This Article is for Educational Purposes Only.
This is an excerpt of a recent Wanderer Financial weekly stock market newsletter. The information provided in this article should not be used as the sole basis for making any trading decisions. It is not meant to provide actionable information or current analysis.
World Health Organization Director-General Tedros Adhanom Ghebreyesus is worried. He said the rest of the world — not China — is now "our greatest concern" when it comes to the coronavirus pandemic. We have reached a point where the number of new coronavirus cases reported outside of China is greater than those within China.
In just 24 hours, seven new countries have reported cases for the first time. Tedros encouraged each country to act now to prevent the virus from spreading. A new disease can wreak havoc wherever it goes. With world travel as easy as it is today, the coronavirus pandemic can spread much easier than past pandemics.
In the early 20th century, the medical profession knew enough about influenza to know it could reach pandemic proportions, yet, despite the knowledge, they were largely powerless to stop it.
In 1918, the flu hit with a particular vengeance. It killed more people in absolute numbers than any other disease outbreak in history. No one knows for sure, but the death toll has been estimated as high as 100 million. In today’s numbers, a comparable toll would be up to 350 million. By comparison, AIDS has killed approximately 24 million people, with an estimated 40 million more people infected with the virus.
While it's important that we take this illness seriously, with a mortality rate of about 2%, today's virus is relatively mild compared to 1918. A letter from a physician at one U.S. army camp to a colleague puts a more human face on the numbers back then.
“These men start with what appears to be an ordinary attack of LaGrippe or Influenza, and when brought to the hospital they very rapidly develop the most vicious type of Pneumonia that has ever been seen … and a few hours later you can begin to see the Cyanosis extending from their ears and spreading all over the face, until it is hard to distinguish the colored men from the white. It is only a matter of a few hours then until death comes…. It is horrible. One can stand it to see one, two or twenty men die, but to see these poor devils dropping like flies…. We have been averaging about 100 deaths per day…. Pneumonia means in about all cases death…. We have lost an outrageous number of Nurses and Drs. It takes special trains to carry away the dead. For several days there were no coffins and the bodies piled up something fierce…. It beats any sight they ever had in France after a battle. An extra long barracks has been vacated for the use of the Morgue, and it would make any man sit up and take notice to walk down the long lines of dead soldiers all dressed and laid out in double rows…. Good By old Pal, God be with you till we meet again” (Grist, 1979).
Take a good look at the chart below. For all the decades that the stock market has existed in the US, the weekly chart as you see it here has never quite looked like it does right now. Never in history has the stock market gone from all-time highs to a full blown correction in just one week (a correction is defined by a decline of between 10-20%).
Now, stocks have dropped further, faster, but never from all-time highs. Usually stocks roll over, drop some, recover, and then drop some more. Each drop builds fear until there is finally panic selling and stocks free fall as investors capitulate. It is unprecedented for stocks to go from making new highs on good market breadth to down 16% in a week.
If you’ve been with us for a while, you know we have been calling for a correction. We didn’t know when it was going to come, but we know enough about how markets work to know that they ebb AND flow, rise AND fall. So, the longer we went without a correction, the more we came to expect one.
Because stocks were relentlessly climbing higher, we continued to participate in the bull market, but we continually jammed our stops higher to lock in any meager gain we could pull out of an already overbought market.
Although we were expecting a correction, the ferocity of the current correction caught us by surprise. The market breadth of the previous rally was healthy and suggested nothing more than a routine correction that lasts several weeks and brings stocks down by no more than 10% or so. Instead, the market went from strength to a waterfall decline overnight. Luckily, we were expecting the market to eventually drop and were stopped out quickly, locking in some small gains and some small losses before moving to 100% cash before the worst of the week's tumble even began.
We ended the week in cash and are ready to jump back in once a durable bottom looks to be in place. USUALLY, but not always, a correction is a three-legged affair. There is the initial spike down, which is wave A, followed by a convincing rally (wave B) that makes people think all is clear. Once everyone is on board for the next rally, wave C down hits and stocks drop to at least test the former low.
Since stocks are short-term oversold, it is likely that A down is either complete or will be complete in the coming week. Next we expect to see wave B up, and then we will get to see if the current action is just a correction, or the beginning of a new bear market. If a new bear market began, than the decline should be a five wave pattern rather than a three wave correction. In either case, there is an initial leg down, followed by a rally (which doesn't necessarily mean Monday), which is then followed by another decline.
If the second decline continues well past the first one, we have to watch how it bottoms. A zigzag bottom would suggest the market is printing a wave 4, and we are now in a bear market. We would then look for the fifth wave down before a durable rally would be expected.
Whether we are in the midst of a correction or a bear market, the first few moves tend to be similar. Short-term traders can hunt for a bottom, but be prepared for the coming rally to potentially be short lived.
Being in cash during a steep market decline is great, but this week many in our Basecamp group were able to really get a feel for the power of options in a waterfall drop. We were already long CSCO puts (meaning expecting a decline) before this week's decline, and those puts ended the week up 283%. On Monday, as the market turned down sharply we bought CCL puts as well, which are now up 224%. There were a lot of similar setups posted and many memeber trades made to the short side using put options this week. One member even reported doubling his trading account this week on the back of CCL and RCL trades.
We really encourage all of you to join us in Basecamp. Those that do, and put in the extra effort to learn to trade options, are showing great results. We used to offer our options trading group as a separate add-on to Wanderer, but a few months back we opened it up to everyone for this exact reason—we wanted everyone to be able to participate.
