For the past few weeks J2 Capital started posting about the Coronavirus (Covid19) and it's potential impact on the economy. We continued to highlight the risks from the virus, but noticed that many were shrugging off the potential negative effects of the virus. This was a warning sign to us that the market would be at risk should the virus continue on it's trajectory. Most important in this equation are the protocols being enacted by world governments that could halt the global economies. The cure to stop it may be worse than the disease?
- Last week we decided to make our headline more bold and call it like we saw it. The title of our headline was "The Market is Taking Crazy Pills". We thought it was ridiculous the extent the market was ignoring the risk from the Cornoavirus as it was going to all-time highs.
- Here at J2 Capital we are risk managers. We attempt to understand risks and potential impacts of things others might not be thinking about.
- We prepared by reducing our equity exposures, raising cash, increasing gold, and even added an inverse ETF. At some point, it wasn't going to take much for the market to realize that this virus could have serious impact on supply chains and economic conditions as investors were leveraged too high in stocks.
What Led Up To This Sell-Off?
Greed, Complacency & (Market Bubble)
- Market complacency was as high as we have seen in the past decade. Speculation on companies like Tesla (TSLA) and Virgin Galactic (SPCE) have continued to add frothiness to a market already at all time times.
(Chart Courtesy of YCharts)
Hedge Funds Leveraged Up
- Hedge Funds we know were massively over-levered to the market due to low interest rates and fed liquidity.
(Chart Courtesy of JPM Prime Brokerage)
Free Trade Craze
- The same can be said to retail investors partially due to the free trading programs rolled out everywhere from Robinhood to TD Ameritrade.
(Chart Courtesy of The Market Ear)Overvalued Markets
- Markets have continued to trend in the upper percentile of valuations that we haven't seen since 2001.
- Growth at whatever cost has been the mentality as the value trade has under-performed but we may be reaching a point where these valuations actually matter.
(Chart Courtesy of Goldman Research)
Our Market Planning and Ideas For You
What did J2 do to Prepare:
J2 Capital is a dynamic risk manager for clients. We believe that people stand the best chance of success long term when volatility can be mitigated in times of high risk. We believe our philosophy compliments other strategies like longer term buy-and-hold.
- We started raising cash a few weeks back as the cornoavirus started. We believed it could have a negative effect on supply chains (policy responses), and with the valuations where they were (high) there was no room for error. We added to a gold ETF given its historic negative correlation to equities and also technical triggers that showed the potential next leg up in its uptrend.This has protected us a bit from this sell off as gold has rallied to new highs as fears of the Cornonavirus increased.
- We added an 2x Inverse Nasdaq ETF in our Dynamic Mid-Cap Growth strategy to help place a brake on any any potential losses due to volatility. That has now been closed out as of yesterday.
What is J2 doing now?
- We are monitoring the trend of the market and are prepared to take further action should certain levels of the market break to the downside. The risk of a recession, while low, is rising rapidly. Corporate earnings will be impaired but we have yet to model for how long. We fear that the recession risk will rise substantially should the U.S. start closing schools, shutting down corporate travel, and limiting social events. These things are being implemented in other countries currently.
- We are monitoring our long term market indicator for signs that the long term bull market is over and we have entered a bear market. Currently, our indicator has weakened but is not showing that we are at risk of a bear market (yet). It's harder to model just how much leverage may of been built into the equity markets the past few years, this is also a cause for concern, as more out sized down moves could occur.
Should I change my investment strategy or sell here?
- Don't Panic Sell!: Markets move quickly. The old adage that markets take the stairs up, and the elevator down are true. By the time you sell, it's possible you missed the down move and you will be selling right before it's ready to go up again.
- Re-balance! I suspect many have equity allocations that are too high! This is inevitable due to the strong market returns of the past few years. to equities after the bull market run of last year. We see many new clients come in that have equity allocations that are 10-20% above where they should be.
- Use different types of strategies: Consider allocating a portion of money to a manager that can manage risk and has the ability to lighten up in times of cash.
