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The new coronavirus is an obvious concern to stock market investors. The media are full of explanations and predictions.
So what should investors be focused on? Let’s explore the issue with the help of a chart.
Chart
Please click here for an annotated chart of the Dow Jones Industrial Average ETF DIA, -1.57%, which tracks the Dow Jones Industrial Average DJIA, -1.57%.
Note the following:
• The stock market has been very overbought. I wrote on the first report of the virus: “Overbought markets tend to be vulnerable. Sometimes it is an exogenous event that topples stocks. What could be happening currently? Could it be that the deadly virus spreading across China stops the buying frenzy in stocks? The first U.S. case was reported Tuesday.” Please see “How an external event could stunt U.S. stocks.”
• The chart shows that, last week before the stock market drop, The Arora Report gave a signal to raise cash and hedges. Our portfolios are now up to 63% protected.
• The chart shows that The Arora Report also gave a signal to short-sell Nasdaq 100 ETF QQQ, -2.07% prior to the stock market drop. For those who could not short, a signal was given to buy inverse leveraged ETF SQQQ, +6.17%. SQQQ goes up when the stock market goes down.
• The chart shows that the trend line that has been in place since October has now broken. This should be of concern to the momo (momentum) crowd and short-term traders but should not be of concern to long-term investors.
• The chart shows the support zone. If the support zone is not held, that should be a concern to long-term investors.
• The chart shows relative strength index (RSI) divergence. The RSI divergence foretold the present pullback.
• Investors suffer from a recency bias. Please see “This 25-year stock market chart shows investors are under a spell of bullishness.”
• Today’s recency bias is that events similar to coronavirus are short-lived and stocks should be bought on dips.
• To counter recency bias, investors should look at the 1918 Spanish flu in which 30 million to 50 million people died and 500 million people were infected.
• Since 1918, both medical science and communications have dramatically advanced. These should help contain the virus. On the flip side, the world is more interconnected now and there is significantly more travel compared to 1918. Better communications help control the disease, but they can also be instrumental in creating panic.
• Scientists have already determined the genetic code of this particular coronavirus. This should make it possible to make a vaccine. However, a potential vaccine is several months away.
• It is conceivable that one of the existing antiviral drugs including those used against HIV may prove to be effective against this virus.
• Highly applicable here is Arora’s Second Law of Investing and Trading: “Nobody knows with certainty what is going to happen next in the markets.”
Be realistic
• The only realistic way for investors to deal with coronavirus is to think in terms of probabilities. In our analysis at The Arora Report, the probability is better than 90% that by spring this virus will be well-controlled.
• Even though the probability is low that this virus will become something more than recent virus epidemics, investors should not ignore this small probability.
• So far significant mutations have not been found, indicating that this is a recent virus. However, not enough is known about how this virus may mutate. Any mutation may have a major impact on the eventual result.
• Keep a close eye on statements from the World Health Organization. These statements tend to move the stock market.
• Typically when the number of new cases stops going higher, stock market starts going higher.
• A huge risk to the stock market is that this virus has come along at a time of extreme bullishness in the stock market. This is a negative. Please see “Extreme greed in the stock market is producing a bad setup as earnings season starts.”
Stocks and ETFs
• As important as the coronavirus is, earnings from mega-caps Apple AAPL, -2.94%, Amazon AMZN, -1.79%, Facebook FB, -1.41%, Google parent Alphabet GOOG, -2.24% GOOGL, -2.35% and Microsoft MSFT, -1.67% are ahead. If these earnings are less than stellar, look out below.
• Semiconductor stocks have been a leading indicator. Intel INTC, -4.06% reported great earnings. Please see “Intel shows the way for conservative investors in this expensive stock market.” Keep a close eye on semiconductor stocks such as AMD AMD, -2.16%, Micron Technology MU, -4.07%, Nvidia NVDA, -4.10% and Applied Materials AMAT, -4.76%. Please see “This U.S. company will benefit as China tries to catch up in semiconductors.”
• Tesla TSLA, -1.20% stock has been an epic short squeeze. How this short squeeze behaves will be an early clue. Full disclosure: Based on our algorithms, one of The Arora Report’s services took a short position in Tesla close to the recent top.
• Keep an eye on oil. An easy way for investors who do not watch futures is to watch ETF USO, -2.84%. Full disclosure: The Arora Report has a position in inverse oil ETF DWT, +8.39%, which goes up when oil goes down, and also a short position in USO. Oil can also often be an early clue for the stock market.
• Keep an eye on the difference between the movement in gold ETF GLD, +0.69% and silver ETF SLV, -0.12%. In theory, gold should be going up if the crisis worsens because of safe-haven demand. Silver has a higher beta than gold. However, silver in theory should be going up less than it would normally or even maybe going down because silver is impacted by economic activity.
• In addition to protecting long-term portfolios, adding to positions as stocks and ETFs fall into Arora buy zones within the constraints of prescribed cash and hedge levels, investors may consider taking advantage of short-term trading opportunities. Please see “How and when prudent investors ought to buy these 5G stocks.”
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.
