The recent stock market crash may have wiped out several years’ worth of your investment returns. I know you are in pain. But do you know covid-19 is not the real culprit of the stock market plunge? It is something else.

I guess that your level of pain is probably negatively correlated to the number of years of your investing experience.

The fact is, stock market crashes occur every 2 to 3 years to varying degrees; so, this most recent crash is not something totally unexpected.

Read my previous articles about the stock market crashes in 2011, 2015 and 2016.

I am NOT here to say that “there is no need to worry” and” stock prices always come back”. Because sometimes they don’t.

And it is likely that you may hold some stocks at a loss forever. But I have seen so much faulty investment advice circulating around. Therefore, I hope to offer some insights into the current financial situation.

Just like you, I don’t have a crystal ball. But as an investment professional, I can probably make some well-informed and rational assessments of the situation. And my assessments may have a higher potential chance to be right.

This stock market crash has been looming for a long time. It was not unforeseeable. It’s just that we didn’t know what would trigger it, when it would happen and to what degree it would last. That is why I wrote a cautious note two months ago (Jan 2020) and asked you to prepare for it.

Read more: Why buying stocks during a financial crisis is a bad idea.

Now, I want to share with you how I look at the recent stock market crash and give you some general advice. I hope this will help you avoid some low-level investment mistakes. You can agree or disagree, and I welcome constructive comments to further discuss the current situation.

The fastest stock market crash since 1987

In less than 3 weeks’ time, the global stock market dropped nearly 30%. This is the fastest drawdown since 1987, which happened more than 30 years ago.

You may have some vague idea about the 2008 global financial crisis. But most amateur investors have no idea of the 1987 crisis. I say “amateur” because if you have studied investment trends from that long ago, you should be well equipped.

It was said that the 1987 financial crisis was caused by the computer program-driven trading (yes, in 1987 the US financial market was that advanced). We all know that today’s technology is far more advanced than 33 years ago; so, it is only reasonable to assume the magnitude of the impact can be much larger today. Bear this in mind and we will talk about it more later.

Recently, when the market started dropping, many people got excited and were convinced that the long-awaited buying opportunity had finally arrived. But then within the blink of an eye, the same people went from complacency to panic.

But why do we panic? Most of the time, we fear just because other people tell us that we should be fearful. They do this so that they can achieve their agenda.

If all you know is that the market is down without knowing why, then it is really hard to make a good decision.

Opinions are cheap

As of this moment, a lot of people are offering you free investment advice. They say things like:

• Now is the best time to buy more, and the market always comes back.
• Buy this bank share or that Telco share now for the long term
• Buy this REIT now, it is still resilient and gives a good yield.
• Buy that index ETF fund using dollar-cost averaging.
• A recession is coming, sell everything now and hold cash.

But you need to be careful. Does the person who offers you advice has a foot in the game? Most of these claims show no respect of the market and offer no practical solutions:

• If the market price crashed, it was down for a reason. There is no such thing as an undervalued market. (If it eventually comes back, it is just because the circumstances have changed).
• People who are always bearish would have sold long ago. This doesn’t make them smarter and it is unlikely for them to buy at a low price.
• People who are always bullish would keep on buying until they run out of cash.
• A broken clock is right twice a day.

What I have learned is that we are all exposed to a limited universe of knowledge and experiences. While your personal past experience might be useful, it is often not enough to help you survive in the next market downturn.

So you need to have your independent opinions but at the same time always keep some doubt in reserve.

One chart which explains everything about the stock market crash

The stock market always crashes for a reason. Some say that the recession is coming and this leads to people selling in a panic. But the financial market is never that simple.

Here is how I look at it. I believe there were 3 waves of selling in the US stock market due to different reasons.

Wave #1 – Covid-19 spread outside China

Before we go on, let me ask you a question and you need to give me a quick answer.

“Between a Shark and a Coconut, which one is more deadly?”

Do you know that falling coconuts kill 150 people each year worldwide, while only 5 deaths were caused by sharks? I think we have seen more sharks killing people in the movies than in real life.

