It's the first quarter of 2020. The coronavirus (COVID-19) is spreading globally. The virus has overtaken SARS in terms of death tolls, and the spread is still growing exponentially. Saudi Arabia and Russia spark off a price war in the midst of this turmoil that results in the greatest drop in oil prices since 29 years ago. Travel and leisure drops to all time lows, and companies and institutions worldwide shut down operations to minimize people congregations.
Stock markets are falling some 10-20% in almost all sectors, barely held up by tax cuts and dropping federal rates. The possibility of a recession doesn't seem quite so far off. In times of great uncertainty, what should you do? Let's take a rational look at the situation and learn from it. Times like these are the best times to learn and grow as an investor!
What is COVID-19?
Coronavirus is a classification of viruses that mainly targets the respiratory system. Well known coronaviruses in the past include the Middle East Respiratory Syndrome (MERS-CoV) and Severe Acute Respiratory Syndrome (SARS-CoV). These viruses can cause anything from a common cold to death in severe cases.
The current coronavirus that is spreading globally is COVID-19. The strain originated from a seafood market in Wuhan, China, spreading from animals to humans. COVID-19 infects people through touch and inhaling infected droplets of fluid, and as of now, does not appear to be capable of air transmission.
This is good news as it makes it easier to contain. By limiting contact and congregations of people, we severely reduce the chance of spreading. However, coronaviruses are known to mutate quickly, and COVID-19 is no different. In the future, it may gain the ability to transmit through air and become even deadlier.
The death rate for COVID-19 is around 3.66% amongst those infected, but it also has a 54% recovery rate. Most deaths only occur in people that already had a past illness, which weakened their immune system and allowed the virus to propagate. However, due to the high transmissibility of COVID-19, the novel coronavirus has already infected more people than SARS in 2003 and caused more deaths as well.
The coronavirus and the economy
So what does this outbreak mean for the economy? Firstly, many factories are shut down in China to minimise the spread of the coronavirus. China is known as the factory of the world. With this shutdown, many companies globally are affected and are unable to produce goods to sustain their business.
Secondly, travel and leisure are all but shut down. Many countries are banning flights in from affected countries, causing all airline stocks to take a huge hit to their revenue. Leisure stocks like cruises are affected too due to a high chance of COVID-19 spread in large congregations of people. No one is going to be travelling anytime soon due to fear of contracting the virus. In fact, a few cruise ships have had cases of the virus spreading to the entire ship, like the Diamond Princess case.
Thirdly, and perhaps most importantly is the decreased spending in the economy. When people are fearful, they tend to hoard. There are news of hand soap, hand sanitizers, toilet paper and canned food going out of stock in supermarkets worldwide. These are all things that point to people holing up at home more or going to places with less people in fear of contracting the virus.
When there is fear, there is less shopping. People avoid places with a lot of people. Coincidentally, these are places where malls and shops are congregated at - places where footfall is high. As such, small and medium businesses worldwide are struggling to get enough demand to sustain their business, and are facing risks of running out of income to support their needs.
Lastly, a lot of companies sustain themselves on debt. With the 10 year long bull run in the market, many companies opt for aggressive growth strategies, taking on debt to grow their company rapidly through expansion or acquisitions. This is coming back to bite them in the butt. Now that spending and production has dropped off a cliff, these companies are finding it hard to sustain their operations while fulfilling the obligations of their debts.
For example, Cathay Pacific (an airline company) is asking its staff to take three weeks of unpaid leave as it is unable to pay their staffs' salary due to them not having enough free cash flows. This issue affects companies big or small that have a large debt-to-asset ratio, or those whose current assets are unable to cover their short term liabilities.
Overall, this means that the coronavirus outbreak is absolutely wrecking the economy. With these issues, companies are struggling to stay afloat in this environment with reduced demand, reduced production and large debts. As such, investors sentiments have turned from bullish to bearish, causing panic sells in the stock market. These two factors compound with each other, causing stock markets to spiral into the greatest percentage decline since 2008, the last recession.
All this sparks the age old question - will there be another recession? How should we invest in this time of uncertainty?
