As we continue to get more and more information related to the coronavirus (Covid-19) spreading across Asia and Europe, the one thing we must consider is the longer-term possibility that major global economies could contract in some manner as the Chinese economy is currently doing. The news suggests over 700+ million people in China are quarantined. This is a staggering number of people – nearly double the total population of the United States.
If the numbers presented by the Chinese are accurate, the coronavirus has a high infection rate, yet a moderately small rate of mortality (2-3%). Still, if this virus continues to spread throughout the world and infects more and more people, there is a very real potential that 20 to 50 million people may die because of this event. That would make it one of the biggest black-swan events in recent history.
We won't know the total scope of the damage to the Chinese and Asian economies for another 35+ days – possibly longer. The information we have been able to pull from available news sources and from the Chinese press is that hundreds of millions are quarantined, the Chinese Central Bank is pouring capital into their markets in order to support the frail economy and, just recently, President Xi suggested stimulus will not be enough – austerity measures will have to be put into place to protect China from creating a massive debt-trap because of this virus.
Austerity is a process of central-bank planners cutting expenses, cutting expansion plans, cutting everything that is not necessary and planning for longer-term economic contraction. It means the Chinese are preparing for a long battle and are attempting to protect their wealth and future from an extreme collapse event.
From an investor standpoint, FANG stocks have outperformed the S&P 500, NASDAQ and Dow Jones Industrial Average indices by many multiples over the past 5-6 years. The chart below highlights the rally in the markets that originated in late 2016 (think 2016 U.S. presidential election) and the fact that foreign capital poured into the U.S. stock market chasing expected returns promised by future President Trump.
It becomes very clear that the FANG stocks rallied quickly after the election was completed and continued to pull away from valuation levels of the S&P, NASDAQ and Dow indices. How far has the FANG index rallied above the other U.S. indices? At some point, the FANG index was 30-40% higher than the biggest, most mature industries within the U.S. In late 2018, everything contracted a bit – including the FANG index.
As or right now, the FANG index has risen nearly 274% since October 2014. The S&P has risen almost 60% during the same period. The NASDAQ has risen 140% and the S&P 500 Information Technology Index rose 180%. The reality is that capital has poured into the technology sector, FANG stocks and various other U.S. stock-market indices, chasing this incredible rally event.
source: theice.com/fangplus
This weekly Netflix chart highlights what we believe are some of the early signs of weakness in the FANG sector. The sideways FLAG formation suggests NFLX has reached a peak in early 2018 and investors have shied away from pouring more capital into this symbol while the Technology and FANG indices have continued to rally over the past 8+ months.
The weekly custom FANG Index highlights the rally that took place after October 2018 and continues to drive new highs today. This move on our FANG index shows a very clear breakout rally taking place, which is why we believe more foreign capital poured into the U.S. markets as the U.S./China trade deal continued to plague global markets and as BREXIT and other economic issues started to weigh on economic outputs. What did investors do to avoid these risks? Pour their capital into the hot U.S. technology sector.
Another chart we like to review is our weekly Custom Technology Index. This chart shows a similar pattern to the FANG chart above, yet it presents a very clear picture of the excessive price rally and rotation that has taken place over the past 5 months. The real risk with this trend is that investors may start to believe “it will go on forever” and that “there is no risk in these trades.” There is a very high degree of risk in these trades. Once the bubble bursts, the downside move may become very violent and shocking.
A reversion event, AKA a 'bubble burst event,' in the technology sector as a result of the economic collapse in China and throughout other areas of the world may break this rally in technology, pushing investors to re-evaluate their trading plans. Until investors understand the risks setting up because of the coronavirus and the potential for a 20%, 30%, even 40% decrease in economic activity and consumer spending may finally push global investors to really think about the true valuations within the FANG/Technology sector.
We are writing this series to alert you to the very real fact that “what goes up must come down” at some point. Pay attention to how this plays out and what may cause global investors to suddenly change their opinion of the Technology sector. A pullback in this area could result in a -40% to -50% price reversion.
We believe the economic collapse and humanitarian crisis that is unfolding in China may be enough to put a massive dent in future expectations for 2020 and 2021. You simply can't have a major global economic collapse of this manner without having some type of cross-over event. As we learned in 2008-09 with the U.S. credit crisis, when a major economy collapses its assets and financial markets tend to follow as the ripples spread across the globe. China may become the next financial crisis event for the new decade.
Catch up on the first three installments of this series: