While there’s a lot of time left between now (Sunday afternoon) and tomorrow’s open, Dow futures are presently trading 340 points lower; which should come as no surprise to anyone.
Frankly, given the fragilities showing up in much of the global macro data that we’ve been pointing to for months, and, not to mention, the underlying leverage in the corporate space, when we factor in the economic realities of the coronavirus we really should be looking at much worse in terms of stock price action.
What should also come as no surprise is that when asked today if the U.S had a fiscal plan to combat the potential economic impact of the coronavirus, Treasury Secretary Mnuchin replied “no question about it.” In terms of central bank response he predicted that “central bankers will look at various different options as this has an impact on the economy,”
Make no mistake, this will be a serious test of the Fed’s and the Administration’s emergency broadcast system. I.e., as Mnuchin suggests, we should expect central bankers and other political appointees to broadcast their aggressive plans to combat the ill-economic effects of this rapidly-spreading illness in the days to come.
The question of course being, will traders buy it this time? While you may indeed hope so, I’m here to tell you that, frankly, you really shouldn’t:
You see, at least ostensibly, one of the stock market’s most important functions is that it can serve over time to discount economic reality; a signaling mechanism that can aid in the appropriate allocation of capital. When policymakers succeed in manipulating stock prices higher, in the face of deteriorating economic fundamentals, the market loses its potential signaling efficacy and has folks believing everything’s okay when, in fact, it simply isn’t. This is when the market is at its most dangerous for the unsuspecting investor.
In our weekly message posted on February 5th we walked through the 8-stage boom/bust cycle. Here’s from that essay:
…the latest action (a strong stimulus-driven rally amid weakening macro trends), whether embodying the sequence/relationship between the actors I just described or not — while it can go on for a very long time — explains how bull markets typically end. That said — although certainly amid a different sequence/relationship among the actors — one could argue that the latest action also explains how bull markets typically begin (strong, sustained move off of a big capitulation selloff [like the Q4 2018 correction]).
Thing is, bull markets virtually never begin from record valuations, amid heavily debt-laden corporate balance sheets and macro data that appears to be topping after a prolonged (longest ever in this case) expansion; they tend to begin under virtually the opposite scenario.
Clearly, the folks (not the seasoned professionals) piling in belong to the looks-like-a-new-bull-market camp.
I suspect that they’re wrong, and that we’ll ultimately (could still be awhile) look back and recognize what turned out to be your classic boom/bust cycle:
1. In the initial phase the trend is not yet recognized.
2. A period of acceleration, when the trend is recognized and reinforced by the prevailing bias; that is when the process approaches far from equilibrium territory.
3. A period of testing when prices suffer a setback. Latest occurrence being the 19% correction in Q4 2018.
4. If the bias and trend survive the testing both emerge stronger than ever and far from equilibrium conditions in which the normal rules no longer apply become firmly established. If the bias and trend fail to survive the testing no bubble ensues. Bias and trend survived the test (i.e., bubble ensued).
5. The moment of truth when reality can no longer sustain the exaggerated expectations.
6. A twilight period when people continue to play the game, although they no longer believe in it.
7. A crossover or tipping point when the trend turns down and the bias is reversed.
8. A catastrophic downward acceleration; commonly known as the crash.
In my view, the action of late screams stage 6, which absolutely can (tends to, actually) go on for a very long time. That (“very long time”) said, while we won’t know till after the fact, present conditions are such that we could very well find ourselves in stage 7 much sooner than later, but not before the Fed (and virtually every other central bank on the planet) and the politicians hit it with all they got…