- Stop Chasing returns: Over the past year we have noticed many increasing their risk and chasing the riskiest stocks and sectors. This has always ended the same way. Euphoria feels good for a while but usually ends up with large losses. Most investors have come to believe that the Index funds such as the S&P 500 is a risk-free asset that always goes up.
What is important for me to know about Covid19?
- The mortality rate for the corona virus is very severe for people over 80 years old with a 14.8% mortality rate.
- Seems like the elderly are the most at risk and there is relatively lower risk for people under 50 years old.
Rate of Spread:
- R0 is a measurement used to calculate how contagious an infectious disease is.
- You can think of it as the reproduction number because when the infection spreads to new people, it reproduces itself
- From the image you can conclude that the cornoavirus has an R0 around 2 - 3.11 which is similar to other viruses such as Ebola, and the Norovirus and is more infectious than the seasonal flu.
- This puts the cornoavirus in the mid range among other infectious diseases but any R0 over 2 is considered very serious.
New Cases Excluding China.
- New infections have started to slow down in China but the spread to other regions is the main concern as pandemic fears continues to rise.
- The big jump in South Korea, Italy, and Iran are the main concern as testing is becoming more common more cases are being found everyday.
- U.S is a smaller portion of this spread so far but as more and more places are ramping up testing we'll see if the U.S. follows suits with new cases increasing significantly day over day.
How can I prepare?
Yes, obviously we are not medical experts and are not looking to pretend to be one. We offer some links and advice from trusted medical sources we think would be helpful for you to consider. We don't aim to be alarmist or cite fear, but proper preparation is essential. Likely, this virus is short term disruption, and yes, life will return back to normal shortly. In the meantime, here are some ideas you can discuss with your doctor.
Authorities may switch from a "containment" strategy to one of "mitigation" of limiting the spread of the virus through social distancing.
- CDC Director discusses need for potential social distancing - closing schools, travel, public events.
What are the things you can plan for? There are two categories:
- Reducing our risk of being infected
- Reducing the chance you will run out of essential foods and goods - lessons from China's quarantine.
Ian M. McKay writes the following on how to prepare for limiting transmission:
"These are things we can do to reduce our risk of SARS-CoV-2 infection".
- Stay at least 7 feet away from obviously sick people.
- We’re trying to avoid receiving a cough/sneeze in the face, shaking hands, or being in the range of droplet splatter and the “drop zone”
- Wash your hands for 20 seconds & more frequently than you do now
- Soap and water and then dry, or an alcohol-based hand rub, and air dry
- Try not to touch your face.
- There is a chance your unwashed fingers will have a virus on them and if you touch/rub your mouth, nose or eyes, you may introduce the virus and accidentally infect yourself. Practice this; get others to call you out when you forget. Make it a game.
Reducing our risk of running short of food and important goods – the 2-week list:
- Extra prescription medications, asthma relief inhalers
- Some of these may be a problem, so talk to your doctor soon.
- Over-the-counter anti-fever and pain medications
- paracetamol and ibuprofen can go a long way to making us feel less sick
- Feminine hygiene products
- Family pack of toilet paper
- In case food shortages limit the variety in your diet
- Alcohol-containing hand rub and soap
- Household cleaning agents
- Clorox Wipes,Bleach,Lysol floor cleaner, toilet cleaner, surface cleaning spray, laundry detergent - yes Clorox and Lysol works!
- Tissues, paper towel
- Disposable nappies
- Cereals, grains, beans, lentils, pasta
- Tinned food – fish, vegetables, fruit
- Oil, spices and flavours
- Dried fruit and nuts
- Ultra-heat treated or powdered milk
- Batteries for anything that needs batteries, powerbanks
- Think about elderly relative’s needs
- Their medications, pets, pandemic stash, plans for care (see later)
- Pet food and care
- Dry and tinned food, litter tray liners, medicines, anti-flea drops
- Soft drink or candy/chocolate for treats.