COVID-19 (2 of 3): A Better Comparison

Good afternoon,

I hope that those of you with children at home are staying sane!  One of the things I have learned this week is that LJ can scream louder than our dog can bark.  It is quite impressive.

Three weeks ago I compared COVID-19's impact on the financial markets to four other outbreaks and concluded that the closest outbreak comparison was to the Spanish Flu from 1918-1920.  However, the Spanish Flu negatively impacted US large-cap equities by only 10.9% over six months.  At the time of my last writing, the more recent COVID-19 had impacted US large-cap equities by 11.3% in one week.  Since then the situation has worsened, as shown below:

The Energy sector has been hit hardest during the crisis, even before the conflict between Saudi Arabia and Russia.  Other hard-hit sectors include Financials and Industrials,  the latter of which includes Airlines and Boeing.

COVID-19 has now had a more consequential impact on markets as compared to past outbreaks.  This got me thinking - what else has had a similar impact on asset prices?  To search for a potential match, I started with the underlying cause:  fear due to uncertainty.  The long lines at supermarkets were a clue.   Hurricane Harvey?  No, that was only a local impact that affected Houston. 

Digression - How much more bad news can Houston take?  I present a chronological list of the Dreadful 13:

Harden choke

O'Brien outclassed

Hurricane Harvey

Harden choke

O'Brien outwitted

Irma

O'Brien oh maybe!? Oh, nope.

Astros cheating

Water main burst

COVID-19

Oil price collapse

Hopkins trade

Matt's unbearably long blog posts

Back on track.  If we cannot draw a comparison to past outbreaks, then we should consider other times where panic reigned supreme.  Does the following script sound familiar?

1)  Extreme anxiety

2)  Increased market volatility

3)  A large number of Americans believe it is a 'hoax' (54% of Americans suspected a hoax during the event I am comparing)

4)  The President called it 'the moral equivalent of war'

5)  Panic buying, long lines

6)  Bankruptcies and similar stress to the transportation industry

The event described above is the 1979 oil crisis.  At that time a 4% increase in supply caused widespread panic, resulting in the price of oil to more than double in 12 months.

I was more curious about how the panic affected oil prices (i.e. behavioral economics) than how the market performed during the period. 

One of the cooler stats I found during that period was related to people sitting in line at the gas stations.  Remember, cars were much more inefficient then.   As the average vehicle of the time consumed around 0.75 gallons of gasoline an hour while idling, it was estimated that Americans wasted up to 150,000 barrels of oil per day idling their engines in the lines at gas stations.

It is dangerous to compare the S&P 500 performance from different periods as market changes are always contextual.  The reasons for the broader S&P 500 decline today are different from reasons causing past declines in the index. Oil is an input to the economy (which is why there is a government incentive to keep prices low).  In the 1970s as oil spiked, stagflation ensued, the Fed enacted aggressive policies to combat inflation, causing a 'double-dip' recession.  Two recessions were experienced because of poorly timed Fed intervention.  The first recession started in January 1980 and the second recession ended in November 1982.

https://www.macrotrends.net/2324/sp-500-historical-chart-data

Let us keep an eye on this.  My good friend and mentor pointed out to me that one thing to keep an eye on is a recent spike in the 3-month Libor interest rate.  This rate is used to set the rates of a vast number of financial instruments around the world.  The 3-month rate spiked up this week from 0.74% to 1.20% as shown below.  It is atypical for the 3-month rate to be above both the 1-month rate as well as above the 6-month rate.  This inverse ‘U’ curve means increased risk in the system for 3 months from today before residing.  If that 3-month rate starts to come back down then perhaps that will signal less stress in the financial sector and markets may warm.

https://www.wsj.com/market-data/bonds

What does all this mean?  The short answer is to hold, buy the dip, and fix liabilities.  Timing the market is silly.  My next and final article on COVID-19 will be titled The Right Course and an Evaluation of Outcomes.  I will discuss the worst-case scenario (which is EXTREMELY unlikely), and why the conclusion from that case is STILL to hold/buy.    People moving to a more conservative allocation are doing so because of two reasons:

1)  Near Term Pessimism and Timing the Market:  They are trying to time the market (which they already probably missed unless they sold high on February 20 and will very likely miss a steep uptick.  Trying to time the market when we are experiencing 10% daily moves seems silly to me.

2)  Long Term Pessimism and System Failure:  They believe the system is at risk, and they are moving to cash for a longer period.

I will explain why each of these moves will prove terrible for them in my next post by playing out their moves.  People are not considering the next steps that would be taken in the extremely unlikely scenario #2.  The Fed still has at least two bazookas left which they will not use until absolutely necessary.  There is a backstop to all of this which people are not considering.  Stay tuned!

Thank you,

Matt Schwegman, CFP®, CPA

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