Last week, we highlighted the 30-year yield’s record low. This week’s stock market weakness caused the US 10-Year yield to also collapse. Once again, we have an inverted yield curve, where the interest rate on a 3-month treasury bill is higher than it is on a ten-year note.
This is an unnatural condition that usually precedes a recession. Under normal conditions, lenders expect to be paid more for longer duration. When you can get a higher yield on a 3-month loan than you can on a ten-year loan, it shows that investors are wary of short-term debt, and are piling into the long end of the yield curve for safety, thereby driving down that interest rate.
Since 1950, all nine major US recessions have been preceded by an inversion of the yield curve. The most commonly watched yield curve is the difference between the two-year and ten-year notes, but right now the two-year yield is lower than the three-month yield.
An inversion of the yield curve doesn’t necessarily mean a recession is imminent. It can even take a couple of years before there is a measurable recession based on past examples. But the movement is viewed as one of the most reliable recession indicators, and is among the first signs an economy is shrinking. This is the third time yields inverted in the last few months, suggesting trouble may be brewing beneath the surface of a generally well-returning stock market.
After making a double top, the dollar index plunged this past week. It is approaching an area of technical support, so we could see a bounce soon. While the dollar drops, the Yen and the Euro are in rally mode. The ETF for the Yen is FXY and the ETF for the Euro is FXE. Both look attractive as a trade, but we will likely pass, since the moving averages are not in our favor.
After initially climbing to new multi-year highs, gold sold off hard and finished near its lows of the week on Friday. Although gold was getting late enough in its cycle where a decline could be expected, the ferocity of selling on Friday was likely due to investors locking in profits on gold in order to feed losses elsewhere.
The CME also raised margin requirements, which may have triggered the sell-off. Once the selling began, the extreme speculative long position on the COT report made itself felt as speculators rushed to the exit at the same time. An extremely lopsided COT report doesn’t mean a correction is imminent, but it suggests that the ferocity of the selling will be greater since there are more sellers.
Silver's sell-off was even more ferocious than gold's was. Silver isn't quite as liquid as gold is, so it tends to be more volatile.
Like silver, oil suffered a severe sell-off. It is rapidly approaching major support. Although some of the oil companies are offering deep value and high dividend yields, they are not immune to falling further as long as oil is in decline.
Every once in a while, something comes out that totally disrupts an existing industry. I recently saw a picture from the year 1900 of a parade in New York City. At that time, the street was completely clogged with horse-drawn carriages, save for ONE automobile. In the entire picture, only one car existed. Fast forward to a photo taken at the same location just thirteen short years later, and the street looked just as crowded, except this time there was only ONE horse-drawn carriage. The rest of the street was full of automobiles. That was a massive change in an extremely short period of time.
Does anyone remember the typewriter? Rendered totally obsolete by the personal computer. How about film cameras? Again, in a very short period of time, they were rendered obsolete. We could go on with how airplanes replaced train travel, or how cellphones replaced payphones, but you get the idea. Sometimes, something big comes and it changes things forever.
The change that is rapidly happening over the next decade is the electrification of vehicles. As battery technology improves, the cost is rapidly coming down to a point where it won’t be long before the internal combustion engine is as quaint as an old flip phone. Electric vehicles (EVs) are here, and they will soon be everywhere.
Lithium is a key ingredient used in lithium-ion batteries. Lithium-ion batteries are used in EVs and for renewable energy storage. The growth of these industries is driving unprecedented demand for lithium, causing miners and battery producers to rapidly scale operations.
Lithium, or “white petroleum” is the world’s lightest metal. About half of the current lithium demand comes from industrial applications such as glass, ceramics, and lubricants. Most of the anticipated growth for lithium comes from the battery segment.
The average electric car uses over 5,000 times more lithium than a smartphone does. Higher range cars like the Tesla Model S use as much lithium as 10,000 smartphones. This is where it starts to get interesting.
In 2019, global EV production consumed approximately 137,000 tons of lithium. But in just one decade, this number is expected to be 1.5 million tons as EVs become mainstream. This tremendous growth in demand cannot be met at current prices. Because lithium doesn’t trade on a futures market yet, it requires a little imagination to gain exposure to the sector. One way to gain exposure is to invest in companies involved in various parts of the lithium cycle. This can include lithium mining, refining, and battery production. The Global X Lithium and Battery Tech ETF (LIT) tracks the Solactive Global Lithium Index and invests in companies involved in each stage of the lithium cycle. The ETF allows for efficient access to companies with high exposure to lithium, all in one purchase. Better yet, the recent market weakness is pulling the price lower. For our long term accounts, we plan on building a position in LIT as its price stabilizes.
This cruising season my family has been making our way east, directly into the trade winds. We started off in Guatemala, then moved on to Honduras, the Cayman Islands, and Jamaica. When moving against the prevailing winds you need to be able to take advantage of any break in the weather. The past couple of weeks have given us some ideal windows. Last week we were able to make the two night passage from Jamaica to Santo Domingo, Dominican Republic. I absolutely love it there. The people are great, good restaurants are everywhere, the grocery stores are fantastic, and the plazas are full of life. There is a vibrancy in Santo Domingo that you just don't see in the Western Caribbean. Our visit also happened to coincide with Independence Day, which meant street parties and a big parade along the waterfront.
I could have spent a lot more time there, unfortunately (or fortunately depending on how you look at it), a great weather window opened up for our next leg to Puerto Rico. The strip of water between the two countries is called the Mona Passage and is notorious for beating ships to a pulp when they venture in during poor weather. So, when a calm appears, a cruiser has to make a run for it whether they are ready to leave or not.
This morning I am sending this off from the tiny bay of Puerto Real on Puerto Rico's west coast.