Will COVID-19 cause a recession? 3 actions you must take for Singapore Investors!

 

Well, what a year it has been! And it’s only February!

Just over 1 month ago in early January everyone was talking about the reflation trade, how 2020 would be the year everything recovers from the US-China trade war.

And 1 month later, we’ve just had the quickest US market collapse since the great depression (all in 1 week!).

Which just goes to show you how quickly things can change in financial markets.

I’ve been getting lots of questions the past week, so I wanted to use this chance to address them. I’ve extracted some below to give you a flavor of what’s going on:

Hi Financial Horse, the US market share price is dropping this week. What is your view on it? Do you think it is just the beginning? How can we know when it is a good time to go in? Thank you!

And…

Dear Financial Horse,

If there is anything, related to how Singapore investors can learn from SARS and now having to deal with COVID-19; so as to make of the most of their investments.

What are the 3 actions they should take?

Thank you & warm regards,

XX

Now I really wanted to pen this piece to share my honest and uladulterated opinion here. No hiding behind qualifications, no double speak, and no pay “12 months subscription” to hear what I have to say bullshit. 

Many of you guys (and girls) are loyal readers who’ve been with this site from the start, and I truly, truly appreciate your support. I owe it to you guys to share my honest opinion in this trying times.

Whether you believe it, and what you choose to do with it, I leave it up to you entirely.

Please note though, that the charts and thoughts in this article are accurate as at 28 Feb 2020 (when I did the research for this piece). The situation on the ground is changing rapidly, so my views may change over time – as should yours.

Basics: What is the market pricing in?

The bond market is pricing in a recession. Simple as that.

Yield curve is inverted from the 1M all the way out to the 10Y, which safe to say, is not a good sign.

Just look at the chart below. Investors are pricing in rate cuts across the entire globe.

In the US alone, investors are pricing in 3 rate cuts this year (total of 75 bps). Eurozone looks particularly scary. Rates are at -0.55 and investors are pricing in further cuts. If that goes through, it’s going to wreck the European banks.

Commodities has absolutely collapsed across the board. What started as a China shutdown is quickly turning into a global shutdown, and traders are pricing accordingly.

WTI down 23% is going to cause credit issues for many high yield energy issues if this holds up.

Currencies are set out below. Global flight to safety has investors moving funds back to the US, creating a rip-roaring USD. This is not good, because a strengthening USD creates tightening financial conditions for the world.

Market sentiment has also swung from extreme greed in early Jan – to “World is ending – Sell Everything” style fear.

Will COVID-19 cause a recession / market crash?

In times like this, cooler heads prevail.

So let’s take a step back, and look at this bigger picture.

The big question that will determine how the rest of 2020 trades, is going to be this: How soon can COVID-19 be contained? Will it be (1) contained soon (3 months or less), or will this (2) drag into the second half of 2020?

If it’s going to be scenario (1), I would say this is a fantastic buying opportunity. If it’s going to be (2), then well, stocks have a long way to fall.

Will COVID-19 be contained within the next few months?

I’m not an epidemiologist, so this is just my lay view reasoning from base principles and my observations.

Lessons from China

When COVID-19 hit China in January, I was pretty confident that all this would get under control quick. The way I saw it, the moment China started closing cities on 23 Jan, it started the timer running on when COVID-19 would come under control.

It’s not rocket science right. With a 14 day incubation period, once everyone stays at home for 14 days or more, you’ll start to see a noticeable improvement in the situation.

And that’s exactly what we saw.

Once China closed cities on 23 Jan, we saw marked improvements in the situation by early Feb. In fact if you look at the China ex Hubei data (whether you believe it or not), you’ll find that it peaked on 3 February, which is 11 days after China started closing cities, and it’s been improving ever since.

So the lesson here, is that drastic, community wide measures such as shutting entire cities works. And the sooner you do it, the better the results. And once you do it, you start to see cases peaking about 1.5 weeks after.

