It’s not just Coronavirus: Red flags for the US Economy

This is a fascinating point in history to be a professional investor. In 2019, US market returns surprised a lot of people. We’re only barely into the new year and some interesting developments have materialised.

Leading the news, we have a potential pandemic on our hands. When coronavirus COVID-19 was isolated to certain provinces in China, markets seemed to ignore the risk. As the virus spreads, so too does awareness of the potential implications. Pundits seem to be attributing the recent global sell-off to the virus. Of course, it’s their job to attempt to explain every market move in simple sound bites. I’m always very cautious of attributing any single factor to a major market move, but in this case the potential economic (not to mention human) consequences of a pandemic are hard to ignore.

World markets have now woken up to the consequences. The trouble is, there isn’t a strong economic foundation to recover from a global pandemic.

As newsletter subscribers will already be aware, on the 13th February the US economy entered into a ‘stagflation’ regime (low growth and rising inflation). When the regime switches into stagflation, the future is likely to entail periods of declining market returns if not a full recession. The chart below highlights historical periods of stagflation regimes for context.

In short, we knew on the 13th February that now is not a good time to be long equities.

Things are going to get messy

This is a particularly interesting situation because we have a panic sell-off on top of weak economic data. As a general rule, downturns are messy. Short sharp declines, fake-out recoveries, speculation of government intervention… It’s a difficult time to be an investor, yet these periods also offer tremendous opportunities.

Just don’t forget:

You don’t need to predict the future. You just need to know when it’s going to change.