The
fallout from the coronavirus has been rapid. The last few weeks have
seen huge levels of volatility and the S&P 500 has dropped around
29% from it’s February peak.
If you have read any of my previous updates you will know that I have been waiting for an opportunity like this for some time.
However,
I have not traded this crisis particularly well. I put a bit of money
to work on the first dip around $2900 and then again around $2500 – too
early on both counts.
Not
being an expert in viruses or epidemics, I cannot make any claims about
the virus itself and my focus in this post is the reaction of major
stock markets.
A good explanation I’ve found on epidemics and exponential growth is this one on YouTube which I recommend watching if you are not already up to speed.
My Take
Looking
at the situation now it appears that the market has scope to fall
further as the economic fallout continues and the virus spreads. The next major level of support would be the $2000 level and it cannot be ruled out in this environment.
However,
if the virus starts to slow down, it won’t be long before stocks find a
bottom given the huge amount of stimulus that central banks are
providing. For me, the most important thing is that we need to see the number of new daily cases start to flatten out.
Currently
the virus is spreading at an exponential rate and that is causing
businesses and services around the world to enter lock-down. That has
dire consequences for company profits.
Some Notes on Exponential Growth
To
summarize some of the information in the mentioned video above,
exponential growth means that as you go from one day to the next you
have to multiply by some constant.
In the case of coronavirus, daily cases have been increasing by about 1.15 to 1.25 times the previous day’s cases.
This
results in an exponential curve with the number of new cases increasing
on a daily basis. In fact, a virus provides a textbook example of
exponential growth since what causes new cases are existing cases.
However,
there comes a time when exponential growth has to slow down. For
example, as millions of people become sick there are fewer people that
can be infected so the rate of new cases must decrease.
Likewise, measures such as hand washing and limiting gatherings also have the effect of reducing the spread. So
an exponential curve will eventually level out at an inflection point
and turn into what’s called a logistics curve. At this point the number
of new cases each day levels out and then starts decreasing.
We have already seen this happen in China and now it is happening in South Korea too.
An
important way to interpret the rate of exponential growth is to
consider the growth factor which is the number of new cases today
divided by the number of new cases the previous day.
Growth Factor = No. New Cases Today / No. New Cases Yesterday
A
value over 1 indicates that we are still on the exponential part of the
curve and there may be higher magnitudes of new cases ahead of us. In
other words the growth is not slowing down.
This is the case right now in the USA and Europe.
Whereas a value of 1 means that growth is levelling out and a value under 1 means new cases are decreasing.
Taking
China as an example, the coronavirus spread began at an exponential
rate which has gradually levelled off thanks to drastic shutdown
measures. With new cases appearing to have peaked the country has been
able to get back to work and reboot its economy.
Meanwhile, the
United States and Europe have only just started to see new cases
increase, indicating that they are likely to be near the beginning of
the exponential curve.
So what does all this mean for the stock market now?
For
me, I think we need to see the growth rate of new cases in the US and
Europe start to level off before we can put in a major stock market
bottom.
So we need to see the daily growth rate drop to one or
below and then stay there, perhaps for a week or so. Once that happens I
think we will see a bottom in stocks and a significant relief rally
thanks to the huge amount of stimulus that is being provided by central
banks.
Importantly, though, I don’t think we need to see growth
rates level off for the whole world. It would be enough to see growth
rates in the US and Europe start to slow for a bottom to be put in.
That’s because these areas (plus China) account for the vast majority of
global GDP.
To keep on track of this I am using the coronavirus dashboard developed by John Hopkins University
which seems to provide the most up to date and reliable figures that
I’ve found. The dashboard provides the latest statistics on new cases
which can then be used to calculate growth rates.
New
cases outside China was 100.5k on Monday March 15th, higher than the
previous day’s 81.7k cases and higher than the 75.1k cases on Saturday, a
growth factor of 2.8.Analysing these numbers
it doesn’t seem all that surprising that yesterday’s 10% drop in US
stocks coincided with a huge daily growth rate of 2.8 times (this is for
locations outside Mainland China).
Final Thoughts
Ultimately,
virus growth rates and the stock market are linked and so long as the
curve is exponential the markets are going to struggle. Although
profiting from such a link is another matter.
Stock markets are
likely to rally every time the virus looks to have been defeated, even
when it’s not. The data isn’t entirely accurate so there is likely to be
some false starts.
It’s also possible that the market will be
able to lead a flattening in the virus whether it is caused by luck,
government intervention or some other reason. But eventually the market
will get it right.
At the end of the day, predicting this kind of
thing is a precarious thing to do and it may not be worth the effort
given that stocks are already off 30%.
A 30% drop in US stocks is surely a relatively good time to put some money to work.
That
being said, when stocks are up and the exponential curve has leveled
off, I think you can be pretty sure that the bottom is in.
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A good explanation I’ve found on epidemics and exponential growth is this one on YouTube which I recommend watching if you are not already up to speed.
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