Epidemics and Stocks – A Look Under the Hood

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The world changed almost overnight. Coronavirus fears are grinding the entire world to a halt. That’s why this time it’s different. The latest pandemic has thrust everyone into a still orderly panic.

I live in South Florida. The population down here is largely elderly. It seems for now that the hottest item to find is toilet paper, because when the apocalypse comes, that’s the currency to hold – not gold. It is the new gold.

It was a chaotic scene at the toilet paper aisle at my grocery store on Tuesday, March 10, before Trump’s rattling speech. One sad person was in such a rush to grab paper stock that he or she left a cane behind. That was the only item left on the shelf.

In all seriousness, this virus is a real issue. Many have been and will continue to be affected. Many will die. It’s tragic, and I take it very seriously. But as a probabilities man, the odds are vastly against death by COVD-19. (With that said, of course any deaths are unwanted – especially if they are preventable!) So I am doing my part – relaxing in my home with plenty of handwashing.

Here’s the deal: we will get past this, and we will persevere. Humankind has faced countless health scares in the past. We lived through plague, polio, 1918 flu, smallpox, measles, and too many to name. There has been an outbreak every year and a half since 1990. Here’s a chart I compiled of most epidemic outbreaks over the past 30 years overlaid on the S&P 500 Index.


Columnist Gary Alexander writes: “Jeffrey Kleintop at Schwab has done the heavy lifting of comparing market recoveries of all of the major epidemic outbreaks of the last 50 years, and he came up with the following chart of stock market returns in the global arena (using the MSCI World Index) in the one-, three-, and six-month periods after the initial outbreak:”

Charles Schwab, Factset

A picture emerges that echoes Warren Buffet: short-term markets can react wildly to headlines, but long-term stocks are the place to be. “Be fearful when others are greedy and greedy when others are fearful.” Translated to an action item: years from now, this market rough patch will prove to be the opportunity of a lifetime.

The message is clear: Be prudent and take care of your and your family’s health, but don’t lose sight of unfolding opportunity. Phenomenal deals are emerging in stocks. The problem is this: when stores announce sales making room for next season’s inventory, it always sounds great! “Hurry, these deals won’t last! Unheard of prices!” It gets you excited. 

Stock market deals usually are wrapped in messages of doom and signals to stay away. That’s how it works.

With that out of the way, we need to address the bear in the room. Last week’s price action shoved us into a bear market, which is classically defined as market prices 20% lower than the previous high. Indexes retreated 25%-plus from their highs before a mammoth rebound Friday. Some are out there asking if this is the shortest bear market in history. Friday’s rally, while immense, was largely at the end of the day and a rally driven by computer short covering, in my opinion.

Does our data detect bear markets? What does it say about them? Can we use data in a bear market?

Last week registered the biggest selling on record in Mapsignals’ 30-year history. We saw 14 buys against 3,044 sells. We also saw 13 exchange-traded fund (ETF) buys vs. 571 sells. ETF buys were in either long Treasury products, levered long gold, or inverse levered market products. More importantly, our Big Money Index (BMI), which measures big buying to selling, dropped to 33.2%. The sellers are in control. This data is clearly risk-off consistent with what we’d expect after last week’s carnage. 

The good news is that we will be oversold this week (BMI 25% or lower). Historically, markets can’t sustain this level of selling for long. That means we will likely see a bottom or at least a bounce soon. 

Here’s another interesting data result: over the past three weeks, starting Feb. 24, 2020, the number of stocks showing outsized volumes has an unprecedented 15-day average of 1,394 per day. That may not mean much until you consider this: Our universe of stocks tracking big money activity is around 1,400. So, 99.57% of our universe is showing big volumes. Usual readings are 500 each day for the past 15 years. 

To show you how deep and wide this selling goes, look at the following sector charts. These plot a moving average of sell signals vs sector indexes. It gives an idea when a sector is oversold. These are some sector charts that make me go “wow!”

Big money signals by sector


Big money signals by sector (continued)


That’s what we see under the hood. Here’s the deal: I’ve seen a lot in my time on Wall Street. Now is very similar to 2008 to 2009. Price dislocations are rampant. Things are broken. We saw days where stocks, bonds, gold, currencies, and cryptocurrencieseverything went down.

That means liquidation. Investors are scrambling for cash. That also means there’s nowhere to hide for those levered. You can see it in gold prices, bitcoin prices, bonds, and stocks.

Liquidity is like oxygen for companies – and those who didn’t prepare correctly will face consequences. If business must shut down for extended periods while we try to slow coronavirus, there might not be enough liquidity to keep all of them afloat. That’s what’s got Wall Street in a fluster. It’s not just coronavirus and energy price collapse – it’s liquidity.

I saw this in the financial crisis. Wild market swings like now were common place. Today’s activity is rhyming with what happened then. I also recall that events like last week leave most unprepared. Three standard deviations account for 99.7% of all observances. Funds set up to weather the potential storm from three-sigma events. Last week was seven-sigma. Nicolas Taleb called these black swan events.  

When funds are leveraged and set up for three-sigma events, and seven-sigma comes, it means game over. Last week screamed of liquidation. I do believe we will see firms go under.

Now let’s talk about a more positive aspect of the future and why this is shaping up to be an incredible buying opportunity for long-term stock pickers. This will pass – likely months from now, but I envision my kids one day studying what went wrong with the crash of 2020.

And when they ask me about it in 15 years, I’ll say: “I saw the GFC. Strange and incredible things happen. That’s why I bought stocks into the crash of 2020. I focused on great companies with wide moats, fat margins, and plenty of cash. I even bought for you.”

The Bottom Line

We (Mapsignals) are bullish on high-quality U.S. equities in the long term, and we see moments like these as areas to pick up great companies.

Disclosure: The author holds no positions in any mentioned securities at the time of publication.

Source: Investopedia

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