• Samuel Zavaletta

Fast and Furious

The current stock market correction is now in danger of morphing into a self-fulfilling spiral, pushing us into recession. From the peak on 02/19/2020 through the close on 03/16/2020, the SPY ETF has returned -29.11% in just 26 days. Rarely has the stock market corrected in such a "fast and furious" manner:

In order to explain such eccentric price movements, market pundits often like to point out that people are irrational. They might make it seem as if "Mom and Pop" got scared and ran for the door...However, the overwhelming majority of US stock market capitalization is controlled by professional investors. These professional investors are not in the business of losing money, yet many trillions have been lost in a matter of days. "Mom and Pop" are not to blame for this frenzy.

The plain and simple truth is that Wall Street is scared of the implications of the coronavirus (and the policy responses to it). Their fears are justified.

Unlike pure financial crises - which are ultimately crises of confidence - there is a definitive corporeal element to the economic stress being caused by this coronavirus outbreak. That is to say, in order to halt the spread of the virus, people and places must be quarantined. Quarantine means that people are not going out and spending money as they would otherwise. Why should this be a concern? Well, supply chains are no longer local, domestic affairs. The global economy is more interconnected than ever:

The benefit of this is interconnectivity is that we can access goods and services like never before. However, just like a physical chain, even one weak link can sabotage the entire process.

The imminent danger presenting itself to us - and I believe the danger that Wall Street has finally awoken to - is that the velocity of money in the global economy will plummet as a result of the various quarantine efforts. With debt balances high by historic standards and with the world already grappling with a slowdown in economic growth, there is a very real possibility that the diminished flow of funds through the economy could induce a new cycle of corporate defaults. Corporate bond markets are already flashing serious warning signs:

At minimum, the coronavirus is an economic "reorganization" event. Many debt-heavy companies such as airlines, cruise ships, and restaurants will suffer because of the diminished flow of funds. This will be especially true of those low-margin, high consumer turnover businesses (such as the three above). Stockholders in such companies might be wiped out by the losses. However, if government is able to step in with pronounced fiscal actions, we might still be able to ward off a deep and/or prolonged recession. Our polarizing political environment, however, does not give me much hope in that regard.

Although I am preparing myself and my strategies for the rebound - especially in the event that the government gets its act together - I do not believe we have "found the floor" to this correction. Although stocks have sold off precipitously and treasuries have rallied with great strength (despite liquidity problems), corporate bonds have not bled to the extent they should in order to confirm maximum pessimism. I would say we are very much in a middle point, at a fork in the road, where two different paths are possible:

If governments step in with concerted and unified action to stem the spread of this virus and support beleaguered industries, I think we have a chance of avoiding a further precipitous drop in to a sharply discounted valuation range (between a PE of 11 and 15). As I mentioned previously, however, I am not convinced this will transpire. Repeatedly I have witnessed policymakers delay hard choices (such as mandatory quarantines) in order to try and preserve the economy. Unfortunately, such delays might ultimately result in greater damage to the economy.

It is time for careful consideration.

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