Time to Quarantine the Market
Date: March 31, 2020
Publisher: Gears of Progress
The panic ironically comes in waves, rising and falling without warning like the very indexes by which it is caused. One morning investors awake to a sea of red and a plummeting feeling that drags spirits down throughout the day like a fiscal ball and chain. The next daily cycle provides a relief-inducing hint of green (albeit on a smaller scale than the previous day’s losses) and a glimmer of hope. Rinse and repeat. A question inevitably forms while watching the madness of a market plummeting toward recession: when will it finally bounce back?
The million-dollar question can’t be answered directly. Nobody truly knows. According to Yahoo Finance, the S&P 500 has tumbled 28% in the past month. At a 26% loss since February 21st, the Nasdaq isn’t far behind. The Dow Jones Industrial Average, down nearly 31% in the past thirty days, is the worst metric of all, to date. Even with a series of small, albeit not insignificant, temporary upturns along the way, it still appears that the bottom is closer to falling out than ever, and the dreaded “R” word is being thrown around with more potency. What gives?
Getting to the root of these volatile times starts and ends with a dig into the factors that initially caused them. An economy on the precipice of free fall didn’t crop up overnight. What led a landscape of gains with no end in sight to transform into a wasteland of red tickers, lost fortunes, and dashed dreams?
One culprit can’t help but take center stage. The coronavirus known as COVID-19 certainly exacerbated the problems we are now facing and sped the timeline up significantly. To date, 245,000 cases of the virus have been identified worldwide, including over 10,000 deaths. While March 19th saw China’s first day since late December with no new cases, the same could not be said for much of the rest of the world.
COVID-19 has seen a moratorium on social gatherings, sporting events, and non-essential travel throughout much of the developed world. Industry has ground to a halt over fears of mixing infected workers with the healthy. Schools and restaurants alike have shuttered their doors for the time being as quarantines and “social distancing” become the weapons of choice for fighting the worst pandemic since the H1N1 “swine” flu. Despite all this, COVID-19 isn’t the only factor to blame for the stock market’s collapse.
Enter the current White House administration. January, 2009 to January, 2017 saw an epic bull run where the S&P 500 jumped 1,350 points and the Nasdaq exploded by nearly 70%. The average bull market, to date, lasts slightly over four years. After eight years of unparalleled highs, it was only right for a correction to be expected by most.
Other than a dip in late 2018, the market managed to avoid what common logic said was inevitable. It was all simply setting us up for a much greater fall to come, we now know in hindsight.
One of the first things the new administration did upon taking over in 2017 was pushing through a corporate tax cut. Along with pressuring the Federal Reserve to lower interest rates – already perilously low – these wholly supply-side measures were said to be sure to prime an already surging economy. They did just that, of course, pumping gains in the short term at great long term cost.
A corporate tax cut can inspire three distinct types of action. The latest iteration prompted all three. Corporations rapidly began to buy back outstanding shares of their own stock, willingly invested in overseas ventures, and hoarded a portion of the money in cash reserves. When buyers enter a market, particularly large, institutional buyers, a stock’s price will generally rise, and that is exactly what happened. The economy was very strong, there is absolutely no doubt about that, but the stock market became over inflated. Price to earnings ratios jumped to 20 on average when they have historically hovered around 15. Companies like Tesla ballooned by 55% in a matter of weeks. In short, a bubble formed.
Eventually, one way or another, all bubbles burst. Aided by COVID-19 and investors wary of a coming global pandemic that much of the world was ill-prepared for, the stock market bubble went the way of the 2008 housing bubble on February 19th. Corporate tax cuts and lowering interest rates in a strong market present regulators with little room to maneuver when things turn bad. Like using up your finite medicine supply on a healthy baby; suddenly the baby catches a fever and you have no way of treating it. There is nowhere to turn now except stimulus packages and debt financing as the market inevitably contracts. Rest assured, a sell-off was eventually coming even if COVID-19 never happened. Eventually, the corporate buy backs would come to an end and leave stock prices pumped so sky high beyond legitimate valuations that investors would grow wary. The pandemic only sped things along and forced the market’s hand early.
A turnaround might not be in the works anytime soon. When it happens – whether weeks or months from now – the global threat of COVID-19 may not be completely abated but will almost certainly be in check. A true bounce back will not begin until investors can gauge an idea of the extent of the damage the virus will cause. Predictions that it may infect between 40-70% of the world in coming months and claim responsibility for millions of deaths could easily depress markets for much longer.
There are other factors to consider. A recession could potentially linger long after COVID-19 disappears. Economic contraction caused by the virus will not be swept away overnight. Valuations and outlooks will change, and some industries (looking at you, movie theaters) could become permanently altered. Lagging indicators of growth, like GDP and employment statistics, take time to catch up. While nothing can be predicted with any amount of certainty, a recession that stretches into 2021 has to be considered likely at this point. Any longer and public sentiment could turn against the stock market in a way we haven’t collectively experienced since the turn of the century.