A voice of rationality
The first thing to do is to NOT panic. I personally take a long term outlook on the market. If we believe that the market will go up in the long term, then as the stock markets fall, now is a great time to get some stocks at a great discount.
This is also probably the worst time possible to sell your stocks. Why reduce your gains by selling when the market is falling? If you believe that your stocks' companies are well run, then they will inevitably return to their original share price or even higher. By panicking and selling now, you are basically cementing your losses. Trust in the companies you invest in, and be patient. There is simply no need to cut your losses if, by waiting a few years for all this to blow over, you can get back more returns.
Of course, there are some exceptions to this. You should only sell if you are confident that you can get higher returns with the money you get back from the sale. This means that you might take a loss (or smaller gain) on the stock you sold, but by putting that money into another stock that fell to a great discount, you will be getting much greater gains overall in the future. Again, this is extremely difficult to predict, so please do your own research and make your own decisions.
The next question on people's minds is probably this: Okay, I know that I should buy some stocks now that they are all falling and are at a discount. But when should I do it to get the highest returns?
Timing is the market is an extremely difficult and unpredictable thing to do. No one can be sure that they can catch the absolute bottom of this market crash. It would be wiser to instead invest money at regular intervals when you feel that a stock's price is at a level where you are satisfied with its returns. Don't invest your entire capital at once, but do it in small amounts (also known as dollar cost averaging).
In this way, you can be sure of getting stocks at a discount. Sure, your returns might be reduced, but you incur much less risk. Some people might be worried about commissions if your broker has commission fees by buying small amounts frequently, but honestly, those fees are minuscule as compared to the gains you're going to get by purchasing at a discount, so don't fret too much about it.
For example, if a stock is falling from 200/share to 150/share, you are already getting a gain of 50 dollars if you believe the stock will eventually return to its original level. You could put in $2000 into the stock at 150/share. If the price drops further to 140 or even 130/share, you could put another $2000 in, and so on. If the price goes back up, then you can rest easy knowing that you secured at minimum a 50/share gain.
Of course, not everyone wants to do this. Some want to time it right so that we can buy in right at the bottom. At the very least, we should probably be able to time it so that we can get in somewhere close to the bottom, right? Well, let's try to analyse the situation rationally and try to see how far down the markets can go.
A (rational) coronavirus analysis
First, we should come up with a hypothesis that a virus spread is by nature exponential, then logarithmic. This means that in the beginning, the rate of new cases will grow exponentially, as each new infection has a possibility of infecting more people and so on, causing exponential growth.
However, as more containment measures are put in place and people minimize exposure to one another, the virus has less of a chance to spread. Therefore, the virus spread will shift to a logarithmic growth, meaning that the rate of increase in new cases is decreasing. You can watch this video by 3Blue1Brown to find out more about epidemics and exponential growth.
Let us illustrate this by looking at China, the first country who got hit the hardest (and is still getting hit the hardest).
Here, we clearly see the above hypothesis in action. From Jan 22 to Feb 11 2020, the number of cases followed a somewhat exponential rate of increase. However, as containment measures were put in place, there was less chance for the virus to spread, causing a drop in new cases. The growth shifted to logarithmic form from Feb 13 onward.
What does this mean? As China first experienced the outbreak, they needed time to react and contain the spread. Thus, new cases increased rapidly. However, we see a marked decrease in growth later on as China responded quickly and efficiently to curb the spread of the virus by reducing congregations of people, and creating quarantine zones and hospitals to treat the illness.
As such, we can roughly postulate that most, if not all other countries will follow the same kind of graph. It's just a matter of when the number of COVID-19 cases will shift from exponential to logarithmic.
In the case of China, they took about a month and half from when the virus was announced in Jan 2020 to stopper the growth rate into a logarithmic form. In fact, as of 12 March, China announced only 18 new cases in a day, down from an average of 2000+ cases a day in February. That is an extremely quick containment duration, brought about with the authority of their government imposing curfews and quarantines, as well as tracking and testing for cases efficiently.