The thing is that our opinions are swung by the media. If you think about it, dengue fever kills 50 people every year in Singapore, but Covid-19 has caused no fatality so far. And we have more Dengue cases this year (378) in Singapore than Covid-19 cases (200) year-to-date.

I have pointed out in an earlier article that Covid-19 will have a limited impact on the financial markets, but then it was weaponized against China.

In the midst of the US-China Trade War, the impact of Covid-19 was exaggerated by the western media. It was labelled as a deadly “China Virus”. US companies were even told not to import goods from China because it contained the coronavirus.

The fact is that Trump knows himself. After misguiding the US people that the virus will kill millions. On March 9, he said the same thing that I said on Feb 11.

But after portraying the virus as a symbol of a doomsday monster, it is hard to make a 180 degree turn and then try to convince the Americans that it is just a rabbit. The US market will have to bite the bullet which was released by themselves.

Having said that, the economic impact of Covid-19 is real. So if the US stock market drops 10%, it was expected. Remember that the China stock market dropped 10% when it opened after Chinese New Year, but then went all the way back up.

The western world was experiencing what we have experienced here in Asia in early February.

The Covid-19 playbook played below summarized the stages very well.

Wave #2 – Oil price slump led credit crunch

While I am not particularly worried about the coronavirus situation, the sharp falling of oil prices seems like déjà vu.

Many people have forgotten or have no idea of the oil crisis in 2015. The reason is that Singaporeans never benefited from the low oil prices over the past 5 years. Note, the WTI Crude oil price dropped 70% from $105 to $30!

And yet we are still paying nearly the same price to pump petrol in our cars.

The real impact of oil price movement on the world is profound. For example, it gave a tailwind to the boost of the transportation and logistics industries so that we can buy things cheaper online today.

However, the sharp falling oil price can also cause turmoil in the financial markets. I wrote several articles concerning what happens when oil prices had a free fall between 2014 to 2015.

Read more: Sharp Falling Oil Price – The Real Time Bomb

The issue is that companies in the energy industry are often heavily leveraged. They had to borrow a lot of money to fund their oil production.

When the Saudis recently instigated an oil price war, it may be passing news to most people, but I immediately knew that the market was going to crash another 10%.

If you refer to my Feb 10 GMC Notes, I said that Covid-19 is a “Black Swan” event, but it won’t be the cause for the next recession. Instead, it will awaken the “Grey Rhino” which is the Debt Crisis. The reason that it is called a “Grey Rhinoceros” is that it is a highly probable, high impact yet neglected threat which is right in front of us but we choose to ignore it.

A discussion of a Black Swan and a Grey Rhino is a big topic which I won’t discuss today. In a nutshell, the impact of falling oil prices won’t be limited to the energy industry, it will soon ripple through other sectors because of the commodity’s key role in the global economy.

My envisioned next financial crisis will happen like this, step by step:

1. Oil companies will default ->
2. Banks will be hit by both low profits (due to low rates) and defaults on non-performing loans ->
3. Banks will tighten credit ->
4. Non-profitable corporations will start to default on their debts ->
5. The downward spiral of the debt crisis will begin!

Wave #3 – Force selling due to mechanical trading and margin call

It is interesting to note that the biggest sell-off didn’t happen in the first two waves, when market participants were still trying hard to stay rational. But the markets are not just controlled by humans.

The largest traders in the world are not you and me but your dear ‘booming’ passive fund industry and quantitative trading programs.

• Passive funds refer to your ETFs and Robo advisers, who design a portfolio based on preset rules and trade with no human intervention.
• Quantitative investors are the funds and trading houses who buy and sell based on algorithms such as momentum and risk parity, etc.

But they all share some baseline assumptions. For example,

• The market is liquid enough for any buy and sell transactions.
• Bonds and stocks move in inverse relationships and offer protection in a volatile market.
• The portfolio has to liquidate most positions, if not all, when the volatility is out of control (mainly for the quantitative traders).

These assumptions are reasonable in normal market conditions, but this time is not a normal market condition.

In the beginning, I mentioned the 1987 crisis was caused by computer-driven trading programs. This time it looks similar. Imagine what happens when your Robo-Adviser is triggered to sell bonds to buy stocks for the purpose of rebalancing due to a wild price swing? Orders worth billions and trillions will flush into the market.

