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Monday, 16 March 2020

Panic in the market?

Looks like today's 8% plunge in the Australian stock market has started to spook 'the market' itself, rather than just individual investors. ASIC has asked 'large equity market participants' to reduce their executed trades volume by up to 25% to avoid 'disruption to market services'. UniSuper has suspending its lending to the short selling market ('any stock currently lent out to short sellers will be returned within two days') and the South Korean financial regulator has banned short selling of listed shares on its market for six months...

It is often the case that when stock markets suffer a rapid decline 'short sellers' are blamed for much of the decline. But, in reality, short selling only occurs when investors expect the market to drop further (after all, they will lose money - LOTS of money - if the market goes up after they short-sell), so short-selling simply adds to market liquidity and makes the market decline to its new 'equilibrium' level as quickly as possible. By banning or restricting short-selling, market regulators and large participants can only slow the rate of decline, not avoid it completely. While it may reduce the amount of 'overshoot' that occurs at the bottom of the sell-off, it generally isn't an effective means to prop up falling share markets. Indeed it may just slow the decline enough to allow large, professional investors to reduce their exposure, while 'mum and dad' (small, retail) investors are gulled into believing the market sell-off it abating, and leave them 'holding the bag' if they end up buying the stocks that the professionals are quietly dumping.

Similarly many institutional investors/fund managers are trotting out the usual 'stay the course' mantra in the face of a rapid market decline (that may continue for an extended period). This may be largely motivated by the fact that they have restricted flexibility to reduce market exposure (due to their investment 'mandate' or asset ranges documented in their PDS's), so they have a vested interest in encouraging small investors to not sell their share holdings, so that their own portfolio losses are minimized.

While 'stay the course' and 'time in the market, not timing the market' and generally sound investment advice, if there is a paradigm shift in the global economy that may dampen global growth for an extended period, it may be sensible to reduce market exposure until the worst has passed.

A look at how the stock market reacted to Spanish Flu pandemic and its aftermath suggests that once the scope of the pandemic start to decline the stock market recovery may be quite rapid. So it may be a good time to invest in the market in 3-6 months time (if the market is significantly lower at that time, and the rates of reported cases and deaths has started to decline). One difficulty with determining when the peak of the pandemic has passed will be the likely inability for testing to keep pace with demand at the peak rate of community spread. So case rate figures are likely to be progressively under-reporting the true infection rate (which might make the fatality rate appear to be increasing when it really isn't). The death rate seems to correlate with the true case rate, but with a lag of about two weeks for any inflection points (this was apparent in the Chinese case numbers and fatalities during Feb/Mar when they managed to restrict the rate of community spread), and it will probably be possible to fairly accurately track death rates even at the peak of the pandemic. So keeping an eye on the daily WHO Sitreps reported deaths might provide a suitable indicator for when 'the worst is over' and it might be time to look at investing close to the bottom of the market cycle...

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