The Dow Jones Industrial Average Index is down 18% from the recent highs, oil is falling 30% in one day and coronavirus is in the USA. Don’t you just want to run around in a circle yelling the sky is falling!!!
Today is a crescendo of mass hysteria promoted by the media and out of touch with reality. Today will not be the norm going forward. We must separate financial market movements, oil price implications and the psychology of the masses and analyze the expected outcome to the financial health of the country.
Let’s look at financial market movements. The Dow Jones Industrials are up 240% since the low from the financial crisis of 2008. As recently as last week, the price earnings of the Dow Jones was at 20x which means at current stock prices and no changes in earnings, it takes 20 years for earnings to equal current prices. This is a lofty level outright and by historical standards. During recessions, this number tends to go to high single digits – or 50% lower in stock prices. As long term investors, if you are happy owning stocks priced this rich and the low level of expected returns, then you are accepting the volatility that comes along with holding an investment for the long term to average the low expected returns publicly traded stocks offer.
With hyperactive monetary policy over the last 12 years, the lowest interest rates ever and most cash ever in our economy has created expensive financial markets throughout the US and globally. So should anyone be concerned when volatility picks up and markets sell off? Markets are not priced for increased risk so any little tick up in risk will lead to exaggerated market moves. Additionally, only 4 or 5 firms that use high volume trading strategies make up more than 80% of the daily volume. These strategies have led stocks to go up in a linear process. Most investors think stock prices have been increasing based on financial results. That’s only a small part of the price movement. Most is based on multiple expansion resulting from high volume trading pushing prices up consistently. Once volatility picks up, markets experience precipitous drops while looking for the marginal buyer to support the market. And when markets are so expensive, it is tough to find a marginal buyer. After all, the Dow Jones Industrial is down 18% and P/E ratios are still historically high at 18.5. Once you separate out overpriced markets and a pick-up in volatility, it’s easy to see that this financial performance has little to do with the real economy – at least for now.
Oil prices just dropped 30% today – that must be a reason to scream the sky is falling, right? Wrong again. All liquid publically traded markets are overwhelmed with few large firms making up the majority of the daily volume using high volume trading strategies. When everyone moves at the same time in the other direction, you get outsized moves. Russia and Saudi Arabia, two prices setters in the oil markets, disagree on upcoming supplies for the markets. Neither want prices to be as low as they dropped overnight. You can say they prefer to hurt other competing countries and products. But oil prices dropping so low so fast only hurts their own economies and does little to change their competition in the long run. You will see positive statements coming out to limit the future volatility in the oil markets – even if policies continue to add supplies to the oil market at a time when demand has been decreasing.
And then there is the 2019 novel coronavirus. Any loss of life is unfortunate. But in the US, there are 100 murders a day, 110 car accident deaths per day and 40% of the population will get cancer in their lives. Coronavirus will prove to have a slightly higher mortality rate than the flu. Current hysterical behavior is largely due to the media spreading fears of something new and unknown. Should we have a more dire financial reaction to this virus than World War I and II? Again, this should be the height of the hysteria to the virus. Hand sanitizer and tuna fish will once again be stocked in our big box stores. More information about anti-viral medication to treat symptoms will continue to inform the public. And an immunization/ preventative shot will be available for the next flu season. As the public starts to understand the issues better and the uncertainty diminishes, the fears will subside. This all starts to get better from today on. Looking at the data, China, the start of the coronavirus, is at the tail end of these issues with only 18 new daily cases.
Where does this all leave the economy? As long as financial markets stay +/- 15% from here, financial market direction and volatility should not seep into the real economy. Higher asset prices assist financial conditions but we should stay in a productive range. Oil price drop will shave off some growth but this is a net positive. The less people and companies have to spend on energy the more they have to spend on other more productive consumption and investments. Again, this should be supportive to the economy once the initial hit to GDP and inflation works through the numbers. And as far as the coronavirus, this will have some volatility on the economic numbers for a couple of months. During these months there will be more domestic consumption and less international travel. But negative impacts will be temporary. More importantly, the positive impact of more investments in healthcare and prevention as well as monetary and fiscal support will lead to a burst of stronger growth going forward.
So for those chicken littles running around petrified about stocks, oil and a virus, let’s put this panic into perspective. We are living on a rock in space spinning one thousand miles per hour, traveling at 67 thousand miles per hour around the sun, spinning 450 thousand miles per hour around the center of the Milky Way while the universe is expanding at 151 thousand miles per hour. Now that’s something to cluck about.
by Michael Carino, Greenwich Endeavors, 3/9/2020
Michael Carino, CEO of Greenwich Endeavors, is a finance specialist with over 25 years of experience. He has owned financial firms with roles including portfolio manager, trader, accountant, risk manager and treasury manager. He typically has positions that benefit from a normalized bond market, higher yields and value investments.