Can the world do what it takes?

China has shown us how to control COVID-19. Heck China has even given us a complete playbook to tackling COVID-19.

The question though, is whether the rest of the world can do what it takes to control COVID-19? Shutting big cities entirely, forcing all residents to stay at home and not leave their houses, those are drastic measures. And the way that most governments are – they are reactionary. So they won’t preempt this by preemptively shutting cities. They’ll wait for signs of widespread community spread within the country, then they’ll start implementing drastic measures. By which time it may be later than desirable.

Multiply that across all the countries all over the world, and the picture looks bleak.

So while back in January I was pretty confident China would get this thing under control (which they have), I’m a lot more afraid now.

You can mock China and it’s central government system all you want, but they get stuff done. There’s nothing China does better than mobilizing it’s people towards a common cause, as we saw the past 4 weeks.

I just don’t see that happening with the rest of the world. I just don’t see global governments banding together and taking drastic measures on the same scale China has, with the same level of speed and efficacy.

Which means COVID-19 in the world (ex China), is going to get worse before it gets better.

Don’t get me wrong though. I think that without a doubt COVID-19 will come under control eventually. Mankind has a remarkable resilience and ability to bounce back from adversity, and I have no doubt in my mind that we will prevail.

The only question – is timing.

I think that the world is slowly waking up to the fact that COVID-19 is a global threat, and that it requires drastic measures to contain. I see moves such as Korea shutting Daegu, Japan closing schools, Italy shutting cities, CDC starting testing, as moves in the right direction. The quicker we progress down this path towards extreme control, the quicker COVID-19 gets under control.

Buy Signals

One of the questions above was on buy signals. When to start buying this COVID-19 dip / crash?

Personally I’ve never believed in technical analysis or charting, so I never use them. I know many of you guys have your own chart signal that you employ though. And my advice: If you believe in charts, and you know what you’re looking for, absolutely go for it.

For me, I’ll stick to basic principles here. I want to buy when global cases (world ex China) start to peak.

The China case study taught us that it’s incredibly hard to time the peak. When you’re on the peak, and you look back, it’s just a stretch of continuous increases. It’s human nature to extrapolate, so you just think that this will continue into the future.

What we learnt in China though, is that the buy signal can be linked to when drastic measures are being taken. So if you go back in time, and you start buying stocks 1 to 2 weeks after China started shutting school and cities, that would have been the perfect time.

If we apply that to the world, it would mean that when the entire world starts shutting schools and cities, it starts the clock running on the buy signal.

Unfortunately, that buy signal is not much help, because we all know that every country is not going to shut school and cities at the same time, neither are they going to coordinate their actions that closely, at this point in time. It requires an escalation in the severity of the situation before that happens.

But I’m sure most of you get where I’m going with this. The key here is going to be watching out for coordinated, global action to tackle COVID-19. The more drastic and coordinated the measures, the stronger the buy signal.

So read the news with an open mind. Leave aside price action from the market for a bit, and focus on the only thing that really matters – How quick can governments control COVID-19, so they can move on to the stimulus phase?

Impact of stimulus

Lots of questions on the impact of stimulus, so I also wanted to address it here.

The question with stimulus is always going to be whether the new money being injected, is sufficient to offset the money being removed (through drop in spending etc).

And the simple answer is that the stimulus packages we’ve seen so far, are but a drop in the ocean compared to the tsunami of an impact we’re going to see if COVID-19 goes global and stays that way for a month or two. The impact on global supply chains, reduced consumer spending, reduced business expenditure, it’s going to be absolutely massive, and we’ve seen nothing yet.

Stimulus will help, but it’s been too little so far.

What I suspect will happen though, is that we’ll see small easing – rate cuts, loan extensions, easy liquidity, things like that as governments battle COVID-19. When COVID-19 comes under control, then we’ll see massive fiscal and monetary stimulus packages being unleashed when people go back to work, and consumers resume spending.

