An Ill Wind

Peter Mallouk

WHAT IN THE WORLD is happening in the stock market? The short answer: Investors are spooked by a supply and demand conundrum. Markets react very negatively to a significant disruption of either.

After the Sept. 11, 2001, terrorist attacks, stock markets plummeted because of a disruption in demand. In the weeks and months that followed 9/11, factories, businesses and services remained open and operating all over the world. The issue wasn’t a lack of supply.

Rather, the problem was that everyone stayed cooped up in their homes, reluctant to go about doing things that make an economy hum, like buying stuff. Americans wondered if there would be other terrorist events, if the government could put measures in place to prevent them from happening and how long it would take to feel generally safe. Over time, people returned to normal life, demand resumed and stock markets recovered, moving on to new highs.

The 2008 and 2009 financial crisis was the opposite. We all know the story: The big banks were reckless with their own money and their investors’ money. Before it was over, the financial system became paralyzed because of a lack of supply. The lending world had frozen. No one could get or maintain a loan to do nearly anything. Without a supply of funds, businesses began to fail, contracting the supply of all sorts of things. At the same time, Americans felt less wealthy and were consumed by a healthy dose of fear. That combination resulted in Americans not wanting to buy anything until they felt secure.

When the market bottomed on March 9, 2009, the S&P 500 was down 57% from its high. In this case, the crisis was eventually resolved by the federal government backing up banks (taking care of the supply side) and giving consumers tax breaks, lowering the cost of borrowing and providing many other financial incentives to consumers. That, along with other measures, finally stabilized the system and incentivized individuals to spend money (taking care of the demand side). Sure enough, stock markets recovered, moving on to new highs.

The cause of today’s bear market is a combination of both a supply and demand shock. Much like 9/11, this is driven by fear about our personal safety and that of our fellow citizens. Normal financial incentives aren’t going to resolve this issue. Imagine if, after 9/11, a major terrorist event happened every single week, with no end in sight? Would you start going to the movies, out to dinner, to work and on vacation? No amount of tax breaks or financial incentives would likely get the average American to do that.

The situation is similar today. Some very smart health care officials think things will get worse, but likely get better in a month or two. Some very smart health care officials think the rate of contagion will double every few days, that it can’t be stopped with the measures we’re currently taking and that the mortality rate may be 1% or even higher. If the latter scenario unfolds, this is the equivalent of a new terrorist event every week, without an end in sight. In a nutshell, this is a health care crisis with serious financial side effects. To alleviate the stock market turmoil, investors need to believe the coronavirus is contained and that there’s a path to defeating it. This can happen in several ways:

  1. A vaccine is announced.
  2. A cure is announced.
  3. A treatment that can stem the effects is announced.
  4. We find out millions of people have it. Strangely, this would be incredibly reassuring, because it would mean that far more people were infected than first realized. This, in turn, would mean many who are infected don’t get sick, which obviously means a far smaller percentage of those who are infected are dying. If we find the mortality rate is 0.2, for example, the markets could react very positively.
  5. The virus runs its course quicker than expected.
  6. The virus is seasonal.
  7. All sorts of things not listed above that slow the spread of the coronavirus or indicate that it isn’t as deadly as feared.

Once stock markets see there’s a path to defeat the current trajectory of cases, they’ll also be buoyed by financial incentives, such as tax breaks, lower interest rates and so on. This is precisely why the U.S. market tanked after President Trump’s first address to the nation on the coronavirus. His address included largely financial solutions. Investors simply didn’t think financial incentives were going to work when the number of people infected and dying keeps doubling every few days.

It’s also precisely why the market reacted favorably when President Trump had his Friday press conference covering his action plan to contain and beat back the coronavirus. Investors believed the administration was focused on real actions to tackle the health care crisis, including a plan to test as many people as quickly as possible with a public and private partnership.

In other words, if investors see there’s a path to health, they’ll gladly welcome financial incentives that provide a path to restoring wealth.

In the meantime, expect wild market swings as we get new information, whether it points to a deepening health crisis or signals that we’ve turned a corner for the better. Some folks think this will soon pass, while others think millions will die. The market is taking every new piece of information and betting on who is right. Until we get conviction on one side of the argument, we will see more market turmoil.

This is going to be a tough paragraph to read, but it needs to be said. Let’s play out the worst-case scenario currently presented by some health care officials. Let’s assume the death toll is in line with some of the most frightening predictions. This would be horrible and every one of us would know someone who lost their life to this crisis. And as for the markets? Well, the other 326 million Americans, as well as people all over the world, will eventually do what every society has always done: go on with their lives. That is just the cold, hard reality. It’s how the human spirit works. And it’s ultimately what makes markets work. At some point, supply and demand reconvene.

What’s my position? I have no conviction that this will get better soon. I have no conviction that things will get substantially worse, either. But I am convinced that this will someday, somehow pass. And when it does, the markets will recover. There’s an opportunity here for the patient and the disciplined. Make sure you seize it.

Peter Mallouk is president and chief investment officer of Creative Planning in Overland Park, Kansas. Peter and HumbleDollar’s editor, Jonathan Clements, together host a monthly podcast. Follow Peter on Twitter @PeterMallouk.

Want to receive our weekly newsletter? Sign up now.

Browse Articles

Notify of
Inline Feedbacks
View all comments

Free Newsletter