7 comments on “The Coronavirus Stock Market Crash

  1. I think you’re looking too much at the average scenario, not the black swan events. Suppose there’s a 5% chance of >100M people dying of the coronavirus, which is what Metaculus is current predicting. Given that this epidemic is more likely to affect people in very interconnected areas, like the US and western Europe, this implies that something like 3% of the US’s population would die. In a scenario that would result in this, probably much of the population would be quarantined for months. Between the quarantine and the direct effects of the illness, this would almost certainly result in the US’s economy going into a recession. So, based on Metaculus’ predictions, there’s at least a 5% chance of a recession, and it is certainly higher than that since a recession could plausibly happen in many of the other scenarios. So say a 7.5% chance of a recession because of only the effects inside the US.

    Now combine that with supply chain failure and other effects internationally, getting you (say) another 7.5% chance of a recession, and saying that a recession implies a 50% drop in stock prices (what happened in 2000 and 2008), this gets a suggested 7.5% drop in share price. Add in a 2.5% drop for a slight overpricing and a 2.5% drop for non-recession scenarios and the effects that have already happened, and you’re at the S&P being down 12.5%, where it is now. Of course this math has a lot of fudge factors and I wouldn’t want to use this as a predicting model, but this suggests that this valuation isn’t too implausible, and even lower numbers would also be plausible.

  2. gt, I think I have a fairly different view than you do about what causes recessions. I also think Metaculus overestimates the probability of a large death toll.

    I don’t see a 2 or 3 month quarantine causing a recession in the normal meaning of recession. I’m more than 90% confident that the virus won’t be impeding economic activity 3 months from now. By June, I expect there to be no obvious obstacles to economic activity returning to pre-virus levels, and likely some reasons for extra activity to make up for what didn’t happen between now and then.

    A stereotypical recession pretty much requires monetary problems (roughly speaking, inflation being too low), and I don’t see a good argument for natural disasters causing monetary problems that last more than a few months. The TIPS spread implies that the market is somewhat concerned with a sudden decline in inflation, but so far it shows less concern than the concern that showed last summer.

    It generally takes a recession with effects at least as long-lasting as those of 2008 to produce a 50% decline in the market, and 50% declines are usually over-reactions even then.

    There is a market on the odds of a 2020 recession that looks somewhat consistent with your position. But I’m saying that, if that particular market is right, it’s still unlikely that the magnitude of the recession would justify a 50% market decline.

    P.S. I forgot to mention in the original post that I bought stock in World Fuel Services Corp on Friday.

  3. Hindsight says that a great way to have made money off the virus would have been to buy stock in Alpha Pro Tech, Ltd. (symbol APT), whose products include face masks and disposable protective apparel.

  4. Ugh, that was embarassingly premature. The market has really overreacted now.

    A good deal of Thursday’s selling was due to margin calls, with not enough liquidity to handle them sensibly.

    Here’s some perspective on U.S. stock market reactions to bad news (of nonfinancial origins):

    – 1918 Spanish Flu: -10% in slightly over 5 weeks?
    – 1940 Fall of France: -25% in slightly over 2 weeks
    – 1942 Pearl Harbor: -11% in slightly over 3 weeks
    – 2001 9/11: -12% in less than 2 weeks
    – 2020 COVID-19: -26% in 3 weeks (so far?)

    These numbers are based on closing values for the S&P500 (for 1918: the DJIA), from the day before the obvious start of the crash, to an obvious low point where it stabilized. Note that the reaction to the 1918 flu is confusing, maybe because WW1 ended just as the biggest wave of the flu ended. The big increase in death rates in New York started around October 1, and peaked in late October. Yet the DJIA was higher in late October than on October 1. I’ve calculated the decline from the October 18 peak to the November 25 low, but I don’t think it took that long to finish reacting to the flu.

    My intuition is that COVID-19 will cause no more harm than 9/11 or the 1918 flu. Why does the market act like this is slightly worse news than the Nazi occupation of France? It’s not due to problems that are specific to the U.S. – many European markets are doing worse.

    Yet the Shanghai Composite is down less than 8% from it’s January high, and is above its early February low.

    Hong Kong’s Hang Seng Index didn’t decline much until this week, when it dropped 10%, roughly in synchrony with the U.S. markets. I was selling some Hong Kong stocks, to help raise cash to buy U.S. stocks that looked like they’d dropped due to margin calls. I presume some of the Hang Seng’s decline was due to a number of investors doing something similar.

    Maybe the U.S. and European markets had reflected a much safer world than anyone at the time of prior disasters had expected?

    Also, OPEC seems to be collapsing, which should be good news for most countries. Yet the markets are not indicating that.

    U.S. GDP could easily be down 20% in March and April, so it’s likely to fit some definitions of a recession, but I expect near-normal levels of GDP to resume by June.

  5. Looking at historical P/E ratios of various companies suggests that the market wasn’t just in “a bit” of a bubble but severely overvalued. I don’t think that stock prices reflected value accurately when including risk, it doesn’t make sense to me that company valuation of large companies grows indefinitely as it has in the past years.

    Knock-on effects from the virus (it won’t just kill 3% of people overnight, many more will be sick, etc…) and measures designed to stop the outbreak have their own knock-on effects – if everyone stopped working for even just a single day the disruption propagates so you end up losing more than 1/365th of a year’s work.

    On top of this we have panic (less demand) and the supply shock from the oil markets (affects US oil producers, with knock-on effects to large US banks). At this point we aren’t even including increase in more macroscopic risks (such as a Sanders presidency) that the markets would be afraid of.

    It’s also completely unrealistic for this to pass by June.

  6. Matty,
    High P/E stocks such as Salesforce have been doing slightly better than the market, which makes me a bit suspiscous of the guess that we’re seeing effects of overvaluation.

    We’ve got a beneficial shock from the collapse of OPEC.

    Near-normal levels of GDP does not imply this will pass. I’m thinking of something closer to the effect of war on an economy.

  7. I overlooked one relevant market decline, that happened in 1957. My study of financial history had left me with the impression that it had fairly typical financial causes, and that still looks like a plausible story. Yet it also coincides well enough with the Asian flu that it seems quite possible that it was primarily a reaction to the flu. That flu is thought to have killed 70,000 in the U.S., which is similar to what I’m guessing COVID-19 will do.

    The S&P 500 declined 21% over a period of 14 weeks, ending right around when the main wave of the flu peaked.

    (H/T Tyler Cowen).

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