With several states considering reopening in May, at least in some capacity this trend will certainly be disrupted and the rate of active case growth will probably rise again.
Not surprisingly, the major US indices bottomed a few days later on 23 March.
Year to Date, the S&P 500 (black) is down 12.6%, Nasdaq (blue) is down 5.52%, Dow Jones (purple) is down 16.96% and gold (yellow) is up 11.16%
A popular theory is that this rapid selloff and equally rapid rebound is a V-shaped recovery.
As of writing the Vanguard S&P 500 VOO ETF fell over 35% from 311.59 down to 200.55 before rallying back 30% up to 261.2
While this certainly is the case right now, I believe that the fallout from COVID-19 will continue for many months and US stocks will make new lows. We’ll see which organizations and governments have been swimming naked as the tide is going out and the results will probably be ugly.
The COVID-19 pandemic is a great tragedy and an unprecedented event in modern history. In the midst of countless negatives–one positive is this market selloff presents a buying opportunity.
As someone who has been overweight cash over the past few years I’ve been looking a selloff like this to be able to increase my exposure to the markets.
I can’t predict when the market will bottom or I would just buy in then. So I want to go over three strategies one could use to enter this market.
COVID-19 case Plateau
It is possible that when the number of active COVID-19 cases plateau that will also be around the time the market bottoms out.
Active Cases in the US continue to climb
As of now the active cases in the US have continued to climb. At some point this will plateau, as it already has in places like South Korea.
Active Cases in South Korea Plateaued in mid-March
Modified Dollar Cost Averaging
This method attempts to capture market exposure at given price levels.
To do this, first determine how much you’re planning on investing. Then break than into a series of price levels. For example, if you’re planning on investing $3,000 at three different price levels, you’d be investing $1,000 per price level.
Price levels could be something like the % fall from the prior peaks drop. So when the market falls 30% from peak, you invest $1,000, when it falls 40%, another $1,000 and if it falls 50% the remaining $1,000.
For example, the S&P 500 peaked at 3393 on 19 February. So $1,00 would be invested at the 30% drop level of 2375, a 40% drop would mean buying in at 2036, 50% would be 1696.
The downside to this is that the market might never fall 40% or 50%. If this happens one wouldn’t buy into the market at these levels and money would be left uninvested. It could also of course fall more, in which case one would have bought in at a higher level.
Looking at the previous bear markets of the past 2 decades, the bottom of markets is not made after just a 35% drop in 33 days.
Given that the number of COVID-19 cases in the US continues to climb I don’t believe the market has bottomed yet. The market has rallied about 14% off of the 23 March lows, but I believe the market will give up these gains and make a new low.
Of course I can’t know for sure.
Good Old Dollar Cost Averaging
This is probably the simplest and most basic method. This is buying a set dollar amount of shares on a set schedule. Such as $100 on the first of each month. When prices are lower, more shares will be purchased and when prices are higher, fewer shares will naturally be purchased.
The downside to this method is that if one has any reasonable belief that the market will fall more, then one is buying in at a higher price than is necessary.
Despite the rally over the past few days, major US indices like the S&P 500 are still down some 23% from the 19 February high.
Of course it’s impossible to know with certainty.
COVID-19 Selloff Buying Opportunity
Gold has been a decent hedge thus far. Gold is up 3% since the 19 February high compared to the S&P 500 which is currently down over 27%.
In the 2000 dot com crash markets didn’t bottom for for nearly two and half years. The 2007-2008 great recession market drop took about 500 days. We are less than 2 months into this crash.
We are certainly living in interesting times. While this has been a sharp and violent selloff, it presents a buying opportunity, if not now at some point over the next few months or years. I personally think the markets will fall lower, perhaps to the 40-50% level before beginning to climb again.
Since early 2009 US markets have been in a bull market. In less than a month that 11 year bull market has ended and we are now officially in a bear market. The big three US indices are all down more than 20%.
NASDAQ in blue, S&P 500 in Grey, Dow Jones Industrial Average in Purple and Gold in Yellow
Interesting that the trigger to the selloff was something no one was expecting. But perhaps the fact that no one saw this specific catalyst coming shouldn’t come as a surprise.
As I mentioned before, making financial decisions out of fear or panic will rarely result in the best outcome. Cool heads will prevail.
At this point in time I have more questions than answers, but in the midst of this bear market there is great opportunity.
Is Now the Time to be “Greedy”?
“Be fearful when others are greedy and greedy when others are fearful.” – Warren Buffett
It’s hard for me to respect Warren Buffett when the man does everything in his power to avoid paying taxes while at the same time publicly saying he should pay higher taxes. It is hypocritical.
Despite my misgivings about Mr. Buffett I can’t argue with the long term performance of Berkshire Hathaway.