Why is this important? If the growth is exponential, this is what we call the "panic period". Due to exponential growth, the virus is not under containment. This means that there is a high chance of you getting it if you go to crowded areas and touch random things. In response, people will avoid going out, shopping, and factories and companies will cease operations to minimize spread. This is what hurts the economy badly, and makes the stock markets crash.
Conversely, if the growth turns logarithmic, it means that the virus spread is being contained. With less new cases being found each day, it means that the virus is about to be contained sooner or later within the country. Sure, it might not be a done-in-a-week kind of thing, but this part is what we call the "recovery" period. The promised containment of the virus is what allows business and people to recover the confidence to resume operations, allowing the cogs of our economy to run again.
Thus, by common logic, we can deduce that the stock markets will continue on a downward spiral during the period of exponential growth, and it will slowly recover during and after the period of logarithmic growth. It's just a matter of how long it takes for a country to go from exponential to logarithmic virus growth rates.
United States and the global economy
We all know that the United States has the world's largest economy, with the second being China. When China was hit hard during their period of exponential growth, the world's economy tanked, but as far as things were considered, the world's economy still functioned as the US was still running.
In fact, during that period, the S&P 500 index tracking the top 500 companies in the US continued to rise. But now, the US is the one being hit hard by the COVID-19 coronavirus. With the US being in the period of exponential spread, the entire world's economy is crashing. We are officially in the midst of the global "panic period".
If we continue from the reasoning above, then the stock markets will recover when the US manages to get the coronavirus spread under control. Until then, the exponential growth signals that fears will still linger and businesses will still be shut down and take losses.
Of course, this may not always be true. We can never predict what the market does, we can only try to apply some form of reasoning to it. Still, let us take a look at our hypothesis in the context of the United States.
As we can see, US is still very much in the midst of an exponential growth state. People are panicking and businesses are losing money due to lack of income and spending. Therefore, the stock market is crashing badly.
Therefore, if we want to buy in close to the bottom, we should track the measures the US is taking to stop the coronavirus spread, as well as the cases within the US - and whether they are still growing at an exponential rate, or a logarithmic one. If it's an exponential rate, we can be somewhat confident that the markets will continue to crash.
Analysing the US situation
So how long will the US take to contain the COVID-19 spread? China was very efficient due to strong government authority, but still took one and half months to successfully go from an exponential to logarithmic growth. Here are some points to consider for the US:
- Trump is not exactly efficient at handling cases with the nation's best interests in mind. He famously said that he'd rather not bring Americans with coronavirus back to US shores to be treated because it would "increase the statistical number of cases in the US". A president thinking about looking good rather than treating their citizens does not bode well for virus containment.
- Schools in the US are faring better. Universities like Berkeley are switching to purely web casted seminars to reduce congregations of students and staff. This reduces virus spread tremendously.
- Companies in the US are doing well on that front as well. Many large companies like Microsoft and Apple are encouraging employees to work from home while still paying them in full, lessening the chances of COVID-19 spread.
- Many large congregations are cancelled, like the NBA for example. Without large events, the chances of the coronavirus spreading is reduced by a large factor since to date, air transmission is not possible (spreads by contact and inhalation of particles only).
- However, the real nail in the coffin is the healthcare system of the United States. Firstly, tests for COVID-19 was not made publicly available, and even cost exorbitant amounts of money to administer. Without the detection of new cases quickly and efficiently, carriers have a much higher chance to spread the coronavirus before symptoms can manifest. Recently, Trump announced that tests for the coronavirus will have their co-payments waived. This is a step in the right direction - but not enough. The treatment of coronavirus still has to be paid, and healthcare costs in the United States are exorbitant. People who cannot afford to pay may rather choose not to be tested, and exacerbate the spread of COVID-19.
If we look at other countries like Singapore, South Korea and China who have managed to contain the spread of the COVID-19 quickly and successfully, we notice several key points.
- Virus testing is aggressive and free. In institutions, companies and airports, there are temperature scanners and other things to immediately spot out anomalies. Anyone with symptoms will be immediately referred to a hospital for testing and quarantine if necessary.