Read more: Why Passive ETFs Face Big Risks in Liquidity Crisis

Look at the chart below. This is what happened to the supposedly safest bonds in the world, the US Treasury Bond ETF. The price swung from $153 to $177 and back to $153. I am sure you didn’t intend to buy a bond with 15% volatility right?

Read More: 3 Myths of Bond ETF Investing and Why I Give It a Miss.

Even the Singapore ABF SG Bond ETF was not spared from such a wild ride.

You need to be reminded that Robo Advisers and Computer algorithm have no brains. When they are supposed to sell, they sell. So the market faced the situation of “selling to anything with a bid!”

The “invisible hand” in the market malfunctioned which in turn triggered the risk management programs by the quantitative traders and banks who finance the margin accounts. This continued to trigger another round of sell transactions to close all the positions.

That is why even gold, the supposedly safe-haven asset, crashed together with the market.

Of course, it is only reasonable to assume that not everyone is a loser. Many traders may be laughing to the banks now.

So what is next

As mentioned earlier, that purpose of this article is to help you understand what is really happening in the market so that you can make the right move(s).

Yes, there are people who made millions during this period, but they also risked millions. As a small-time investor, that is not our game. The most important thing for us now is to:

• Protect our investment capital.
• Seek potential opportunities.

As you can see, it is more than just Covid-19 and the market crash, but also a lot of other dynamics at work that are causing people to panic. And our biggest risk is not from the virus itself but from man-made events:

• The political and economic interest of Russia and the Saudis
• The conflict and unsynchronized response among Trump, the opposition party and the Fed.

The crisis can be managed only if the decision-makers are doing the right thing at the right time. By far, only the Chinese government has achieved it. So it is a no-brainer that the China stock market is the best performing major market in the world right now.

Get out of your comfort zone

If you are always just investing in Singapore and US stocks, it is time to wake up.

If you are one of my clients and a follower of my blog, I have talked about investing in China stocks since 2019. If your portfolio does not have China stocks, you are missing something.

Read more: Why should a foreigner invest in China A-Shares and How

The 3^rd wave is unlikely to last. Once the robots bite the bullet, the bulls and bears will have a new balance of power which will likely be within the 2^nd wave.

My general advice is as follows:

Don’t sell in a panic – Understand what has driven the stock price movement and make rational decisions.

Don’t get over-excited – Stock prices are low, but it doesn’t mean they won’t go lower. The worst hasn’t even started yet. Don’t be overconfident with any stock prices, things change very quickly. Always focus on a portfolio approach.

Don’t average down losers – A stock doesn’t always perform the same as the general markets. Don’t just look at the key indices such as STI or S&P 500, know how the individual companies are affected by the situation differently. Contrary to common belief, you should not just buy more of the losing positions, anchoring your decision based on previous purchase price will lead you to make disastrous decisions.

There is no undervalued market – If the market is down, it is down for a reason. It is always fairly valued based on supply and demand. Be extremely careful about free stock tips especially now. Protecting your investment capital is your #1 priority.

My parting words…

Despite the wild move of the stock market, nothing really happened yet. The markets are just preparing for the future. So there are two possibilities in the short term.

1. The US stock market went back up sharply: but it may be hard to go back to the early February level anytime soon as we have to factor in the economic loss reflected in Wave #1. So you need to decide if you want to chip in now or diversify into other markets and asset classes for this period.
2. The market continued to trade wildly: it could be due to the policymakers’ inability to assure the market or there is some new development of Covid-19. If this is the case, you can be sure that the market will continue to go down as the market doesn’t like uncertainty.

Either way, I want to emphasis again the importance of managing your portfolio risk exposure and protecting your investment capital.

The debt crisis as I described will come sometime in the future, but not until you hear some established names start to file for bankruptcy. That is why your investment objectives and investment strategies are of paramount importance. You need to have a diversified portfolio and a game plan.

We all hope the worst stock market crash will be over soon, but “hope” is not enough. You cannot control the market, but you can control your action. Good Luck!

Feel free to leave your comment below to discuss the situation.

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