Coronavirus Pandemic Is an Excuse, Not the Fundamental Problem

04/10/2020 6:00 pm EST

Focus: MARKETS

Al Brooks, MD

Professional Trader, Author, Lecturer, Brooks Price Action, LLC and Brooks Trading Course

Despite some notable arguments to the contrary, equity markets were just fine prior to Coronavirus outbreak, reports Al Brooks.

It is important to repeat a point that I have made several times. The charts over the past 2 1/2 years have indicated that the bull trend was ending. It is easy to say that the pandemic took a good economy and made it bad. That is not what happened.

The pandemic came during a sick stock market. It started an unwinding that was going to happen soon anyway even without the pandemic.

How do I know? The pandemic will be over in a couple years. Let’s see if the stock market is far above the February high in three to five years. It won’t be, and people won’t have the pandemic to blame anymore. They then will have to begin to accept that the economy was in trouble since late 2017, not since February 2020.

Pandemic Math is Telling a Different Story

Dr. Anthony Fauci said that the best case is that we will lose 100,000 people. With a death rate of 1% to 2%, that means we will have about 10 million infected. A big number, but is it really?

There are approximately 330 million people in America. The above scenario indicates that only 3% of the country will be infected. Does anyone really believe that a 3% problem caused the stock market to fall 35% in a month? The behavior of the American people and of the economy is telling us that the problem is much bigger than a 3% pandemic.

I have two explanations. First, his best case scenario could be absurd. Past pandemics have infected 20% to 50% of a population. If that happens here, then maybe a million people will die. I have looked at the charts and I understand how he gets 100,000. I agree that it is reasonable to estimate that only several hundred thousand people will die in the United States. That still does not eliminate a third of the country’s wealth in a month.

My second explanation is more important

My other explanation is the one I keep saying, but so far, I am the only one. That is that there have been serious problems in the economy since 2017 that have been hidden by the residual momentum of a decade-long bull trend.

The pandemic is lifting the lid and now people are beginning to discover what is really under the surface. They see a stock market pumped up by stock buybacks, government and corporate debt, and ridiculous policies. And they are afraid that this is a weak foundation to support a rally to the highs in February.

That means that the decade-long bull trend was doomed to end with or without a pandemic. There is always a trigger. If it was not the Coronavirus, it would have been something else.

But what happens long after the pandemic is gone, and the stock market is still floundering? Everyone will come to accept that the problem was the economy and not the pandemic. They will then conclude that this is a secular (decade long) bear market and not just the usual one- to two-year cyclical bear trend within a secular (decade long) bull market.

The Economy: The Fed is everyone’s insurance policy

Traders appear to believe that the Federal Reserve will prevent a free-fall. Sometimes you will hear that the Fed is a “put” under the market. By that, traders mean that the Fed will act like a put option for your account. They will protect everyone’s portfolios from horrendous losses.

Traders see the Fed as guaranteeing that selloffs will not get too big. The Fed is the market’s insurance policy. How big is too big? The biggest selloffs since World War II were about 60%. Traders will bet that the Fed will use that as its benchmark.

How to trade using the Fed

It is important to remember why the Federal Reserve was created. It exists to maintain a stable and growing economy through price stability and full employment. The Fed governors are the best people in the country in terms of both intellect and integrity. If we are going to trust anyone, we are going to trust them.

I said that traders believe that the Fed prevent the market from falling below some undisclosed level. That has created a sense that a trader can buy at any time and safely buy more lower, trusting that the Fed will protect them.

Let me tell you a secret. That undisclosed level is around 60%. Why? Because that has been around the biggest selloff since the Great Depression. The Fed knows that if it allows a bigger selloff, there could be tremendous panic and damage to the economy. They would violate their mandate.

At what level is it safe to buy?

With many traders confident that the market will not fall much below 60%, they know that there will be lots of buyers somewhere above the 60% level. No one ever knows how far a selloff will fall, but if you are confident that 60% is the floor, you might be inclined to start buying when the market is down 30 or 40%. Then buy more at 50% or 60%, betting on a strong bounce off the Fed’s secret floor.
What happens if I am wrong and the floor is 70%? It might be, but the principle is the same. The Fed will create a floor. They said essentially that they will print “infinite dollars” to protect the economy.
Traders also believe that the Fed will use some of that money to buy exchange traded funds (ETFs), if necessary, to stop a collapse. If they buy ETFs, they would essentially be buying a broad basket of stocks. The market is made up of stocks. If there is strong buying, the market will go up.

Can the Fed fix this mess?

No. The damage that the economy has suffered is broad and deep. It is as if an Olympic sprinter broke both legs and his pelvis in a car accident. The doctor might save his life, but he’s not going to be winning gold medals any time soon. The sprinter has to heal himself. The doctor has no magic that immediately makes him normal again.

Remember, the Fed’s mandate is to maintain a stable economy. That means it exists to prevent disaster. It does not exist to take a horribly damaged economy and quickly make it normal. It could not do that even if it wanted to. The Fed is simply trying to prevent a bad situation from getting worse.

It cannot turn that terrible economy into a good economy. The economy has to heal itself. The stock market was the most overbought in its history. It will take a decade for the fundamentals to catch up with price.

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