Thoughts While Viewing the Market in Fright Mode
As we write this, the stock market appears to be in a free-fall. The Dow is down around 1,800 points having fallen 2,100 already this morning. It currently stands at 21,646 and down from the February high of 29,500. This is panicky selling, which is virtually never caused by anything logical. It starts with a worry; in this case the coronavirus, and gradually grows until it is all out of proportion. The fear may start with institutions like mutual funds beginning to worry about their account holders who will see lower prices and request redemptions. Naturally, this includes holders of retirement accounts like 401k’s, 403b’s, etc. The institutions managing these investments begin to anticipate large redemptions, and consequently start to raise money. Institutions are massive percentage holders of equities. Then, the margin players become afraid, and rightly so. If they have borrowed the maximum amount allowable, they have reason to be apprehensive. It is not uncommon to see serious margin accounts owing 60% or more to the brokerage firms who have lent them the money. When the call for more margin comes, virtually always – they are forced to sell.
As selling gathers fast momentum, there are investors who will sell for no reason other than their stocks are lower now than they were a month ago. In their minds, I suppose they envision that stocks can go much lower and never go up again. Does this make sense when these companies will continue to supply us with goods and services people need and want? Of course, there will be a temporary impairment to earnings for most companies, however they will endure and ultimately continue to grow. If the value of your home drops, do you immediately go out and sell it?
With respect to coronavirus: yes, it continues to spread in Europe and the US. There is no question that business activity will slow, impacting certain industries more than others, but this is not forever. The news from China over the last two or three days indicates their contagion situation has been improving. Following weeks of lockdown, China is beginning to return to normal as businesses and factories are starting to bounce back to life. While this is clearly a very infectious disease and could infect hundreds of thousands or millions of people across the globe, the vast majority who become ill will not need hospitalization.
Over the last few days, there were two other news items which were considered negative. One was that the price of oil, which had been hovering between $50 and $60 per barrel, suddenly plunged to just above $30. This was primarily due to a disagreement between two huge oil producers, Russia, and Saudi Arabia. As we might say, Saudi Arabia got their nose bent out of shape. They increased production forcing the price much lower.
The other news item was the Federal Reserve cutting interest rates by .50% in response to the potential economic impact of the coronavirus. The current yield on the 10-year U S Government bond is a little below .8% (that is eight tenths of 1 percent per year). Interest rates that are too low hurt the nation’s banks because they are in the business of loaning money.
Let us stand back a moment and look at these three negative elements mentioned above. First, we will eventually see this coronavirus fear abate. The big uncertainty is both the severity and length of time, but rest assured it will pass. China is already giving us some encouragement on that front.
Secondly, lower oil and gas prices, while they will affect the companies related to the oil industry, they may not be so bad for the rest of our economy. Cheaper energy is not a long-term negative!
Thirdly, let’s consider low interest rates. Yes, it can create difficulties for certain industries, but for businesses looking to grow and expand, having access to cheaper capital is an important benefit.