The Doctor Is In
The Investing Logic of the Coronavirus
Computers are logic boxes built of blocks of computer code attached to clocks. Computer code at its most basic level is a series of if/then statements, so if A then B.
Financial companies like insurance companies work on similar principals – for example, if your house is on the beach in Florida, and hurricanes cause damage with a probability of P, then your premium and deductible become a certain number.
Given that most equity market trading is now done by computers, it is helpful to look at the potential logic inputs of the current situations.
Scenario A – Coronavirus is a covariant of SARS (Sudden Acute Respiratory Syndrome)
Covariant – of one magnitude with respect to another – varying in accordance with a fixed mathematical relationship.
The base logic then would consider the fact that during the 2002-2003 SARS outbreak the S&P 500 topped on January 14, 2003 at 932.17 and fell to a closing low of 800.73 on March 11, 2003.
The recent February 19 high on the S&P500 was 3386.15, so a similar move would suggest a low around 2868 on the S&P 500. The markets are trading near this level as of Friday morning while I’m writing this.
Scenario B – Double Dip Recession Pricing Logic
The yield curve, which has a solid track record as an early indicator of recession, has inverted for a second time indicating a double dip recession. Recessions by definition are at least two quarters of negative GDP growth, and historically recessions have lasted 16-21 months. As a result, if one were programming a computer to reflect a recessionary shape, then one would instruct the computer to look for at least a 6-month low to account for at least two quarters of negative earnings. If there are 240 trading days in a year, then the computer logic code would look for a low that is the lowest low of the last 120 days. The Dow Jones Industrial ETF hit such a 120-day low this morning.
Obviously, recessions can last more than two quarters, so it is important to note this is a minimum expectation. Equities typically bottom during a recession, once investors can begin to discount an upturn in earnings.
I would note that this morning’s low is higher than the last time the Dow Jones Industrial ETF hit such a 120-day low which was in the December 2018 slide. Interest rates, however, are reaching new lows in yields, indicating conditions may be worse than in December of 2018. This leaves a very wide range of possibilities on whether equities return to prior recessionary lows like the yield curve. Computer trading models could put the December 2018 lows in to play. If, however, markets begin to feel a recovery from the virus scare, then there could be quite a boom as investors begin to forecast a more positive future.
Another consideration with computer programming and economic recessions is the element of time. The Dow Jones Industrial Average first reached current levels in January 2018, and 21 months (the typical length of a recession) from then would be March 2020. This timing is similar to the time element embedded in Scenario A. Global equities markets have been weaker than US markets, so they are even more reflective of less than robust conditions. Companies, however, will work out of inventories due to supply chain issues. Ultimately, this will help to clear supply overhangs caused by recessionary conditions.
Three weeks of rest and a recovery from a health panic and a recessionary low may just be the right prescription for logically thinking investors in 2020.
It has been awhile since we have seen this type of market activity, so it never hurts to revisit my 13 Things to Understand About Bears that I wrote a few years ago.
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