My intention when I am starting this late on Saturday night is to do something a bit different with the ‘Stocks & Markets’ Blog this weekend and if I can get cracking on this it should contain plenty of blurb about the Markets and what has happened and is likely to happen, and also more on my Strategy. If this plays out as I would like then you could be reading this on Sunday and I will issue a separate Charts Blog late on Sunday night and that one will obviously look at both long-term and short-term Technical factors and I won’t be including any other stuff in these Blogs.
Last week was obviously highly dramatic and more than a little scary and the speed of the drop was utterly bonkers and I understand it was one of the quickest falls from a Peak ever. This in itself is a technically worrying development and hardly hints at strength but I won’t talk too much about the Charting stuff in this Blog. I will try and break what I see as the key factors down into several headings.
The Virus
Previously we have had some Market wobbles from things like SARS and Pig Flu or whatever they were (oh, and Ebola) but the difference for all of those was that they were fairly contained in the sense that they did not seep into The West and as with Ebola it was not particularly contagious simply because it is so nasty it killed off a ‘Host’ fairly quickly before they could spread the disease around. A big problem with this Virus is that it seems to be extremely contagious as has been evidenced simply by the floating Petri-Dish which was that Cruise Ship in Japan and the way in which an Outbreak in Italy seems to have spread to at least 6 or more European Countries and probably other places outside of Europe. And of course the Hotel in Tenerife. Up until now the Virus has been contained within the UK and the NHS etc. has been very good at tracing contacts for the small number of People who have been infected but it is important to note that pretty much all ‘Experts’ that I see interviewed are saying that it is merely a containment exercise which buys time during the peak Winter months for the NHS so that the NHS will have more capacity to deal with a crisis as we get towards Summer. Indeed, this is backed up from comments by both Mathew Hancock who is the Health Minister and Helen Whatley the Care Minister who both admit they are merely buying time so that the NHS is in a better situation to cope. From what I have picked up it looks like the NHS is going to really struggle if cases become significant and I heard something about there being only room for about 350 people in High Dependency Units. It is also worth pondering why Boris is hosting a COBRA meeting on Monday and this doesn’t suggest it is not much to worry about. So far in the UK the cases have been from infection via Italy or Iran or the Cruise Ship but in recent days the first case of ‘person to person’ infection has occurred and of course there is some delay between the unfortunate person getting infected and it actually being diagnosed. So there could easily be a lot more cases and if you look at the progression in Italy, South Korea and Iran and China (although with the latter 2 you really need to be skeptical about any figures put out and it is highly likely they understate the reality), the increase from day to day once it sets in is pretty rapid. The US is clearly an important one as well and this is particularly relevant to the Markets as the US Indexes look very stretched and valuations especially in the Tech Sector are simply crazy. Trumpy has been going on about 18 cases or so but just today the first person to die in the US has occurred and CNN last night were saying the true number of cases is something like 68+ and there has been a case which was ‘person to person’ within the US and not caught outside. I suspect if we see cases in the US ramp up fast then the Markets are gonna worry a lot more. It looks like the spread of the Virus is being contained in China and at the end of last week I heard that the growth of numbers outside of China actually exceeded China for the first time. I guess this is good in the sense that it is being controlled perhaps but of course a big problem is that the measures Chinese Authorities have taken are draconian and it would be pretty much impossible to do this in the ‘Democratic’ West I suspect. Having said that, the Italian Authorities have shutdown several Towns so maybe it will happen in the West. South Korea seems to have quite an Outbreak and Iran is looking a bit messy and even 2 members of the government have caught it. Japan has it and the numbers are growing (the third largest Economy in the World) and I think the last count I heard was over 42 Countries now have cases. A big one to worry about is Nigeria because many ‘experts’ are concerned about Africa being a breeding ground due to low quality Health systems and the effect of poverty etc. whereby people tend to be crammed in at close proximity. I might have written this already but I don’t think I have so I will sling in a new paragraph. A lot of people keep saying this is like Common Flu but I don’t think that is correct at all. Firstly the Mortality Rate appears to be 2 to 3 times higher and secondly the ‘Experts’ don’t really understand the Virus fully yet and it could be worse than they think or better. What is clear is that it is highly contagious and seems to impact people who are 60+ in the main and people in their 80s are the highest risk. Strangely it doesn’t seem to be fatal for kids which is a rare blessing I guess but you can bet the little blighters will be spreading it around like crazy !! I am picking up that a Vaccine is at the earliest 1 to 1.5 years away and that assumes such a Vaccine can be developed. Some ‘Experts’ have suggested that it could behave like the Flu and continually evolve and move in waves with the seasons between the Southern Hemisphere and the Northern Hemisphere and back again. Anyway, it is clearly spreading and now we will look at the impact on the Global Economy. Impact on Economies This is extremely important because in my fairly lengthy experience of Stocks and my study of Economics, there is clearly a close correlation between big Markets falls, Bear Markets and the state of the Global Economy. In simple terms, if the Global Economy goes into Recession then we have to expect a Bear Market alongside this. Here is a list of Bullets about why the Global Economy is likely to be in trouble:
