Q & A: BEATING THE ‘PANIC OF 2020’
17th March 2020
The S & P 500 index, currently trading at 2,386 is now down nearly 30% from the all-time high reached last month. Other world markets have fared even worse, with the FTSE 100 index at 5,073 (down 35%) and the ISEQ at 4,684 (down 36%). The EuroStoxx 50 index, at 2,425 has never surpassed its all-time high of 5,450 reached in March 2000, despite the 2003-2007 and 2009-2019 bull markets. Its recent peak was at 3,840 on 14th February 2020, so it is now down 37% in the ‘panic of 2020’.
Q: Are we at the bottom of the market?
A: It is near-impossible to call the bottom of a bear market. Beware that a lot of money is lost by ‘early bulls’ attempting to predict the bottom of the market. Many of these investors have seen their portfolios drop sharply in value, and are trying to recover these lost gains by buying in. That is often a recipe for disaster. It is better to wait until a sustainable recovery starts before investing new money in stocks.
How will you recognise a sustainable recovery? A very good indicator is the 150 day simple moving average. Wait for the S & P 500 index to rise above the 150 day simple moving average, and also for the 150 day to turn upwards. The market will be well off the bottom at that point, but this usually signals that a new bull market has begun. This will be highlighted in the ‘Overall Market Trend’ section on the free part of this website when it happens.
Remember that you don’t need to buy at the very bottom of the market to make money in stocks.
Q: I have a substantial portfolio of shares and the value has declined significantly. What should I do?
A: Reduce your exposure to the stockmarket by selling some or part of your holdings on each rally. The downward trend is usually interspersed with occasional rallies, and these are good days to do some selling. This will free up some cash to invest again when the market turns.
Q: How low can it go?
A: The S & P 500 index is currently finding some support at the December 2018 low around 2,400. If that level does not hold, then the next support level is at 2,000. That is approximately 15% below the current level. If that level breaks, then the next support level is at 1,500 (being the high of the 2003-2007 and the 1995- 2000 bull markets) which is 37% below the current level. Failure to find support at the 1,500 level would point to a fall all the way to the financial crash low of 666 of March 2009, which is 72% below the current level.
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These support levels are important because these were the levels that attracted significant buying from 'bargain hunting' investors during previous downturns. Alternatively, these levels were significant resistance levels in the past, and these often become support levels when the market falls.
CLICK HERE FOR CHART OF S & P 500 INDEX SHOWING MAJOR SUPPORT LEVELS
Q: What is the worse-case scenario?
A: The worst-case scenario is a prolonged 20 year bear market of the kind seen in Japan from 1991 to 2011, caused by deflation. Deflation is a consistent trend of falling prices. Hoarding cash is a profitable strategy for investors in a deflationary environment, as purchasing power increases when prices fall. Therefore, there is little incentive to invest in any type of asset (the principal ones being equities and property) in a deflationary environment.
While this looks unlikely, it is still a possibility. The losses caused by the virus, result in investors selling ‘good’ assets to pay for losses elsewhere and this has a multiplier effect. More importantly, investor appetite for risk changes dramatically and problems that were ignored for years (such as the ‘pensions time bomb’ etc) suddenly come to the fore.
Q: Should I move into ‘defensive’ stocks?
A: ‘Defensive’ stocks are those companies that supply essential services such as food, electricity and water. However, these stocks (eg Tesco. SSE & Severn Trent) have also fallen during the ‘panic of 2020’ (by 15%, 25% & 11% respectively). ‘Defensive’ stocks fall in a bear market – they merely fall less than the stocks of companies affected by more discretionary consumer spending. In the medium term, a recovery in these stocks can take place, if they are oversold, due to indiscriminate selling by investors.
Q: How can I make money in a bear market?
A: By ‘shorting the market’. The most practical way of doing this for private investors, is by means of a ‘Bear’ Exchange Traded Fund (ETF). A Bear ETF is designed to act as an inverse fund. This means that if the market index that you are tracking, falls, then the Bear ETF will rise by the same percentage. A Leveraged Bear ETF will multiply this inverse movement.
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The Wisdom Tree 3 x Daily Short Bear FTSE 100 ETF (epic code: 3UKS) on the London market is currently trading at £24.78. It is designed to move inversely by three times the daily movement of the FTSE 100 index. Therefore, on a day that the index falls, say, by 5%, it should rise by 15%.
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3UKS was trading at £10.07 when the index peaked on 19th February, so it has risen by 147% while the FTSE 100 has fallen by 30% in the same period.
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The reason why 3UKS has risen by almost 5 times the fall in the FTSE 100 index (instead of 3 times) is due to compounding. This is a daily short ETF, in common with almost all short ETFs, so the inverse movement is calculated on a daily basis.
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Therefore, if you get off to a good start and the FTSE 100 falls, say, 10% on the first day you are holding it, then you will gain 30%. Further gains or losses will then be based on this higher figure (which is rebased daily), hence the compounding factor.
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Conversely, if you get off to a bad start, and the FTSE rises 10% on day one, then an investment of £1,000 will fall to £700. The next day’s movement up or down, is applied to that lower figure of £700. Let’s say on day two the FTSE falls 9%, then that is calculated as 9% of £700, multiplied by 3, which amounds to a value of £889 for the ETF. The FTSE is back to where it started, buy you are down 11%. That is due to the compounding effect.
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Therefore, to avoid the risk of getting off to a bad start, a trader wishing to invest £10,000 in this type of investment, should invest £4,000 on a day the market rallies. Then wait, and invest a further £3,000 on the next rally, with a further £3,000 invested on the next up day after that.
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How low can the FTSE fall? It is currently finding support around the 5,000 level. However, if it breaks through that level, then the next support level is at 3,600 / 3,800 being the level it bottomed out at in 2009 and 2003.
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This type of investment is suitable for traders who wish to speculate on a further fall in the market. It may also be suitable for experienced investors seeking to ‘hedge’ the value of their portfolios in the short term.
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You will have to sign a complex instruments form, before your brokerage will allow you to invest in this type of ETF. In addition, you should read the ‘Key Information Document’, referred to as the ‘KID’ as your brokerage will ask you to confirm that you have read and understood this, before they act on your instructions to invest in same. You will find this by searching for:- 3UKS Key Information Document which will take you on to this document in Wisdom Tree’s website.