The last two months have been an exceptionally volatile period for global stock markets. The current CORVID-19 pandemic was a quintessential black swan event, which took everyone by surprise and its consequences have had a clear affect on the markets during this period. For a long time, I thought that markets were overvalued and due for an eventual correction. The root of my worries were based on the increasing levels of global debt since the last financial crisis of 2008 that have been fuelled by an unusually long period of low interest rates. With low interest rates money is cheap and cheap money has been the cause of the high valuations of many stocks and other assets such as property. All this concerned me. I knew it wasn’t sustainable and that eventually something would have to give. Yet little did I know that the catalyst for this current market crash would be a virus, which is now affecting citizens and the economies of every country on the planet.
I wrote an article back in 2017 and another one last year stating my fear that markets were overheating. Throughout all of 2019, I almost became resigned to the fact that we were in a ten year plus long bull market that seemed to show now signs of slowing down. Save for a sharp but very brief correction in equity markets from October to December 2018, the markets duly recovered and subsequently continued to hit new highs. Earlier this year, the NASDAQ index hit over 9,000 points and by mid February it had hit a new record of over 9,700 points. Back then I decided to view a longer term chart of the NASDAQ index and had discovered that back in March 2009, in the wake of all the wreckage of the last financial crisis, the NASDAQ index had collapsed to just under 1,300 points. In almost 11 years, the index had increased over 7 times in value. In the UK, only the FTSE 250 index comes close to matching the NASDAQ’s performance, but even the FTSE 250 has been no match. During that same time frame, the index went from under 6,000 points in March 2009 to a record high of almost 22,000 points in January this year. That represents an almost four fold increase in value. Impressive but still falling short of the NASDAQ’s run.
The reason for the NASDAQ’s epic performance is quite simply the unbelievable success of many of the biggest technology companies in the world, which are all listed on it’s exchange. The following NASDAQ listed companies: Amazon, Apple, Facebook, Alphabet, Netflix and Microsoft: have all been quite simply ‘crushing it’ throughout the last decade.
In the UK, the two principle stock market indexes are the FTSE 100 and the FTSE 250. Even though the UK doesn’t have anywhere near the kinds of innovative and exponential tech companies that come out of the US, the UK has a lot of thriving successful growth businesses and lots of these are listed on the FTSE 250. The FTSE 100, on the other hand, is made up more of long established big businesses with multi billion pound market capitalizations. Examples of such companies include Royal Dutch Shell, BP, Rio Tinto, HSBC, Unilever, Vodafone and British American Tobacco. These are big behemoth companies, which may lack the growth prospects of the smaller businesses listed in the FTSE 250. Yet what they lack in growth potential, they make up for by paying quite large dividends to their shareholders as their businesses generate a lot of cash. The FTSE 100 overall has, by comparison, not been a great performer. Even though from March 2009 until the January 2020, it went from less than 3800 points to almost 7700 points. Even though the index more than doubled during this period, it’s also worth bearing in mind that just before the turn of the new millenium, on December 10th 1999, the index was over 6700 points.
What is noticeable about this particular market crash is just how dramatic it’s been. Before the very beginnings of this market crash, when the markets closed on Friday 21st February, the NASDAQ was trading at over 9500 points, the S&P 500 was over 3,300 points, the FTSE 100 was over 7,400 points and the FTSE 250 was just a few points short of 21,800 points. By the time the markets closed just a few days ago on Monday 23rd March, the NASDAQ was below 6,900 points, the S&P 500 was a little higher than 2,200 points, the FTSE 100 had gone below 5000 points, and the FTSE 250 was trading slightly north of 13,000 points. In fact, just a few days previously on March 19th, the FTSE 250 had hit almost 12,800 points.
In the space of little over a month, the NASDAQ had fallen around 27%, the S&P 500 had lost around 33%, the FTSE 100 had shed 32% and the FTSE 250 had lost over 40% of it’s value. Since these lows from last Monday, markets have made some gains owing to stimulus from central banks, yet at the close on Friday yesterday, a good chunk of these gains were erased.
The question now is, how will markets behave over the coming weeks and months? Will the lows hit last Monday be retested? It is always hard to predict the future, but I think they will be. The difference between this crisis and others is that this virus has been very disruptive. Since there is still currently no cure for the virus, the only measures to contain the virus have been for governments to impose lockdowns and restrict the movement of people. The most affected industries include the airline and travel industries. The airline industry in particular has been greatly affected as the number of flights have been severely diminished. It is likely that even the most established airline companies will struggle going forward without some form of a government bailout. With their cash flows from operations dramatically reduced, they will be drawing on their precious cash reserves to keep the lights on. But the truth is, with the restriction of movement, most industries will be affected. If a lot of the most affected companies struggle to remain a going concern they will go bust and as a consequence many people will lose their jobs. As an increasing number of people lose their jobs, they will have no income and likely also little to no cash savings to keep them going. There will be a frantic need to create liquidity to free up emergency cash. And this is why there has been a sell off of almost everything, even the most defensive of assets such as gold. When people are desperate for cash they will sell anything. This notion that cash is trash is a myth. In a difficult crisis such as this one, hard cash is king.