Long story short, the economy will rebound, but only after COVID-19 comes under control. Until then, all the stimulus is going to be targeted at keeping businesses on life support, keeping them alive and rolling loans over until spending returns.

3 actions a Singapore Investor should take

One of the questions above was on the 3 actions that a Singapore investor should take.

Here are my 3:

1. Assess your asset allocation
2. Prepare a list of stocks to buy
3. Execute

1.Assess your asset allocation

I’m sounding like a broken record at this stage but I’m going to say it again. Asset Allocation is the most important thing when investing.

Asset Allocation is the amount you put in stocks v REITs v bonds v cash, and it determines by far the bulk of your investment returns.

Watch your asset allocation. It absolutely needs to match your risk appetite.

We talk about this in much greater detail in the FH Course (which is on promo now btw), so check it out if you’re interested.

Otherwise, relook your asset allocation, and ensure that it’s suitable for your risk appetite. If you’re having trouble sleeping at night, you’re probably taking on too much risk.

2.Prepare a list of stocks to buy

Whether to buy stocks or not really goes back to your asset allocation.

As stocks drop in value, the percentage of stocks in your portfolio is going to drop. To illustrate – Imagine you have $1 million, with $300,000 in stocks. That $300,000 drops in value to $250,000. To maintain your 30% allocation to stocks, you need to buy another $50,000. You may even decide to shift some money from cash/bonds into stocks. Which is exactly why asset allocation is so important btw – it decides your entire investment strategy.

For me personally, stocks/REITs make up about 35% of my net worth, and I have a big chunk allocated to gold and bonds (my full net worth break down is available here). Given my risk appetite, I’m technically underallocated to equities.

So yes, I’m going to use this opportunity to add to my equities position (and by opportunity, I mean COVID-19 as it plays out over the span of 2020 – not necessarily the next week).

And that starts by preparing a list of stocks to buy. I already prepared my list a few weeks back, but with the recent collapse in global markets (ex China), I absolutely need to refresh it. We shared some undervalued stock ideas a while back too, so you can also look at that for inspiration.

Rules for a warchest list in times like this? Focus on companies with:

• Sound balance sheet to outlast COVID-19
• Resilient business model that will rebound after COVID-19
• Cash flow – can’t stress this enough, cash flow is king. Look for companies with strong cash flow and not bullshit like revaluation gains

My personal stock watchlist is available here for those who are interested – I will be refreshing it further over the next few days.

3.Execute

And the final step – Execute.

There’s nothing that annoys me more than investors who plan and plan everything in their head, but never go on to execute. You know those guys who say that they’ll invest big in a market crash? And then the market crash comes and they keep thinking stocks will go even lower, so they never actually get around to buying?

Don’t be like that.

Once you come up with a game plan, you need to execute.

Nobody times the bottom perfectly, so don’t worry if you miss it. As long as you focus on sound companies that can outlast COVID-19, you’ll be fine.

Doesn’t matter if you buy in at a certain price and it drops another 10%. Nobody times the bottom remember?

If you have cash, just use the opportunity to average in if you believe in the company. If you don’t have cash, just sit tight and ride out the storm.

Closing Thoughts

And there you have it! My pure and unadulterated take on COVID-19.

It’s still early days, so no way of predicting with any degree of certainty whether this triggers a recession.

My advice: cooler heads prevail. Go back to basics here. Look at what really matters – the spread of COVID-19, and the response from governments.

When COVID-19 comes under control, governments will unleash fiscal and monetary stimulus. Life will go on. It’s not the end of the world.

Do take care of your health though. Health is truly wealth. Live to fight another day.

Share your comments below!

Note: FH Course Promotion ends on 1 March! If you’re thinking of using this market sell-off to add to your stock positions, why not take the time to learn about investing? Or if you’re quarantined at home with nothing to do… ???️‍♀️

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