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The worst is yet to come!


27 February 2020

Buying the dips has been a very successful strategy over the past several years when it comes to equity trading. Even the US National Economic Council Director, Larry Kudlow is providing this advice to long-term investors. After the Dow Jones Industrial Average Index plunged 2600 points or 8.8% from its record high, Kudlow sees it as a good opportunity to buy cheap stocks.

Indeed, stocks are cheap, but cheap is a relative term. They may be cheaper than two weeks ago, but when compared to historical averages or relative to foreign stocks, they are still way too expensive.

Higher valuations are justified when there is no better alternative to stocks. That’s especially the case when US 10-year bonds are providing a 1.2% yield and most European government bond yields are in negative territory. However, when recession fears begin to play out, investors will no longer look at valuation metrics as all they want to do is preserve their capital.

Today’s coronavirus can be compared to a global natural disaster.  Global supply chains are facing their toughest challenges, corporates have already issued profit warnings, capex will likely evaporate, many employees are working from home while some are on unpaid leave, businesses will begin to default on their obligations unable to pay their workers and confidence will continue to deteriorate. So, it’s not just the supply side that is impacted by the coronavirus, it’s also the demand side.

Buying the dips may pay off if coronavirus gets under control, especially because we’ll end up with more liquidity in the market. The problem here is no one knows when will it take a U-turn, especially as the outbreak appears to have entered a new stage of contagion, after World Health Organization officials said the number of daily cases reported outside China has now exceeded the number of cases within the country of origin.    

Unfortunately, it’s becoming more likely we are heading into a global pandemic, and that is not yet priced into markets. Fiscal and monetary policies may do their best, and I wouldn’t be surprised to see the money helicopter expand beyond Hong Kong, Macau and Singapore. But their impact won’t be strong enough to restore investor’s confidence.

US equity futures are indicating a high possibility of entering correction territory when markets open up later today, that is a 10% or more decline from the latest peak, but given where we stand currently, a bear market or a 20% decline from this month’s record high is becoming a highly likely scenario.

#source

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