I think that does the Economic situation to death and you should get the picture. The only bit I haven’t mentioned much is the impact of fear about the Virus on Consumers and I suspect this could really take hold if the Virus does start to spread more in the West. If this happens it will likely mean people avoid anything where there are large gatherings and even things like Restaurants, Cinemas, Shopping Centres, Bars, Pubs, etc. etc. On top of this we could have people doing ‘self-quarantine’ which isn’t going to help the workforce be productive and we have had Profit Warnings from several companies already such as SSP Group SSPG and Diageo DGE who have been affected by problems with Flights and the consequent fall in demand at Airports. All this feeds in to reduce overall Economic Demand. Impact on Earnings and Stocks If we do get a Recession or even a bit of a Slowdown, then it is hard to see how Companies do not find themselves in an Earnings Downgrade Cycle. This is when Analysts look at their Earnings Forecasts and they reduce them because of the impact of a Slowdown. It is very much the opposite of what we have mostly had for 10 years or more where Earnings have been mostly growing and many Stocks have been in an Analyst Earnings Upgrade Cycle. Along with this, there would have been loads of Broker ‘Buy’ Ratings but as Earnings Forecasts are marked down, the Brokers will be dropping their Recommendations to ‘Hold’ (which probably means ‘Sell’ really) and in really bad cases they will actually call a Stock a ‘Sell’. It is pretty obvious that if Earnings are going to be lower and by definition ‘Earnings Per Share’ (EPS) are going to be lower, then even if you keep the same Price/Earnings Ratio (P/E) the implied Share Price must be lower. For example, if you have a Stock that is expected to make 23p of EPS next year then on a P/E of 18 it would mean a Share Price of 414p (23p x 18). If the Earnings Forecast now gets dropped to 17p, then the implied Share Price even on the same P/E of 18 would now be 306p (17p x 18) – that is a drop of 26%. Trouble is, at the same time as the Earnings Downgrades, we will also likely get ‘P/E Compression’ where the Market is fearful and it awards much lower P/E Ratios to Stocks (indeed, at the moment P/E Ratios in general are extremely high and on many Stocks they are way in excess of what would be ‘normal’). For example, on our Stock above which was priced at 414p, we could find we get the new EPS of 17p but on a lower P/E of perhaps 14 – in this case the implied Share Price would be 238p (17p x 14) which is 42% down. My Strategy There was a lot of discussion on Twitter today after some Tweets I slung out about all of this and I think a lot of people are confusing Market Timing (which for some reason is seen as a bad thing although I totally disagree with this) with Risk Management. For me it is quite simple (you know me, I only do simple stuff), when times appear a bit dodgy and the overall Risks have clearly risen, my stance is to lower my Risk and to get through the problems and then when things look better, I can put my foot to the floor and make money on the Long side by being fully invested. So I don’t see my actions as necessarily timing the Market and if anything I would argue that people who are buying Stocks now are precisely timing the Market and in reality they are increasing their Long-side Risk at exactly a time when this might be unwise. If you are buying now then you are assuming that Stocks will keep going up but is that really realistic after the longest Bull Market in history and with all the problems which should be obvious from what I have written already? Peter @Conkers3 and myself discussed this on our last Podcast, TPI 17, and if you go to the ‘Podcasts’ page on WD2 then there is a link to it. Peter C3 made the point that things have gone well recently and that it might be wise to bank a little bit of Profit and to take a bit of Risk off the table. That seems extremely sensible to me and completely the opposite of buying Shares now even after the mess last week. To me there is a lot of ‘Head in the sand’ going on here and people are just closing their minds to the immense risks that are around. I suspect 12 years of “Buy the Dip” have dulled people’s critical faculties. Anyway, I could well be wrong about the potential for big falls that I suspect we are facing but in reality that doesn’t matter. My approach contains an inherent Flexible Plan which means that whatever happens I can quickly adjust and avoid huge Downside Risk whilst being able to quickly switch stance if I need to because Markets are rising again. Let me stress that. I can adapt quickly to a Long or Short stance so I can react to whatever hits us. I am pretty sure that people who are buying now have barely considered any Downside Risk and if things go south, I wonder what they will do. You can be sure that whatever happens, you will see me still blogging and tweeting and I will always tell it as it is. If I screw up, then I will admit it and change my stance as needed. You can be pretty sure our next TPI Podcast will also discuss all of this stuff in some detail – hopefully we can both get into the Recording Booth soon !! Right, back to the Strategy. I have written extensively on Hedging over the last few years and quite frankly I am bored shi*less by it. If you go to the ‘Category’ of ‘Hedging’ on my ‘Educational Blogs’ page on WD1 then you can read about it for probably the rest of your life (it may well bore you to death !!) In essence my Approach is an alternative to selling a load of my Stocks which is quite an expensive thing to do and it takes time and effort and is certainly not quick and responsive. By keeping my Shares which I am pretty much happy with, I can then use Index Shorts (in the current case I am Short on the S&P500 and I will probably Short this more in the coming week – see my ‘Trades’ page on WD1) to quickly Hedge my Long Portfolio and this has the same effect as what would have happened if I had sold a load of my Stocks and moved into Cash more. It is hard to know the best level of Hedging to do but I will probably aim for about 30% of my Long Portfolio – so it would be like me selling about 30% of my Stocks but the beauty is that it is much more like turning a light switch on and off. Combined with this I will be looking for the true Bottom (I doubt very much that the low point on Friday was the ultimate Bottom and I suspect we will see many more Bums before we get to that final one) and I will be using the Charts to assist me with this. To keep it simple, the main Indicator I will be using is the 13/21 Day EMA Lines and I will be talking about this in the Charts Blog that I will issue on Sunday night if things go to plan. I also use some other simple TA stuff and I will be talking about that and I use some anecdotal stuff as well. Once I think we have hit the Ultimate Bottom, I will be then closing my Shorts and looking to go Long on an Index so that as my Long Portfolio rebounds, I will also make on the Index Longs (probably the S&P500 again). Of course this is difficult in practice but by using Stoplosses and stuff I am not married to either Long or Short although at all times I will be more exposed on the Long Tack and I find this the best way because if you Hedge too much that can be problematic as well. OK, I have had enough now. After all the tweets about this today my head is really spinning !!! Cheers, WD.
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