How Long Will the COVID-19 Response Impact the Economy?

COVID-19 pandemic and its public policy response have caused a massive drop in economic activity. It's a given that Q1 and Q2 GDP numbers will be negative worldwide, but what can we expect going forward?

One way to look a the future is to check how China is doing to far since they were the first impacted and based on data coming from the government managed to contain SARS-CoV-2 virus by the end of February 2020.

COVID-19 Cases in China

This was achieved thanks to draconian lockdown measures, including locking persons suspected to be infected into their home. Shanghai stock market did drop by around 10 percent during Chinese New Year but quickly recovered, until it become clear COVID-19 would have a serious impact all around the world.

The PMI dropped sharply in February to 35.70 points, but we still have to wait longer to know the extent of the rebound in March and April.

Many businesses have re-opened, and while Hubei province has recently re-opened its borders (March 28), neighboring provinces are still wary of letting people travel. We also have contact in China, that non-essential business (e.g. entertainment) will not re-open until the end of April, and that's in Liaoning far from the epicenter in Wuhan. So in China, it's quite possible the local economy returns to normal in May. It would have been 4 full months since the beginning of the spread of the disease. However, China's GDP will certainly be impacted by the drop of activity in the rest of the world that is around 1.5 months behind in terms of cases.

My best-case scenario where the virus is contained around the world as fast as it was in China is that activity returns to "normal", yet somewhat lower levels, in July 2020. That would mean a sharply higher quarter-on-quarter Q3 GDP (worldwide), but still fairly lower year-on-year.

This assumes somehow few businesses and consumers bankruptcies, not currency crisis following helicopter money from central banks, or any other major financial issues related to the COVID-19 shutdown. How likely is that I'm not so sure, but this was the view of Goldman Sachs around a week ago with a 24% GDP drop in Q2 in the US, followed by +10% in Q3, and +8% in Q4 with the full year down 3.8%.

That would be a short recession, but considering how the US stock market was extended in February 2020 (and still is), problems are likely to linger much longer in the US, and many other countries.

Viruses are also interesting creatures, and earlier this month, we tried to look at the 1918-1919 Spanish flu to understand the economic and market impact of the novel Coronavirus, and we posted this chart representing the numbers of death per 100,000 in the UK at the time.

Viruses come in waves. It started in June-July 1918, then dropped until around early October, before coming back with a vengeance until the end of December with a small retrieve in January, before the last wave topping in in March 1919 before ending at the end of May 1919.

If this pattern occurred again that would be mean on and off lockdowns over a 10+ month period in each country, meaning nearly 12 months of lower economic activity worldwide, and the greatest depression we've ever seen. I have no clear idea what the world would look like in that case but there would be a low economic activity, out of control money printing, resulting in inflation down the road especially if they keep giving money directly to citizens also called MMT (Modern Monetary Theory) leading to the inflationary depression touted by Peter Schiff, at least in the US and the western world.

How will it exactly pan out? We just don't know, nor does anybody and only time will tell, but everybody should be aware of the risks and prepare at best as they can.

2020: The Great Depression of 1929 All Over Again?

Following the governments' responses to the threat posed by COVID-19, stock markets around the world have collapsed rapidly and entered bear markets. How does the 3-week drop compare to historical events in 1929 and 1987? Here's how

Source: ZeroHedge

As of March 20, the drop is faster and deeper than for the first 40 days of the crash of 1929, and faster, but not quite as bad (yet) that the crash of 1987. The October 1987 crash was a one-time event that did not affect the economy that much, but analysts expect some serious repercussions in the real economy with expectations of a 24% GDP contraction in the US and up to 12% worldwide in Q2 2020,

That's worse than the great depression, so we may expect similar results, especially we also started with an overvalued stock market. There's one important difference though: the policy response is now much different with central banks and government throwing money around like there's no tomorrow. This will likely not prevent deflation in the short term, but a long period of deflation is unlikely. With that out of the way, let's have a look at the chart of the Dow Jones index during 1929 and 1932 courtesy of MacroTrends.

I've marked the tops and bottom with respectively green and red dots. Bear in mind, this is a monthly chart so the data represents the end of month value, not the absolute tops or bottoms. The Dow Jones topped at 5686.69 in August 1929 before falling to 3572.79 points in November 1929, or a 37% drop in 3 months. It was followed by a bear market rally that topped at 4379.05 in March 1930, a 22.5% increase. Then the market "slowly" collapsed to 814.82 over the course of 2 years a massive collapse of around 82%. If counted from the top of 1929, the stock market dropped by 85.6%.

While I don't believe the exact same scenario will happen, let's see how low the Dow Jones would have to fall to match the same pattern as in 1929.

The Dow Jones reached a top of 29,551.42 in February 2020. A 37% drop over three months would mean a Dow Jones valued at around 18,600 in May 2020. We are almost there though after a little over three weeks with 19,173.98 points. So we may not have to wait that long for a dead cat bounce. With a percentage gain of 22.5% that would bring us to around 22,800 points in the next three to four months or May/June considering a rebound starting as early as March. Under our scenario, it may stay at this level for a while, and then for whatever reason (second wave of COVID-19?) collapse to depression levels by May/June 2022: That would be 4,104 points, even lower than the market low of 6,469.95 reached on March 6, 2009. Put it that way it does not seem as impossible. Is it likely? Maybe not, as it would mean all that money created out of thin air would go in other assets than the stock market. Charles Nenner has been forecasting a market bottom at 5,000 points based on his work on cycles so it's not so far off.

