his surreal efforts to conjure away the virus”, and then his appointment of Mike Pence to deal with the “non-crisis” – he who doesn’t believe in science!
No one knows what might happen next. No one. With this almost complete lack of visibility, both on the road ahead for the virus and lack of political leadership in key parts of the globe, investors are doing the only sensible thing – don’t panic later, sell now.
For some time we have discussed the vulnerability of markets. The pivotal US stock market is, by some measures, uniquely overvalued. Plus bond markets are at unique extremes – there have never been more corporate bonds, and the quality has never been so poor. Yet there is ample evidence that complacency is also extreme. (See the most recent TopFunds Guide on this, particularly “Shocks in the wings” on page 11).
The analogy we have used is that markets are like an avalanche-prone snowy slope. There was never any point trying to figure the timing of the final snowflake (the shock), which brings the whole edifice down. The key was, and remains, controlling what you can control. And that is good money management – for most people that should be having a greater than typical cash buffer in portfolios, or a stop-loss e.g. sell if the investment falls by 10%, and literally stop-the-loss.
Until last Friday we liked the idea of a healthy correction in the pivotal US stock market. A fall of 30% from the recent peak would take it back to a clear point of support, and in turn create a great buying opportunity in UK small caps. Yet we must also acknowledge that this could be too optimistic – we must visualise a range of possibilities, not just those which are conveniently optimistic.
For example, if this global health emergency is the final snowflake which will bring down the whole uptrend since March 2009, the falls could be much greater, over 50%. [I should add that such falls are not unusual, and have occurred twice since 1999, and we are all still here to the tell the tale!]
Nonetheless you can console yourself knowing that from the ashes of the big uptrend from 2009 will possibly be the most exciting and profitable investment opportunities of your lifetime.