Market Overview: Panic and Fear Have Gripped the Markets

Wikipedia describes a cascade effect as “an inevitable and sometimes unforeseen chain of events due to an act affecting a system”.

A cascade effect occurs in markets when an event or connection of events kickstarts a positive feedback loop, which then goes on to dominate price action until it burns itself out and the process goes into reverse.

George Soros touches on this particular dynamic by saying:

At any moment of time, there are myriads of feedback loops at work, some of which are positive, others negative. They interact with each other, producing the irregular price patterns that prevail most of the time; but on the rare occasions that bubbles develop to their full potential they tend to overshadow all other influences.

Panic and fear have gripped the markets. Below is a list of a few of the things that are fundamentally driving the sell off:

• Corona Virus is being declared a pandemic
• Massive supply shock from China due to supply chain issues
• Potential country lockdowns and economic stagnation
• Oil prices plunge
• Corporate debt is at all time high while fundamental will suffer significantly

The number of people worldwide infected with the coronavirus is now over 126,000 and more than 4,700 people have died from the virus. The worldwide data seems to indicate that the overall death rate is around 3.5% and it’s much higher for seniors and people with ill health. The fatality rates, however, might not be based upon actual facts about COVID-19 because most people are not being tested so we really have no idea of who might have had COVID-19 and recovered. The coronavirus is having a tremendous impact on travel, global trade, and supply chains.

The World Health Organization finally declared the COVID-19 a global pandemic. WHO Director Dr. Tedros Adhanom Ghebreyesus said the WHO is “deeply concerned by the alarming levels of spread and severity” of the outbreak.

Investors have been frantically trying to gauge the potential impact of the coronavirus on the U.S. economy, with starkly differing opinions.

The growth rate of the U.S. economy had already been slow and decelerating, with rising debt levels, and that makes it more vulnerable to an economic shock. The question is, how big will the shock be? Will it be the worst epidemic since the Spanish Flu, or will it start to resolve in the summer and not come back too fiercely in the autumn, and turn out like the anticlimactic H1N1 scare in 2009? Will it be enough to trigger a recession, kickstarting the vicious cycle of higher unemployment and debt defaults, or could the U.S. avoid recession like it did during the slowdowns of 2012 and 2016?

Here are a few of the things that are going on:

- Oil prices dropped below $30 a barrel overnight on Sunday because Russia and Saudi Arabia have started a price war — which will be a boost to most of our economy. Saudi Arabia is aiming for a higher market share and hence lower prices. Prices dropped nearly 25% in a single day.

- The Coronavirus spread seems to be slowing in China. Perhaps there will be a seasonal effect in that as temperatures warm the impact will go down. The Coronavirus only seems to strongly impact the aged and those who are already sick. The virus seems to have little impact on healthy youth and adults.

- The bond market has been extremely bearish this time around, with a historically sharp plunge to record low rates on long-term Treasury notes and bonds, pricing in multiple interest rate cuts by the U.S. Federal Reserve. Yields on 10-year US Treasury notes went as low as 0.319% as investors fled to the safety of bonds. That also means lower rates for borrowing which will increase liquidity and borrowing.

Fed forced to increase bailout facility; with credit and funding markets showing signs of major stress, the Fed has been forced to increase the size of its daily bailout facility (overnight repo operations) to $150 billion on Monday. Credit Suisse’s Zoltan Pozsar, widely recognized as a guru in this matter, shared a note explaining that the Fed should “combine rate cuts with open liquidity lines that include a pledge to use the swap lines, an uncapped repo facility and QE if necessary. However, liquidity injections won’t stop it; fiscal and economic policy actions in the wake of the virus crisis are secondary. As this article by Marcetwatch explains, “monetary policy can’t mend broken supply chains.” This health crisis is not an issue as the GFC of 2008 that saw disruptions to the flow of finance being fixed by banks’ liquidity injections. “The problem today, however, is a sudden stop in production, which monetary policy can do little to offset”, the article notes.

- The Dow fell a record 2,000 points when trading opened Monday morning and the S&P 500 was poised for its largest single-day percentage drop since December 2008 in the depths of the global financial crisis. The Dow and S&P crash from the last 24h has now confirmed a bear market, which by market standards gets called after a drop of 20% from the top, while as part of the bear market, it has now erased most of the Trump-presidency rally. This is the fastest drawdown from a peak into bear market in history, and the worst start to a year since 2009, adding that we are crashing at the fastest pace since Lehman (the sudden drop is reminiscent of the first moments of crisis in August 2007).

Sectors overview:

- Data suggests the global economy toppled into a recession this quarter. Figures from China over the weekend showed their exports fell 17.2% in January-February from a year earlier.

The economic impact of the virus is just beginning to wind its way through the global economy and we should expect things to get worse before they get better. And that’s scary, considering Global Manufacturing PMI and Service’s New Orders are at their lowest levels since the GFC (charts via HSBC).

To put into perspective the bad side of the potential spectrum for economic problems that we’re facing here, China’s economic activity has grinded to a halt over the past month.

China Manufacturing PMI:

China Non-Manufacturing (Services) PMI:

The Institute for Supply Management (ISM) revealed the first-round results of a survey focused on business and supply chain impacts due to the virus. The findings were that nearly 75% of companies report supply chain disruptions in some capacity due to coronavirus-related transportation restrictions, and more than 80% believe that their organization will experience some impact because of COVID-19 disruptions. One in six (16%) companies report adjusting revenue targets downward an average of 5.6%.

Delivery times have spiked, indicating disruption to supply chains:

Significant effects from supply disruptions in China and Italy:

The volatility index remains extremely high: Fear levels are very, very high. The volatility index (VIX) has only been as high as it is now twice before — during the financial crisis in 2008 and back in October 1987 when the Dow lost 22.7% in one day.

The market has already discounted a big drop in profits for the year. This discount is much larger than past pandemics outside of the 1918 Spanish Flu. This means stocks are cheap here as long as the economic impact doesn’t feed into the credit system and cause a cascade in the credit markets.

Will that be enough to tip us over the edge to kickstart a feedback loop of liquidation? Or will the virus burn itself out in the next couple of months, and stimulus from the Game Masters (central banks and governments) suffice to keep the system from locking up, thus setting up markets for an incredible buying opportunity?

Only time will tell… Until then, we need to keep managing our risks and listen to what the market is telling us.

Originally published at www.trading-manifesto.com