China’s Butterfly Effect Causes Stock Market Storm

The Butterfly effect is often exemplified by the hyperbolic statement that “the flapping of a butterfly’s wings can cause a hurricane on the other side of the world”. While such a statement can never be proven, the concept of small changes in one area causing larger effects far away is increasingly valid in our interdependent world. The quarantine of millions inducing massive supply and demand disruptions in China are curtailing business around the globe. To what degree the current Coronavirus will negatively impact the planet is unknown at this point, but life will return to normal and clearly there are signs that Chinese butterfly’s are creating nervous butterfly’s all over.

Some factories in Europe have warned of production halts coming in March due to the curtailed production in China. Jaguar in the UK has laid off 500 workers and reduced the workweek. Fiat in Europe indicates it may need to idle some production if China doesn’t resupply them by the end of February. GM had 10% of its China workforce quarantined. A major China titanium producer had to halt operations. US may run out of many medications whose ingredients often come from China. Starbucks and Apple are seeing major reductions in China store traffic with Apple warning of supply disruptions as well.

Until February 20th, stock investors had cast a collective yawn at the news of major business disruptions and escalating contagion from Coronavirus (aka Covid-19). Stocks zoomed to record highs on almost a daily basis in February despite the growing alarm, including Germany whose auto industry was severely impaired by China. Investors had been looking past economic slowing as a brief event that would be quickly recouped with pent up demand realization later in the year. With reports this week of Covid-19 breaking out in Italy, Oil, Stocks and Bond yields fell sharply. Bond yields are a good indication of economic and inflation expectations and with the US 10 Year Treasury Note collapsing to a new record low yield of 1.33%, it indicates a fear of deflation and potential Recessions popping up around the globe.

The 2020 hyperbolic action in tech and market volatility surrounding Coronavirus have shifted our ExecSpec reporting focus from longer term detail to our more frequent short term stock market update model. Below are highlights over the past month of ExecSpec comments on website with dates and quotes in the SP chart below that provide indications of our current and past short term forecasts:

 > 01-09-20   Watch Jan’ 24th & Feb’ 21st + or – a day turn dates (Sells)   

 >  01-15-20  We will keep  3340 as our key next level where we look for topping action into the 24th         

 > 01-24-20  We have talked frequently of a Jan’ 24th top & with stocks and especially commodities like Oil and Copper falling hard, it appears our inflection/turn date is a notable trading top   

 > 02-11-20  Sentiment is once again approaching record peak similar to January 17 to 24th. With option expiration on the 21st, we view that date as February peak.   

 > 02-14-20 expect ideal…top near the end of next week ~21st.  Record highs late next week may warrant raising cash & hedging for 5 to 10% downside.     

 > 02-17-20   If downside picks up steam this week, then 21st/24th inflection flips to possible momentum move lower.   

 > 02-20-20   SP 500 Index test of 3300 likely soon … If 3300 is reached, then the eventual correction low for March should then target over 6% total. Any rally back to new highs appears to be low odds    

> 02-23-20  Confidence now increases that we have begun the one to two month corrective phase likely heading into the 3100’s on SP >6% overall correction phase.

 > 02-24-20  Now that many pros are jumping on board with the 3150 to 3200 area we forecasted as a 1st zone of a correction low, we would focus a bit more on the potential for >10% drop under 3,000 SP as this epidemic is not yet mature. 10 year Treasury Yield is testing record lows (1.34%) and likely headed for a Yield near 1.25%

(Click chart to enlarge)

The current 8% drop from record highs last week is notable so far as a garden variety correction that occurs once or twice a year and now due for a bounce before even lower prices. Our overbought reading shown below at the late January and February tops, ignoring the China virus, were indicating a >6% drop was coming as our updates forecast. Our conservative scenario continues to expect a drop over 10% ending in April (SP 500 Index~3,000 or lower). It will take another couple weeks of turmoil in stock indices before our charts have potential to generate oversold areas to consider medium term equity purchases again. 

The potential pandemic from this Covid-19 virus presents increased potential for a Black Swan element of unknown risk to all investment markets. While most virus scares burn out by April, the degree of Coronairus spread and reactionary mandates by Governments globally favors this stock market correction moving beyond 10% with a large degree of latitude in the forecast. Investors need to be vigilant of road signs with extreme outcomes to watch for in Western countries, such as draconian quarantines and business shutdown measures being instituted. While the markets ignored China’s quarantine of 60 Million people, they panicked this week with the Italian virus outbreak that shut down schools, theaters, museums and many businesses throughout northern Italy. If these measures are needed in other parts of Europe, the chilling effect on stocks and the global economy will be far more acute than the recent 8% move lower in stocks this past week. Imagine even one major US city calling for a total quarantine, closing schools, shopping, travel and face to face contact? Now that S.Korea, Hong Kong, Iran, Japan and Italy are experiencing outbreaks, the potential for Government restrictions on our lives – though temporary – warrant our continued defensive posture awaiting more clarity on the potential climax of Coronavirus expected over the next two months. Even the cautious CDC has announced today that an “outbreak” of this virus in the US is “not a question of if, but when”. Caveat emptor!




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