So going back to my earlier question; will markets continue to fall? I think they will as I don’t see lockdown measures easing any time soon. I also see an increasing number of people continue to lose their jobs and as a result an increasing need for emergency cash as more incomes dry up. In this situation, markets will continue to sell off. Shares that may seem like a bargain now will get even cheaper. I think the situation is serious enough to say that it is likely that some of the lows of the 2008-9 financial crisis will be tested. Yet do I think there are currently bargain shares to buy? Of course. But at the same time one should ask themselves the following; how much free cash do they currently have to invest? Not essential cash to survive, but cash they can either afford to lose or not have any need to draw upon for at least five years. If the latter than I would recommend periodically drip-buying a select number of quality companies (that are not over leveraged, that generate a lot of cash and have sufficient liquidity to be able to ride out this crisis and thus recover once its over), investment trusts or tracker funds over the coming weeks and months.
It is likely that as the current crisis continues to bite, they will be a lot of government intervention to help citizens and business. One solution that has been doing the rounds is the idea of creating ‘helicopter money’ whereby central banks print money which is then given directly to households to help them and keep them solvent. In the USA, the current Trump government is planning on putting together a $2tn rescue package to aid businesses and households most affected. With interest rates at close to zero, the idea of printing staggering sums of money is a tempting one. As mentioned at the beginning of the article, since the 2008 financial crisis we have had a long period of low interest rates. And since the first shocks of the current crisis began to appear, both the Fed and Back of England reduced interest rates even further. As of now, the current Fed interest rate stands at 0% and the Back of England interest rate is 0.1%. With such rock bottom rates, the temptation to just keep printing money to infinity is very strong. As previous rounds of Quantitative Easing (QE) since the 2008 financial crisis have barely had an impact on triggering inflation, the current conventional wisdom is that even bigger rounds of money printing will also barely stoke inflation. Even the former head of the European Central Bank (ECB) Mario Draghi who back in 2012 vowed to do ‘whatever it takes’ to save the Euro, recently commented that interest rates will remain low for a very long time. Others also share this belief. But what if, out of nowhere, in the midst of all this money printing, a tsunami of inflation catches everybody off guard forcing central banks to abruptly increase interest rates to control it?
In gold and silver we trust
If you have read some of my other articles you will see that I have always been a big fan of precious metals. And this is especially true now in our current economic climate where uber-low interest rates and cheap money have been reigning supreme. A consequence of more than a decade of low interest rates has been that total levels of government, corporate and household debts have increased dramatically. To exacerbate an already fragile economic situation, the current crisis has triggered central banks of major economies to drop interest rates to zero. On top of this, humongous rescue packages are being created to aid affected households and businesses. Although this may create short term relief, it will further accelerate already staggering levels of global debt, which have already been allowed to get out of control for too long. Taking on debt is fine when interest rates are low, but what happens if all of a sudden interest rates increase? I say this, because as I previously mentioned, not many people are taking into account the very real threat of inflation, which may finally be awakened out of its slumber in a big way as a consequence of larger than normal levels of money printing. When interest rates increase to control this inflation, suddenly all this cheap money floating around will seize to be cheap and all this gigantic debt will become more expensive to service.
I can’t help but think that all this will be nothing but beneficial towards the prices of gold and silver. Over the last several months, gold has been slowly increasing in value. It recently hit $1,700 an ounce and is currently hovering in the $1,600s. In my view, I think any dips in the gold price should be taken advantage of. It is unavoidable that there will be dips in the gold price as households scramble to free up cash, but over the coming months and years I think gold will do very well.
I am equally keen on silver. It is less scarce than gold and is more sensitive to industrial demand, but compared to gold it is currently extremely under-priced. For many years the silver to gold ratio (SGR) oscillated between around 20 and 100, and it was an incredibly rare moment if it ever went above 100. Over the last two weeks, this ratio broke the 100 ceiling and spiked to over 125 at one point. As I type, the ratio is 112. A consequence of this further distancing between the gold and silver price has caused some to say that silver is done and has lost its appeal as a store of value. Yet I disagree strongly. If anything, I think this is an incredibly good buying opportunity to have exposure to silver as I can foresee it playing catch up to gold in an epic way.
By Nicholas Peart
29th March 2020
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