- All people at risk of carrying the virus before symptoms show (symptoms take an average of 5 days to show) are kept in self-quarantine. This means that if someone came back from places with high risk like Italy or China, they have to stay at home for at least 2 weeks to ensure that they do not carry the virus.
- Contact tracing of carriers is extremely efficient and effective. Once a carrier of the virus is identified, all those who have came in close contact with the person, and people who have came into close contact with those people are traced and kept under quarantine or self-quarantine for 2 weeks to make sure they do not have the virus as well.
- People under quarantine have meals for free. They may even be paid a compensation fee due to the quarantine. People under quarantine are kept strictly in a HEPA filtered room with negative air pressure so that air can only flow in but not out, ensuring no virus spread.
- Regulation of masks and other necessities like hand sanitizers to ensure that stocks don't go out. Masks are important if you are sick to prevent the spreading of infected droplets of fluid, and hand sanitizers will kill any viruses on your hand after touching an infected object.
- Treatment of people with the coronavirus is heavily subsidized either under insurance or by the government. This allows treatment to be conducted at all costs, keeping death rates low and allowing every victim to undergo treatment, minimizing COVID-19's spread across the country.
How many points does the US fulfill among these effective measures? Sad to say, not enough. While the US has finally responded to take measures to quarantine people and conduct temperature screenings at airports, the government must take heavy handed measures to slow the spread.
Importantly, those under quarantine must be compensated for their time, or one would risk people who are carriers choosing NOT to quarantine themselves and worsening COVID-19's spread. Treatment of the coronavirus should be free as well to encourage people to turn themselves in if they feel unwell or exhibit symptoms.
In light of all these points and the measures the US have taken, it is clear that the US is not responding as quickly or as efficiently as China did, and thus the period of exponential growth and panicking will probably be more prolonged barring the discovery of a vaccine or the introduction of heavy handed measures.
Therefore, we can roughly estimate this market crash to last for at least one, and likely two months (Apr-May 2020). This means that current market prices still have a long way to go down!
Will there be a recession in 2020?
If the US does not introduce heavy measures to stop the spread, then a possibility of a recession in 2020 is moderately high. Since a lot of US companies take on large debts to fund themselves, the reduced income now is hurting many small and medium businesses. Even large businesses are not spared.
If small and medium businesses start to fail, then the ripple effects could cause a large economy meltdown. And if large business start to run out of money, then the banks will be affected and could cause the need for a huge government bailout, which would spark a recession greater than that in 2008. We examine this in greater detail in our article about recessions (not out yet).
So what's the conclusion here?
Well, we still have a long way down to go, if past statistics of the coronavirus spread holds. There are two key things to watch: The rate of growth of the virus, and the financials of your favorite companies, big or small.
If the rate of growth is still exponential, be patient. We still have a downturn in the economy. If the financials of companies start struggling AND the rate of growth is still exponential, then we should be very worried. And it's a very real possibility at this moment. With oil prices dropping due to Saudi Arabia overproducing oil, oil companies are struggling to stay financially sound and could be the first big companies to fall.
Businesses failing to pay their liabilities will cause a recession in 2020 larger than what happened in 2008. In that case, we can be sure that waiting is the right plan, as a recession will cause stock prices to dip to great discounts that we can scoop up as long term investors.
As Warren Buffet once said:
Be fearful when others are greedy, and greedy when others are fearful.
Be patient. The stock market's fall has only just started. Keep a watch list of your favorite stocks, and scour the news for new stocks you can get at a great discount. You can choose to buy small amounts at various intervals to lock in your returns, or you can go the statistical route and choose to wait for a larger dip (remember the exponential!).
Either way, you will be getting some great returns at a discounted price with a long term outlook. Just don't expect this to blow over anytime soon - the market will stay down for a long time from the aftermath of this coronavirus outbreak.
As always, let me know your thoughts in the comments section below. What stocks are you looking at? What is your plan for investing throughout this period? I would love to discuss more on the topic and hopefully, we can all learn something new! Times of uncertainty like these are most trying for the average investor, so buckle down, and don't sell at a loss unless absolutely necessary!
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