Coronavirus Market Panic and Opportunity

Worsening coronavirus or COVID-19 news drove a 12.4% decline in the Dow Jones Industrial Average, last week, erasing $5 trillion in global equity market value. This COVID-19 market panic was exacerbated by both China’s news suppression and the virus’s suspicious Wuhan lab origin; and further amplified by the news–stock market reaction–feedback loop. Historic market panics like this offer a rare opportunity for those investors who can distinguish between the price of an investment and the value of that investment.

While COVID19 and its full economic impact remain unclear, there is a compelling investment case to buy closed-end midstream MLP funds because their earnings and distribution risk is negligible. We are buying Kayne Anderson MLP Investment Company (KYN) for our clients because it just dropped 30% resulting in a 13% yield and a 10% discount to NAV. Since MLPs process and transfer energy within the United States, the economic slowdown from COVID19 should have a negligible impact on MLP’s utility like cashflows. Once this panic subsides and money flows stop going into US Treasuries, money flows will turn to stable higher yield vehicles like midstream energy MLP funds like KYN. The chart below of KYN shows its 30% decline since mid-January.

For decades, MLPs have traded in line with bonds, due to their stable utility like cashflows. However, during market selloffs, MLPs are sold like stocks and are among the first assets to rebound due to their noncyclical cashflows. The spread between Alerian MLP Index yield versus 10-year US Treasury note shows this market behavior. As of Friday’s close, the spread MLP to Treasury spread was 10% and only exceeded by the 2008 Financial Crisis. Even in the event of a pandemic inspired global recession, this unfolding event unlikely to be as bad as the Financial Crisis.

Source: Yahoo Finance

Only during the financial crisis of 2008, when Lehman Brother’s collapsed along with Fannie Mae, Freddie Mac, and other major financial institutions, and the 1987 market crash, when the Dow Jones Industrial Average declined 22% on October 19th, has the market priced in more frightening scenarios than it does today. This current intense market decline is the result of instantaneous computerized trading to COVID-19 news. The economic risks now reflected in the equity markets are unlikely to be as consequential as the 1987 Crash and 2008 Financial Crisis.

Technical Measures Also Among the Worst

Ari Wald, CFA, CMT at Oppenhiemer shows that this extreme decline ranks among the sharpest since 2010. While past price action cannot predict the future, the study below shows the statistical probabilities of investing in the market now are improving.

Source: Oppenhiemer & Co. and Bloomberg

Fast Money technical analyst Carter Worth believes that markets which decline below a rising moving average are a rare and compelling trading buy. See chart below showing the S&P 500 below the 200 day moving average.

Corona Virus News Last Week—Problem to Pandemic

We have been monitoring the Coronavirus, a SARS like influenza of suspicious origin. Through February 20th, China’s aggressive quarantining of whole cities like Wuhan (population 11 million), led to the belief that this virus would be largely contained in China. However, last weekend, February 21 and 22, brought news of COVID-19’s spread to Italy, South Korea and Iran which promptly changed the global health risk assessment from contained to global spread. The Dow Industrial Average dropped every day last week on increasingly heavy volume. The markets have adjusted for more impactful global economic outcomes recalibrating the risk that this virus, now in 33 countries, will spread globally.

Below shows the Dow Jones Industrial Average price, volume and percentage decline for every day last week.

Economic news has shown some hopes with Apple, stating that it will not have supply chain issues, and with Starbucks reopening stores in China. Epidemiological details are still being determined, but, renowned expert Dr. Anthony Fauci said mortality rates are largely limited to the sick and elderly, and that is a limit subset of the 20-25% who suffer an intense form of this influenza, and that is a subset of those who even get this COVID-19 flu. There appears to be intense global efforts to contain COVID-19, and international travel and exposure to where the flu is spreading is being systematically curtailed. Simultaneously, development of therapeutics and vaccines are under development, and testing and response policies are being implemented. If China’s claims that the spread of COVID-19 is, in fact, slowing, we could see the spread of this influenza begin to decelerate in coming weeks and global containment beginning to take root.

Even with Pimco’s assessment of a negative 6% GPD in China in the first quarter, it appears that the rapid cuts to economic forecasts are being reflected in the markets. This past week’s market action is simply an orderly, though alarming, adjustment to the risk that this pandemic could have a long tail and material global economic impact.

We believe the worst case scenario is largely being priced into the stock market. And, for those investors who can distinguish between the price of an investment and the value of that investment, this decline is rare opportunity to pick up bargains like closed end MLP funds with high yields, discounts to NAV and steady cashflows. We have been selling gold, gold stocks and bargain hunting and will continue to in the days and weeks ahead.