COVID-19 Derails the Surging Bull Market. Oil Price War Starts!

One virus, one month was all it took to change the traction of the world economy as the COVID-19 virus plunges the world into a twin supply/demand shock which will probably bring an end to the decade long bull market. As the virus spreads west from the country of origin in Wuhan China, the trembles of the the virus spread from the stock markets of the East to the West. The stock market, which is reaching new record highs on hopes of the resolution of the US-China trade war, was thrown into a sharp correction with little warning, literally jumping off the cliff from its peak and diving down in a matter of days. Investors became extremely concerned as the virus infection worsen in Europe and seems to be gaining traction in US.

The US central bank had an emergency rate cut of 0.5% but investors view that as an ineffective measure in the current twin supply/demand shocks. An interest rate cut is more effective in dealing with recessions dealing with over-leveraging of debt or property crashes. So what are the concerns for the investors and what are some of the possible solutions in the face of this virus market crash? There are two shocks we need to consider: Supply shock and demand shock.

Supply Shock occurs when there is a sudden scarcity in the materials needed to produce goods and services and in this case, the supply shock comes from China where many essential components needed to produce final manufactured goods are unable to reach their destinations in the factories of other countries as the whole country goes into lock down. As the virus spreads to other parts of the world, large numbers of employees and service staffs are quarantined are asked to work from home and businesses are unable to produce their usual productivity output due to these measures. Prices of the now scarcer resources will now impact the profit margins of the local enterprise and may result in them retrenching staff in a bid to cut cost. In the case of supply shock, governments will need to help companies find alternate sources of supplies and give out low interest loans, to help these companies to keep afloat to while waiting for the virus or the supply crunch to blow over. This will minimize a  large number of companies from collapsing and creating long term damage to the economy due to a loss in these enterprises.

Demand Shock occurs when there is a sharp fall in a demand for goods and services, and in this case, a sharp drop in tourism and demand for experiential services such as events and restaurant dining as people engage in social distancing to prevent themselves from contracting the virus. In this case, the government cannot do much, as putting money into the hands of the consumers, will not have much effect as people are too afraid to go out to spend. The primary measures governments should do in this case is to put in measures to prevent further panic such as timely and transparent communication on how the virus is being contained. They also need to control the pandemic and manage economic activity in such a level that people still have confidence to continue to consume.

Oil Price War

As the demand for oil falls sharply due to the COVID-19 virus, oil prices started to fall and the two top oil producing nations: Saudi Arabia and Russia, saw their country coffers take a hit as barrels of oil sit in their warehouse without any buyers. The discussion to cut production fell apart as both countries raced to grab market share in order to protect their oil revenue. Saudi increased their oil production and started offering steep discounts to key oil buyers in a bid to take down their competitors such as Russia and USA and as a result, oil related companies in many countries saw their shares take a hit, and top that off with the worries of the spread of COVID-19 around the world, the stock market saw a viscous sell off on 9th March, now known as the 2020 Black Monday. The US stock market lost 7% in a single day while oil producing economies such as Russia and Brazil losing 12%. Italy, the center of the COVID-19 outbreak in Europe, saw its saw market plunge by 11%. The market rebounded the next day.

Usually, steep oil drops like this will eventually benefit most economies but with the threat of COVID-19 looming, this created the perfect storm such that emerging economies, which are not that as badly affected by the COVID-19 virus, were also impacted indirectly.

Portfolio Strategy

The portfolio lost -1.4% to -1.8% in the month of Feb as compared to the average drop of 5%-10% in major stock markets around the world. This is thanks to the generous allocation of bonds and cash in the portfolio.The healthcare fund also showed its resilience in the face of the COVID-19 threat and proved its defensive nature in the current downturn.

The portfolio took a hit after the events of Black Monday is the portfolio is down by -3.74% for the month of March and I am glad that the damage to the Emerging Market fund is not as pronounced as it is as the fall in Russia and Brazil stock markets are compensated by the more positive developments in the Asian stock markets as the COVID-19 virus saw its spread arrested in China.

Is this a good time to enter the market? I will say that the worse is yet to come, as US hasn't seen the worst in the COVID-19 outbreak and I am only starting to see the panic started to creep into the psyche of the American public. I believe that there will be another round of correction in the US markets once the COVID-19 hits it peak in the western economies in a few more weeks time.

I feel that this is a great opportunity to allocate our cash and bond holdings into equities and in my opinion, the global economy will most certainly lapse into a recession this year. We are very well posed to take advantage of this down cycle with ample amount of ammunition and if history is of any guide (SARS), the stock market will recover quickly once the virus blows over. Meanwhile, I will encourage all of my clients to update their CKA online so that I can help you perform a timely switch when the time comes.