Can Stock Markets Ignore COVID-19 for Long?
The world started hearing about coronavirus in January, that was wreaking havoc over a populous Chinese town called Wuhan. By early March 2020, many people were worried that it could become a global pandemic. The entire globe has been on a partial or a complete lockdown since then. All major continents like Asia, Europe, Americas and Africa have been ravaged by the pandemic.
Many stock markets were at their peak levels in February 2020. It is not a surprise that few of them crashed as much as 40% from their peak levels in March 2020 following the pandemic. A global relief rally followed helping many markets to recoup much of their earlier losses (as on 7th June 2020).
Indices With a Gain of 20% or More From March Lows
- DJIA (USA)
- FTSE (UK)
- CAC (France)
- Nikkei (Japan)
- NIFTY50 (India)
- ASX200 (Australia)
China, the world's second biggest economy, neither had a serious fall nor a dramatic recovery like the rest of the markets did.
Factors Driving the Stock Market Rally
Given below are the key factors driving the rally.
- A belief that what goes down must come up.
- A hope that a vaccine will end this pandemic.
- Every previous market crash was followed by periods of glorious returns
- There is no other alternative to stock market investments.
- Liquidity boosting stock markets
It is time to look at each of these factors with a dispassionate approach. Towards the end, I will do crystal ball gazing in an attempt to predict the future.
1. What Goes Down Must Come up - Not Always
Many investors assume that a correction is always an opportunity to buy. They base their assumption based on the stock market crashes in the last 3 decades. The dotcom bubble that burst in 2000 was followed by a boom period. The subprime crisis that triggered the 2008 crash was followed by a decade long bull market.
Similarly, many believe that the COVID-19 led correction in March 2020 should be followed by a boom period. COVID-19 is not part of a normal economic or business cycle. It is a black swan event that changes the way we approach life and business.
Given below are the genuine concerns arising out of COVID-19 outbreak.
- Health concerns / higher death rates
- Unprecedented unemployment crisis
- Many small and medium businesses may not withstand extended lockdowns.
- Drop in consumption levels.
- Social unrest.
In this backdrop, one cannot assume the impact of COVID-19 to be the same as a dotcom bubble or the subprime crisis. It could be worse.
2. Will a Vaccine End the Pandemic? Less Likely
I am not a scientist or a medical professional. Even as a commoner, I know there are so many viral diseases for which vaccines are not available. With due respect to the sincere efforts of many scientists and research professionals around the world, an effective vaccine looks less likely to arrive at the right time.
That said, I would be the happiest person if there is a breakthrough in COVID-19 vaccine. The vaccine would be a lifesaver for millions around the world. Even then, it would take many years for the economy to recover having slipped into a recession.
3. Every Previous Crash Was Followed by Boom - This One Is Different
It is true for the dotcom crash and the subprime crash. Those were crashes fueled by excess greed. When the greed got deflated, markets crashed only to recover later. Greed and fear are parts of business or economic cycles.
The COVID-19 crash was not a result of excess greed or fear. This is real. Economic activity has come to a grinding halt in many countries. Unemployment is soaring. Consumption is dropping. Most of us cannot visit a friend, shop, travel or many of the things we love. The world has changed and for the worse.
4. There Is No Other Alternative
Investors have very little option to look beyond stock markets in a low interest rate regime. A bank deposit, government bond or real estate cannot match the returns given by stock markets in the long run.
I share this belief that stock market returns would continue to be better than bank deposits or real estate. Stock market is still a great option for a long-term investor with a 10 year time frame.
5. Liquidity Boosts the Stock Market - Not Forever
Liquidity can always propel stock markets heigher. Liquidity combined with a drop in interest rates is like a performance enhancement drug to the stock market. Low interest rates would not motivate one to keep their money in bank deposits. They would look at stock markets for better returns.
A performance boosting drug may help an athlete win once or twice. But once he is caught, it would be the end of his sports career. Liquidity injected by central banks all over the world is the performance boosting drug keeping the stock markets up. It would not last long. A liquidity induced bubble would pop.
Crystal Ball Gazing
What is the worst-case scenario in case of another market crash? Will markets touch the previous lows in March or go even lower? Most countries have to shut down economic activities. In a lockdown, both the supply and demand sides of the economy are impacted. This would cause a drop in the world GDP, corporate profits and stock prices.
There is also the danger from the virus itself. We do not know the extent of damage this virus could cause or the duration of the pandemic. It may wreak havoc for another two years or suddenly disappear in a month. My guess is as good as anyone else’s.
In such a scenario, most markets should retract 50% from their historic highs. This would translate to 15,000 for DJIA and 6,000 for NIFTY. The trigger for the crash would be the corporate results for the quarter ending June 2020. Since the quarterly results would be declared in July and August, one can expect the next big crash to begin then.
Do not make any fresh investments now. It is better to hold as much cash as possible to invest in the next crash. Should you consider trimming down some portion of your portfolio? It is not a terrible idea, assuming there may be a crash. But stock prices can be unpredictable. The prices may rise 20% after you sell or decline 20% after you buy. It is the risk that makes the investments exciting.
I have trimmed my investments to a bare minimum and I am planning to reenter the market by August 2020. I may pick up stocks at an attractive bargain or will end up paying more if the stock markets continue to rise. Only time will tell if my strategy has worked.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.