So I've created a virtual chart of the Dow Jones with the data points above, and a slightly compressed schedule with the bottoming occurring in December 2021.

Dow Jones Simulation - Jan 2020 - Dec 2021

 It's not a prediction, just a simulation of what the next two years would look like if the Global Great Depression of 2020 had indeed started, and would take a path similar to the great depression of 1929. Hopefully, it's all wrong. Note that during market bottoms, the Gold price historically happens to match the Dow Jones price, so it would be at over $4,000 per ounce in our scenario.

Overvalued Markets (March 2020) - Top 10 Countries

Last week we wrote about the top 10 undervalued stock markets using data from StarCapital AG. Data is up-to-date as of February 28th, 2020, and markets went through interesting gyrations in the last two weeks, to say the least.

But let's go ahead anyway with a list of the top 10 overvalued markets based on metrics such as CAPE (Cost Adjusted Price Earning Ratio), average dividend yield, price-to-book ratio, and price-to-sales-ratio.

Here's the list of the top ten most undervalued markets as of March 2020.

Indonesia was the most expensive at the time, followed by the United States, India, New Zealand, Denmark, as well as Australia, Brazil, the Netherlands, Belgium, South Africa, and Switzerland. Most have experienced a sharp 20 to 30% drop in the last two weeks, Let's have a look at the 10-year charts of the largest markets, namely the United States, India, and Australia, using Trading Economics as the source.

The S&P 500 has a CAPE of around 28 before the drop. It went down as low as 2,400 points this week but ended the week at 2,711 points. Even with the drop of around 20%, the CAPE is still well over 20 historically speaking is considering to be overvalued for the US market. To get into undervalued territories, we'd have to go with a CAPE of under 10 which means the S&P 500 under 1,000 points at current levels. Note earnings are likely to sharply drop in the next quarters due to the reaction to the coronavirus outbreak.

 Another way to look at the long term valuation of the stock market is to check the valuation against the GDP. The Whilshire 5000 to GDP ratio (source: longtermtrends) is around 1.2 right now well above the historical average of ~0.8. If we ever went back to the ratio reached in 2009, the S&P 500 would be around 1,200 points.

Moving to India's stock market with the 10-year chart of the SENSEX shows the recent drop in perspective with the market still doubling since the lows in 2012. If we look at the 2008 lows when the SENSEX was at around 9,000 it nearly quadrupled in 12 years. If earnings grow at that pace that's not an issue, but the rise was also due to an expansion to the price-earning ratio which led to the overvaluation of the market.

The Australia S&P/ASX 200 stock market index does not look as extended as the other two. The CAPE was 18.7 at the end of February, and the sharp drop have brought it down just under 15. We don't have historical information about the Australian CAPE, but it's clearly not in undervaluation territories. Another measure to look at is the PB (Price-to-Book) ratio which was at 2.0, and undervalued markets are often around or even under 1. 

It normally takes one to two years for a bear market to bring valuations to fair value or undervalued, and Charles Nenner, a market cycles specialist, expects markets to bottom out at the end of 2021. Note that shorting stocks may be very risky due to the central bank involvement in markets (if they print enough, stocks will go higher no matter what), and purchasing bear ETFs often have very high associated costs.

Despite globalization, not all markets move in unison and some of the undervalued markets we pointed out last week start to have interesting valuation although it may pay to be patient. I'd see further weakness in Russia, Singapore, Austria, and South Korea as a potential buying opportunity once the situation with the Coronavirus become a little more clear.

Undervalued Markets in March 2020 - Top 10 Countries

Value and contrarian investors will always look for undervalued and unloved markets or stocks, and one tool I like to use to find out which market may be worth looking into is Starcapital stock market valuation that ranks different countries based on their CAPE (Cost Adjusted Price Earning Ratio), average dividend yield, price-to-book ratio, and price-to-sales-ratio. They also show RS26 (26-weeks relative strength) and RS52 ratio to show which markets were oversold or overbought in respectively the last 6 months and the last year.

This is what the map looks like on February 28, 2020 with countries in blue being undervalued, and the ones in red being overvalued using CAPE as reference.

Russia, Turkey, Poland, Oman looks to be quite undervalued using this metric, while the US, Ireland, Switzerland, New Zeland, and Finland are overvalued.

Here's the top ten list of the most undervalued markets as of March 2020.

That's Russia, China, Italy, Spain, Singapore, Turkey, Austria, South Korea, Portugal, and Hungary.

Starcapital does not use the CAPE as the only metric to rank to the country with average PC (Price-to-cashflow), PB (Price-to-book), and PS (Price-to-sales) ratios. To find out if the CAPE is undervalued, one needs to look at the long term ratio for each country, and the ratio can not be compared between countries because each stock market has different types of companies. For example, Russia will have a large share of companies related to the oil business which command a lower price-earning ratio. Sadly, the company does not provide its historical data, so I'll just trust its color scheme for that part.

