Hello 2018.
Yes, 2018, not 2008. The drop has been sharper, but it feels the same. Computers panicked! This drop has been caused by panicked computers, not humans. Between 60 and 70 percent of all stock trades on normal days are made by computers. They can read the news in a fraction-of-a-second, and they have a list of rules on what is good news and what is bad. When the news falls into “bad” parameters, the computers sell. They don’t just sell once, but many times, and they make money on fractions-of-a-dollar, and then cover their sales a short time later – wash, rinse, repeat.
The algorithms are not built to deal with a pandemic. They are built to deal with drops in oil prices. The computers read the news about the decrease in the travel and hospitality industries due to the coronavirus. The computers read the news about the disruption of supply chains, about factories shut down in China, read about the financial news. When the news is this tense, it would normally mean a recession, and the computers panic.
When the worldwide economy slows, demand for oil drops off and oil prices usually fall. But something different happened over the weekend. Last Friday, there was an OPEC meeting intended for member countries to reduce oil output in order to maintain oil prices. Vladimir Putin refused to reduce production. Over the weekend, partially in response to Putin, Saudi Arabia dropped the price of oil to $10 per barrel.
At $10 per barrel, Saudi Arabia is still making money. Their price of production is $6 to $8. By contrast, in order for US fracking operations to break-even, oil must be at $25 per barrel; Russia’s price of production is the most expensive in the world at $42 to $44. This move by the Saudis seems intended to hurt Russia and the United States. A major portion of Russian government revenues is raised with oil sales.
If the price holds at $10, it will mean a number of oil-adjacent companies in the United States will end up in bankruptcy. But it will also be a big boost for airline and travel profitability, as well as a large swath of manufacturers. This will also benefit American working families, a huge boost for the economy.
But the computer algorithms are not built to understand potential positives. So, when the computers panic and sell as they did Monday, they trigger even more selling from margin accounts, which have margin calls. When there is selling, the talking heads begin to hypothesize why. Paul Samuelson, who wrote the popular textbook Economics, began a chapter saying this: “The stock market has correctly predicted nine of the last five recessions.” In other words, a downdraft in the stock market may or may not predict a recession, but that will not stop a number of “gurus” from predicting a recession. The media will pick that up and reinforce it.
I am most reminded of December 2018. In September 2018, the S&P 500 TR was up 15% for the year. The news that came out seemed “bad”: the yield curve was inverted, the Democrats had taken a majority in the House of Representatives, the Federal Reserve was raising interest rates, worldwide growth seemed to be slowing, China’s growth was slowing, US GDP growth was projected to slow, and on and on.
I followed the charts on the market, and each time as news was released it seemed the computers would sell and all the gains from the first nine months of 2018 were more than wiped out, with the S&P 500TR ending down 4.5% for the year.
When the negative forecasts did not materialize, the markets recovered in the first three to four months of 2019. On December 24, 2018 the DOW sold off 653 points. 36 hours later, on December 26, when things normalized, the DOW jumped up 1,080 points. Both of those days were among the biggest drops and gains in the history of the market. I believe it was computers on both days.
On February 27, 2020 the DOW dropped 1,191 points, the biggest down day in history – until Monday. On Monday, March 2, 2020 the DOW rebounded up 1,290, the biggest up day in history. I just cannot believe that human beings change their minds that quickly. It is computers that are panic-selling, then quickly buying again the next day.
I believe that history does not repeat, but it rhymes. There is history: the markets sold off during previous pandemics: Ebola in 2014, SARS in 2003, Swine Flu in 2009. In each and every case, the markets recovered and went to new highs within three months. We are beginning to see a decline of COVID-19 cases in China and factories are already being reopened.
On Monday, I flew to Phoenix for an investment conference. Last week, I understand, SeaTac Airport was empty and no one was flying. Today, the airport is running at 50% to 70% capacity. It feels like we are returning to normal.
My advice: Don’t panic. A big drop in oil prices should be very good for most industries in America and in the world.
