The stock market received a one-two punch in the second part of February.
The first punch was the COVID-19 panic because of the global spread of the virus.
The second punch was the fact, that the market was long overdue for a correction.
The result was a 10 to 20% drop of stock prices all around the world.
Now, I wish I could tell you that the markets overreacted or that we will soon get a V shaped recovery. But I think that the chances are that COVID-19 is a real danger to the world economy in the short to medium term.
The virus itself doesn’t mean that the world will end. We will get through this like we went through all the other crises in the past.
But in the short to medium term the virus will have a huge effect on the world economy and our lives.
This virus is far deadlier than standard influenza. We don’t know for sure how it spreads. It has the ability to spread via “asymptomatic” carriers. You could have a virus and don’t even know about it, because you are perfectly healthy. This means that the real number of people who are infected is far greater that the reports show, and that the virus is far more prevalent than we think.
And the scariest thing about it is that about 10 to 15% of sick people need intensive hospital care. That’s a big strain on our healthcare resources.
Would you go on a vacation to Italy now? Probably not.
As the virus spreads, people are less and less likely to travel. The travel industry is one of the largest industries in the world, with $5.7 trillion in revenue. Roughly one in 10 people on the planet works in this sector.
This industry has already taken a huge hit due to travel restrictions and canceled trips. The Chinese (the most frequent global travelers) don’t travel any more due to the restrictions. But that’s just the start.
Big events like Geneva Motor Show are being cancelled. Business travelers are staying home and using online meetings instead of live ones. Some industry reports already state that business travel has gone down more than 30%.
And when the travel industry suffers, most of the other, interconnected industries, suffer also. Travel industry is also a part of the retail, a part of technology and so on.
Then we have an important effect on the supply chains.
David Rosenberg says that “the spread of the virus outside of China to South Korea, the other economic giants in Asia, and to Italy, is particularly worrisome. The only thing we know with certainty is that South Korea is a massive exporter and much of its outbound manufacturing shipments are inputs into the global production process. So, the implications for disruption to global supply chains are significant, irrespective of the slowing in the rate of infections in China. The cat is out of the bag.”
For now we don’t feel the effect of closed Chinese factories, because most products produced in China are still on the ships on their way to US or Europe. This will be felt with a delay of one to two months. Manufacturers can then expect big supply chain problems. John Mauldin says that “the economic problem is that inability to obtain one critical component can shut down an entire factory. In this situation, 95% or even 99% may not be good enough. We could be weeks away from some US and European producers running out of input materials. Then what? Plant closures and probably layoffs.”
And this can then cascade through the economy. Workers getting laid off, wage cuts, company profits going down, less taxes collected and so on.
There will be a quick government response to all this. FED will probably cut rates (again) and bring new stimulus to the markets.
But it probably won’t have the same kind of effect as it did in the past.
Peter Boockvar explained this in very simple terms: “A rate cut won’t bring Chinese factories back online any quicker. And a rate cut won’t get people flying and traveling again until the virus peters out.”
Monetary policy tools aren’t designed to fight viruses.
I’m an optimist. I think that the world will move on and find solutions for all the problems facing us.
But from what I see, the COVID-19 problems will not be solved overnight. There will probably be no V shaped recovery unless some kind of positive black swan event happens (a quick development of vaccine or cure). The global economic disruption is real and it will have a cascading effect on all aspects of our lives.
If the virus spreads and if we don’t have an effective solution for it, the stock markets will probably go down much further in the coming months. We can also expect increased volatility. This doesn’t mean that I’m selling my stock index funds. These are my long-term investments and I’m not touching them.
But if the stock market falls by 30% or even 50%, it could mean a once in a decade opportunity for long-term investors to buy stocks when they are cheap. Just like in 2009.
Remember, when you are buying stocks, you are buying businesses. And business innovate, bring new value to the market and they can adapt to any situation. So when the stocks are down, my first instinct is not to sell but to buy. Stocks have always outperformed all the other asset classes over 10-year plus periods and there is a 99% chance that this will continue in the future.
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