If the price-to-book ratio is lower than one, that means the stock price is cheaper than the book value, and it's always a good metric to check you don't overpay for a stock or market. If the dividend yield is fairly high, that's often a sign, stocks are undervalued as well.

I view the relative strength index more as a timing tool, as it shows whether the stocks for a given country were sold or bought during the time period. Starcapital allows to filter results as well, and I often set PB to one or lower, and RS26 to a value under one (e.g. 0.94).

That leaves us with 5 countries: Russia, Singapore, Austria, South Korea, and Poland. The next step is to look at mid-term charts (e.g. 10 years) to see how stocks performed. I like to use trading economics.

The Russian stock market did very well in the last 6 years, and we did buy a Russian ETF (3027.HK) in 2014-2015, and sold in October/November 2019. It went up further since then, but a correction happened due to the Coronavirus panic. If the market corrects further it could be a nice entry point.

The Singapore stock market (STI) has been trading in the 2600-3500 range in the last ten years, so if it goes back to 2700 points it may be an interesting entry point. Looking at an even longer-term chart, we can see the market performed fairly well since 2002, but as a smaller country, it may suffer more in downturns.

Next up is the Austria stock market (ATX), which we can see went down for over 2 years.

Looking at the chart since 2001, we can see the ATX never covered in a big way from the GFC (Global Financial Crisis) in 2008.

It's almost 50% below its all-time high in 2017..., and if we look at the long term bottom trend we could go a line showing there may be opportunities right now. I still feel uneasy investing in Europe due to structural issues with the Euros though.

The 10-year chart of the KOSPI (South Korean stock market) shows the index did not return much over the last ten years, and long term bull markets are often born from a long bottoming process.

To balance that, the KOSPI did really well in the first decade of this century, quadrupling from 500 points to over 200 points in 2007, but 13 years later we are still at the same point. It's been a long wait for investors who are still getting a 2.3% dividend yield at this time.

Let's finish with the Polish stock market (WIG). The last two years have been brutal which should explain why it's now considered an undervalued stock market.

It seems to be at the bottom of the trends (using a line passing through 2012 and 2016 bottoms), but the 20-year chart shows again the great performance of emerging markets in the 2000's.

Yet the WIG is still well below its all-time high in 2017. All those five markets look interesting, in the short term are likely to be affected by the impact of the Coronavirus outbreak, the policy decisions of central banks and government around the world, and potentially the health of the US stock market which looks to be extended at this time, but we'll look into the later in a subsequent post

What did the US Stock market look like during the Spanish Flu?

Stock markets sold off heavily this week due to the fear of the impact of the Coronavirus pandemic on economies, as more and more people stay home, and supply chains are disrupted.

If we look at the S&P 500 over a 3-month period the drop is dramatic.

That's an 11.5% decline in just one week. Look at a chart over a longer period, puts the decline into context.

You can see the 5-year chart for the S&P 500 above. A sharp decline, but nothing too bad, and it could just be a correction. The coronavirus, and associated CODIV-19 disease, is still nothing like the Spanish Flu that infected 500 million people between January 1918 – December 1920 and killed 50 million or about 10% of patients. Hopefully, it won't get that bad, since the virus is highly infectious, there's a chance it gets out of control with millions infected, and the medical system unable to cope.

So I'd like to take us to the past to see how the market behaves during the Spanish flu. Market valuation matters over the long team, so let's check Shiller CAPE chart first.

WWI was still going in early 1918, and markets were already depressed with a CAPE of 6.64 in January 1918, which went all the way down to 4.78 in December 1920, the lowest ever. In the meantime, we are now at much more elevated levels with a CAPE of 30 equivalent to the one at the top of the roaring '20s. So if it does get out of control - which hopefully it won't - we should expect a much sharper drop.

I wanted to check the S&P 500 chart in 2018-2020, but since it was created in 1957, we'll revert to the much older Dow Jones.

That's a drop from 1470.47 points to 956.72 points, or around a 35% drop. It's probably not purely related to the Spanish Flu, and one would have to look at the history of the time, notably, the end of WWI in November 2018 which may help the jump to 1600+ points before the sharp drop.

One way to check the effect of the Spanish Flu is to see if we have a chart of cases, especially in the US since after all, we are looking at the Dow Jones here. Most info is shown on Wikipedia. The first chart is in the UK which shows three waves.

 

The worst happened in November 1918, and nothing is shown in 1920 at all, so there must have been few cases during that year.

The chart above also shows fatalities in big cities in the USA (New York), as well as in France, the UK, and Germany with all peaking in October-November 1918. If we look at the Dow Jones nothing much happened market-wise during that period, and an article on Seeking Alpha and the related chart shows it clearly.

Source: Seeking Alpha

As we've seen above, markets were already very cheap at the time, and the market situation today is much different with several stock markets clearly overvalued around the world, and globalization was not a thing in 1918-1920.