It’s important to ignore what Warren Buffet says on his virtue signaling tours and look at what he is actually doing with his money.
Others are fearful right now so it could be a good time to be “greedy”. Of course buying things on sale isn’t actual greed but I digress.
Who Knows when the markets will bottom out?
I’ve been underweight US stocks and will be using this bear market as an opportunity to dollar cost average into US index funds and ETFs. I do not believe it is possible to time the bottom so I’m not going to try. What I am trying to do is to buy into the market at an interval of good prices.
Compared to the highs stocks are on sale at a 25% discount. They might go on sale for 40% off or even 50% off but in either case it is a significant discount from the mid-February highs.
How is Gold Working Out?
Gold has been a decent hedge so far. However during a panic the yellow metal will probably fall as people sell everything. And indeed gold is down from the $1,700 high made earlier this month.
For the first five years after the last financial shock (2008-2009) US stocks were the place to be and gold, which had a tremendous run-up, went into a bear market. Of course past performance is no guarantee of future performance, but it can provide a guide for how markets could possibly perform.
Gold in Yellow and S&P 500 in Blue
Over the past five years, as a result the current crash, gold has outperformed the S&P 500. Gold is up 32.71% compared to the S&P 500 being up 24.06%.
Gold in Yellow and S&P 500 in Blue
However, even after this large drop. Since the 2008-2009 financial crisis, stocks have been the place to be. The S&P 500 is still up 248% since February of 2009, while gold is up relatively modest 68.9%.
Gold in Yellow and S&P 500 in Blue
And despite this large drop, for the past 10 years, stocks have done very well.
NASDAQ in blue, S&P 500 in Grey, Dow Jones Industrial Average in Purple and Gold in Yellow
The Fed Tries to “Help”
Not one to stand by and allow the free market to operate–the US Federal Reserve announced more quantitative easing (QE4) on Thursday. Of course if you count the not-QE QE, this would be QE5, for those keeping score at home. It is also anticipated that rates will be cut again.
Rates were over 6.5% prior to the 2000 dot com crash. They were hiked back up to about 5.25% prior to the 2008-2009 financial crisis. But after the 11 year bull run rates only made it as high as 2.4%.
In short the rates have never been this low going into what could be a recession.
The Fed is entering this bear market (and potential recession) with interest rates already so low they have little ammunition to “help”.
The Fed is already doing more Quantitative Easing.It seems inevitable that rates will go negative.
Stock valutations in the United States are no longer driven by profits, future earnings, productivity or any other free market measure of value. Instead they are controlled, in practice by President Donald Trump trade war tweets and Fed Chair Jerome Powell’s comments about future interest rate levels.
These two economic central planners met on Monday the 18th to talk about “Everything”.
Trump
Trump has already made clear he wants negative rates and more quantitative easing. He mentioned discussing negative interest rates with Powell.
“Trump called the meeting ‘very good & cordial,’ adding that ‘everything was discussed,’ including interest rates, negative interest, low inflation, easing, dollar strength, and its effect on manufacturing, trade with China, the EU ‘& others, etc.'” (Emphasis added)
Powell sounded like a 3 year old parroting some rehearsed line, stating monetary policy will be set to support maximum employment and “stable prices”.
The Fed’s target for price inflation is 2%. Which means that the value of a dollar will be cut in half in about 36 years. This is hardly what I would consider to be price stability.
On the topic of “maximum employment”. The unemployment rate is at a half-century low of 3.6%. To have a lower unemployment rate you have to go back 50 years to 1969.
Do interest rates need to be below the level of inflation in order to support maximum employment?
A Health Person on Life Support
Interest rates are at 1.75% and central bank balance sheet growth has resumed. These are the kind of extraordinary life support measures seen during economic crashes and recessions.
If the economy is healthy, vibrant, growing and strong you don’t need to pump it up with stimulants and preventative measures. Yet these extraordinary measures have been going on for a decade.
Say you have a patient in a hospital. The doctor says they are fine and doing great. However, we’re going to pump them full of antibiotics, keep a morphine drip and IV going, and hook them up to an iron lung, “just in case”.
You would rightfully be suspicious of that doctor. If the patient is fine then why do they need all of those extraordinary life preserving measures?
It seems clear to me the Fed is keeping interest rates low for some reason other than price stability or supporting maximum employment.
Central planners President Donald J. Trump and Fed Chair Jerome Powell both spoke regarding the US Economy this week. Trump was Tuesday; Powell Wednesday.
One interesting quote from Chair Powell’s prepared remarks were the following: “Nonetheless, the current low interest rate environment may limit the ability of monetary policy to support the economy.”
In other words if the economy goes south, the Fed won’t be able to do much to prop it back up.
