For the past two months, investors were betting on the reopening of the world’s major economies and the coronavirus being under control.
On Thursday, after two and a half months of non-stop gains, the US markets had their worst session since March: the DOW lost 1800 points, the S&P 500 was down 5% and US oil prices fell 8%, sparking fears of a second stock market crash.
What caused this sudden stock market selloff?
The most conservative analysis believes the sell off is due to profit taking after the recent market rally: From March 23rd to June 12th, the S&P 500 index increased 35.9% and Thursday’s sell off could simply be a case of investors taking profits after two months of consistent gains.
More alarmist analysts suggest the sell off could be the start of the second crash. They point to the following facts as evidence a second market collapse is on the way:
- Fears of a second coronavirus wave are emerging:
- In the USA, the 2 millionth coronavirus case was recently confirmed and the total death tolls exceeds 115K.
- In China, after 55 days without any new reported cases, lockdowns are back after dozens of people tested positive in Beijing.
- Spain saw daily cases double twice last week.
- French health experts are warning that a second wave could hit the country in autumn if hygiene measures aren’t respected.
- In Italy, a cluster of new infections in Rome is sparking panics that a second wave may appear.
- Unemployment in the USA is at record highs:
- In just three months, close to 45 million unemployment claims have been filed.
- Last week, more than 1.5 million Americans applied for unemployment benefits and over 700K sought compensation via the emergency federal program.
- The economic data is confirming the USA is in recesson:
- The US Bureau of Economic Analysis says that Q1 2020 GDP growth will be -4.8%
- The New York Fed’s Nowcast for Q2 2020 GDP growth stands at -25.9%.
- The N.Y. Fed’s Nowcast for Q3 2020 GDP growth stands at -12.5%
Initially, the market rally was justified by the market pricing in the lockdowns and negative Q1-Q2 GDP growth.
The question is has the market priced in a second coronavirus wave and a longer than expected recession?
As the negative data starts to pile in, investors are worrying the market may be getting ahead of itself so all eyes turn to the Federal Reserve for guidance.
Will the Federal Reserve save the day?
In May, during the height of the rally, Fed Chair Jerome Powell issued a stark warning that went unnoticed by most investors: he said “the path ahead is both highly uncertain and subject to significant downside risks“. He knows full well that even the Fed’s aggressive stimulus can’t prop up the markets forever as a wave of bad news can send the market crashing no matter how much liquidity is pumped into the system. A longer and deeper recession than expected could result in the “an extended period of low productivity growth and stagnant incomes“, he said.
On Wednesday, the US Federal Reserve predicted the US economy will shrink 6.5% this year. As a result, it left interest rates unchanged and said it would pursue its unprecedented stimulus plan until the economy “has weathered recent events“. For info, the Fed is spending billions of dollars a day purchasing US Treasuries and mortgage-backed securities in an effort to support financial markets, businesses, states and local governments.
The result is a dramatic increase in the money supply.
From 2014 to March 2020, the Fed’s balance sheet stood at roughly $4 trillion. On June 14th, 2020, it stands at $7.1 trillion, which represents a 65% increase in approximately 90 days. This is a similar situation to the 2008 Recession, wheb the Fed’s balance sheet increased 150% from August-December. If the Fed keeps printing money at its current pace until September, it’s on par to repeat this 150% increase of its balance sheet again.
On the legislative front, the Federal government is preparing for a second round of stimulus that will prop up the markets and the real economy.
Last week, US Treasury Secretary Steve Mnuchin said “we are going to need another bipartisan legislation to put more money into the economy but we don”t want to rush into that because we want to be both careful at this point in seeing how the money is in the economy. A lot of the money is still not in it“. Evidently, the $6 trillion stimulus package implemented in March is not enough to save the economy.
Will the Fed and the Treasuries’ stimulus be enough to avoid a second market crash?
Maybe, but for now, their intervention has propped the market up to a point where investors are flabbergasted at the disconnect between the market and the real economy.
The Buffet Indicator, which compares GDP to the stock market’s capitalization, is nearing its all time high. Its not definite proof of an incoming market crash but it has proven to be ruthessly trustworthy in anticipating both the dot com and the 2007 crashes. It’s just one more piece of data to watch out for going forward.
How should investors interpret these developments?
The market selloff today was severe and reminded us of the brutal crashes we witnessed in March. It should serve as a wake up call that the market eventually adjusts to reflect the real economy.
On May 15th, when the stock market was rallying and almost reaching the 3K mark, I warned investors of the likelyhood of a second stock market crash.
I recommended offloading your riskiest positions to raise cash, only investing in Blue Chip stocks (if you really wanted to keep investing), and to consider buying gold and Bitcoin.
Today, I reiterate these recommendations.
I understand you may think it’s too late to offload your riskiest positions but that’s simply untrue. It’s never too late to cut your losses and move on.
If you have sound money management, the majority of your portfolio consists of S&P/Nasdaq ETFs and blue chip stocks, so no single speculative position represents more than 2% of your total portfolio. If that’s the case, you can offload them at a small loss with minimal pain.
If you don’t have sound money management and you YOLOed 80% of your cash into a pure gamble play, then you must exercize due diligence and determine whether that company is resilient enough to survive both a recession and a possible bear market. If yes, then by all means hold. If not, you should seriously consider selling now before your losses seriously ravage your capital.
What is my strategy going forward?
First of all, I’m not panicking.
I have a 30-year investing horizon and I have faith the US economy will eventually recover.
Second, I purchased some quality stocks (cf my previous articles) and I believe they will survive both the recession and a possible bear market.
However, I’m well aware that many debt-laden household name companies may not survive a prolonged recession.
Consequently, I will regularly evaluate every stock I own and determine whether or not the company in question has sufficient cash on hand and borrowing capacity to both preserve and raise liquidity. I will follow the news, corporate press releases and earnings to follow the latest developments and make sure their fundamentals are not eroding.
As cash flows dry up, watch out for unsustainable debt burdens and high-yield debt offerings. A company desperate for liquidities will be tempted to issue expensive debt it may not be able to pay it back. If it ever goes bankrupt, those bonds could end up in the graveyard.
Now, more than ever, it’s all about survival – so make sure you guarantee your own first.
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DISCLAIMER: This is not financial advice. Do your own research before investing.