After a cliff-diving that saw markets in the US lose 35% in 5 weeks–and then gain 30% in 4 weeks (recovering about 60% of the losses). Interest rates being driven to 0%, infinite QE, etc… in the midst of the greatest health crisis in living memory (I am young, and only lived through SARS [coronavirus] in its epicenter in south China, and H1N1, and felt that those were nowhere near as bad), surging unemployment (and substantial loss to income for most).
So, what does this leave the average investor? I will tell you a story about annuities. The Chinese Yuan (￥) is used in this discussion, as this annuity was purchased in China.
My mother was 33, and took out an annuity for herself. The premium is ￥920 a year, and she would pay 23 years, and started collecting ￥500/month at age 56, and will continue to collect the same amount until she dies or the company goes out of business, whichever comes earlier.
If we take a look at this and think: well, what is ￥920 a year compounded at a 10% annualized return for 23 years? That would have been ￥73 179. At 10% annualized growth, the return would be ￥7 318/year, but ￥500 * 12 = ￥6 000. So, that meant the company that sold her the annuity thought that it can profit big time. Except that is likely to be wrong. Even though GDP growth had been above 10% annualized for a long time, that growth had slowed to only 6%, and now it just plunged to deep negative due to the coronavirus. With extreme population aging and the lack of immigration, they are being Japanified at a horrifying speed. To expect 10% growth for another 20 years in the future is flat-out delusional (average life expectancy of a woman is 77.6 years right now).
Sidenote: my sister is at the same age now as my mother was when the annuity was purchased. I know for a fact that the annuity should be more than twice as expensive for her if she wants the same payout, inflation adjusted or not.
So, what does this mean for the average investor? It is simple: if you live on $10 000, then
- when interest rates were 20%, you needed $50 000 to retire
- when interest rates were 10%, you needed $100 000 to retire
- when interest rates were 5%, you needed $200 000 to retire
- when interest rates were 2%, you needed $500 000 to retire
(The 30 year US treasury yields less than 2%)
- when interest rates are 1.5%, you need $666 666.66 to retire
- when interest raes are 1%, you need $1 000 000 to retire
- when interest rates are 0.5%, you need $2 000 000 to retire
It doesn’t take a genius to realize that when interest rates are 0%, you will never retire in absense of public pensions (CPP/OAS in Canada and Social Security in the US). Period. Even at $1 million, it would take someone highly frugal 35 years to save up. At $2 million, it would be impossible for anyone making less than 6-figures to ever save up enough before dying of old age. That means investing your entire portfolio in 30 year bonds and clip coupons is not really an option any more, no matter what your age is.
This brings me back to stocks. In 2000, the S&P 500 companies had $56.13 earnings per share, in 2001, it plunged to $38.85. That was a 30.8% collapse, and it took until 2004 to recover. In 2007, the EPS was $82.54, and in 2008, it was $49.51, a 40% collapse–and the 2007 EPS was almost 6% below 2006. It took until 2011 to recover to (and surpass) the 2006 peak.
Therefore, I posit that in 2020, earnings will collapse from $162.35 to $113.65 or even $97.41 (somewhere between a 30-40% collapse) and will not recover to 2019 levels until 2022 or even 2024. At $113.65 EPS and 2874 for the S&P 500, the P/E ratio is 25.28, and at $97.41, that P/E becomes 29.5. If the average P/E ratio at the bottom of a bear market is 16.7, then based on these earnings, S&P 500 should bottom out around 1625-1897, which is somewhere between 300 and 560 points below the March 23 low.
People think that this crisis will pass quickly. Err…no, and I will tell you why:
Who will go to the malls, stadiums, airports (even if you have millions in your bank account)? You can catch COVID-19 and risk a 1 in 250 chance of dying within 1 month of catching it (I pulled that statistic out of Germany’s ass).
If a substantial number of people are not going out and spending, then a lot of people who work in these industries will simply not have a job. Unemployed people don’t spend any money on anything besides essentials like housing, food, clothing and transportation.
Also, once things open up, there is nearly guaranteed to be a second wave of infections. China, Hong Kong and Singapore are places where this second wave is already happening. A second wave will mean a second shutdown, inflicting more damage on the economy. This would cause a greater collapse in earnings and stock prices.
This is absolutely horrific for any investor who is saving up for retirement. This kind of stock market pump is merely a transfer of wealth from the prudent to the reckless, not necessarily from the poor to the rich (some rich people can be very conservative in their investments).
Options positions planned (in Canadian dollars), for both hedging and speculation of the coming financial crisis:
- TD $55 2021/12/17 P
- BMO $70 2021/12/17 P
- CM $80 2021/12/17 P
- RY $85 2021/12/17 P
- BNS $55 2021/12/17 P
Close positions when the banks go to 50% of their all time highs, or if TSX goes below 9000 points.
If S&P TSX goes below 9000, I will be all-in on XIU–and keep averaging down and go long on the Canadian market to oblivion. I can even leverage myself to the hilt by buying calls and selling naked puts to avoid having to pay for the calls. But I will go net short the financial institutions starting next week because the mortgage and housing bubble will go bust like it did in 2008 in the United States. Mortgage defaults will sweep the country like we haven’t seen since the 1980s. Airbnb hosts who ran highly leveraged investments thinking they can get $3 000 a month in rent from each property are now going bust and will probably declare bankruptcy when no tourist goes to the cities, this puts downward pressure on residential real estate prices and rents.
Sorry for the long rant. But I want to make clear that I am not a permabear. I will become a bull when the stock markets are cheap again.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.