This assumes rates don’t go negative (like Trump is already calling for) or Quantitative Easing (QE) isn’t further expanded (which Trump has also called for). With those in mind, the Fed still has tools at it’s disposal to wreck the dollar and re-inflate asset bubbles.
Powell also read, “In a downturn, it would also be important for fiscal policy to support the economy. However, as noted in the Congressional Budget Office’s recent long-term budget outlook, the federal budget is on an unsustainable path, with high and rising debt: Over time, this outlook could restrain fiscal policymakers’ willingness or ability to support economic activity during a downturn.”
As he states the obvious, Powell is of course correct about the unsustainable federal budget.
Seeing as how the Fed is empowering the Treasury to go deeper and deeper into debt it is ironic that the Chair of the Fed is concerned about the debt.
Powell also mentioned his “In no sense, is this QE,” Quantitative Easing program: “To achieve this level of reserves, we announced in mid-October that we would purchase Treasury bills at least into the second quarter of next year and would continue temporary open market operations at least through January. “
In his Tuesday speech President Trump called for negative interest rates. He is further complaining the Fed isn’t working with him and that interest rates were cut too slowly.
While touting the stock market at all time highs (which he once called a big, fat, ugly bubble), Trump purports the stock market would be 25% higher if not for the Fed.
Trump is the Bubble-Blower in Chief. He basically wants the kind of sweetheart deal Obama got.
He also mentioned a desire for more tax cuts. Tax cuts are fantastic and important, but without cutting spending they will only increase the unrepayable and unsustainable deficits.
All of this should be good news for gold. While the yellow metal has not dropped through the $1450 resistance line, it is hovering just about it.
Until recently market dynamics have been something like the following: Trump threatens more tariffs, the market sells off, the fed eases and the market rallies. I wrote about this in a past article entitled Trump is Beating the Fed like a Rented Drum Set.
Recreation of a BofA Merrill Lynch Diagram
Phase I: Get Interest Rates Low
The result is interest rates at 1.5-1.75%, “This is not QE” QE, and the S&P 500 at all time highs.
Trump Playing the Trumpet in a badly Photoshopped image
I believe Trump’s prospect for reelection is tied almost entirely to how the stock market performs. So why would he threaten tariffs if they cause the market to go down?
I conjecture firstly that Trump genuinely believes in tariffs and secondly: so he gets lower rates.
But this is only Phase I: where interest rates are already low and perhaps the Fed has signaled they intend to keep lowering. On 30 October the Fed poured a little cold water on Phase I by indicating they intend to pause easing.
Low interest rates and QE is just the first tailwind.
Phase II: “Win” Trade War
I expect Phase II, the “Double Tailwind”, to occur in 2020 and be timed for the election.
Phase II is kicked off either by winning the trade war, or (more likely) simply declaring the trade war won.
The market believing there won’t be new tariffs is the second tailwind, which combined with the first forms the “Double Tailwind”.
Phase two means fewer tariffs or even a complete trade war victory
The “Double Tailwind” means the market isn’t getting freaked out by tariffs and selling off and interest rates are low.
The US stock market could go to even higher highs and secure Trump’s re-election. Trump can then use the bully pulpit of the presidency and appoint an uber-dove to ensure that rates are raised slowly or not at all.
Interest rates might very well stay where they are at. During the 30 October press conference Fed Chair Powell said, “I think we would need to see a really significant move up in inflation that’s persistent before we even consider raising rates to address inflation concerns.”
Why he appointed Jerome Powell only to throw him under the bus is beyond me, but he will probably do more to ensure he get’s a low interest rate puppet as Fed Chair for his second term.
I don’t know if Trump is planning this out in some grand ‘3D chess’ maneuver or not. But if he is, I have to admit it has a sort of Machiavellian genius to it.
Potential Problems
3D Chess – metaphor for using multiple, non-obvious levels to outmaneuver one’s opponents
Whether it is intentional or not, Trump is now responsible for blowing more air into what is now an even bigglier and uglier bubble and can join the ranks of the Presidents responsible for destroying the dollar and the US economy.
Quarter three GDP was up 1.9% beating the expected 1.6%. Employment is robust. Inflation as (not) measured is “contained”. Between that and the S&P 500 rise will the Fed be able to justify continuing to cut rates?
Another problem is when you get high on heroin you have to deal with the crash. You can’t take the heroin away and keep the high. In fact you have to keep taking more heroin to get a similar high.
Low interest rates are monetary heroin. So if interest rates don’t continue to fall then the market will fall. This most recent “insurance” rate cut may have been the last. If so there is a whole year between now the election in which even the Double Tailwind can fade, bringing the economic ship to a halt. Timing the trade war “victory” correctly before the election will be essential.
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