A few notes from last time before diving in … there’s many ways to talk about “the stock market”. The three most common indices are NASDAQ (comprised of technology stocks), the Dow Jones Industrial Average (“the Dow” – composed of 30 large stocks meant to represent various industries) and the S&P 500 (a group of 500 US companies that Standard & Poors, a Moody’s competitor, compiles and tracks). My preferred method is to reference the S&P 500 because I think it provides the broadest view of what is going on in the economy. The S&P 500 contains all the household names you’re familiar with like Apple and Facebook all the way down to companies you likely have never heard of and would probably guess are fake (what do you think Zebra Technologies makes?) Of course, the list changes as S&P sees fit, and the company has certain criteria for inclusion, but that makes sense because business turnover is a vital part of why the US economy is so strong. The old die out, and the young take their place. Because it’s such a commonly tracked index, there are several exchange traded funds (ETFs) that attempt to mimic the performance of the S&P 500. A few of them are SPY, VOO, and IVV — for our purposes, there aren’t any real differences between the three. Let’s take a look at where SPY has been trading recently.
Ouch. So last time, when I mentioned buying SPY puts, I was talking about my strong belief that the value of S&P 500 companies was going to fall in the near term. Let’s explain buying/shorting stocks and compare that to buying options. The most common way to make money in the stock market is to buy low and (AUDIENCE?) sell high. Correct. There’s another way you can do the same thing, just in reverse timing, which is called shorting. With shorting, you sell high and then buy low. To do that, you borrow the stock from someone who owns it and return it when you’re ready to cash in your profits (or, more likely losses … shorting is hard). Well, if buying stocks and shorting stocks are addition and subtraction, option contracts are multiplication and division. With options contracts, you’re doing basically the same thing as buying and sell stocks, but the consequences are more magnified. Buying put options lets you lock in a price to sell your shares, so if the value of your shares drops, you make money. Here’s a bit more on puts if you’re interested. So this is all great, Chris, thanks, but does this actually matter to me or anyone I care about? Well, sure. Say your uncle worked for Ford all of his life and now receives his pension through the company. What happens if Ford, currently trading at just $4/share, which is down from a high of $16/share back in 2015, goes bankrupt? Say goodbye pension, and sorry about your luck, uncle! It’s not like your uncle can just go get a pension from some other company, he’s stuck with Ford covering his retirement income. If he was astute, he could buy and roll put options on Ford, so he at least has some protection against losing his pension should the company go bankrupt. In this way, put options can be seen as insurance. You’re paying money up front to protect yourself from some negative event — in this example, the risk that Ford stock collapses. By the way, for the prediction crowd: I think Ford will declare bankruptcy before 2020 is over, so go ahead and buy those puts, uncle. You’re going to need them. 1
Let’s talk exponential growth. Quick, without looking it up, do you know what the definition of exponential growth is? How would you describe it if you were trying to be as precise as possible?
You may be a little perplexed, and that’s ok, because writers talk about exponential growth the same way they talk about something being decimated. If you know the origin of decimation, where Romans would kill one in every ten soldiers to boost morale (or unboost mutiny?), you’re probably confused when writers talk about something that was decimated falling by more than 10%, but that happens all the time. Exponential growth, by definition, is something growing at the same rate of return over time. So, if you have $100 and you’re growing at 5% exponentially, you’ll have $105 next period, then $110.25 the next period, then $115.76 in the period after that. Three periods of growth and you have less than $20 more…doesn’t sound like much for being “exponential,” but that’s how this kind of growth works. It never looks like much, until suddenly it does.
Confirmed coronavirus cases in the US. By the way, how much money would you have after 300 periods? $227 million.
If you want to understand the stock market and you want to make a lot of money investing, you have to understand and appreciate exponential growth because what doesn’t look like a threat today can become a problem tomorrow, which turns into life as we know it over by Friday. That’s essentially what’s happened with coronavirus. At the risk of making everyone’s day worse, let’s think two weeks ahead. What does the graph above look like? As of March 28, we have 124,000 confirmed cases growing at 37% per day in March. Where are we by April 10 (just two days before Easter, when Trump wants the economy back firing on all cylinders)?
Many people are half jokingly referring to March 2020 as a decade unto itself. April will be worse.
8.7 million cases. Not good at all. What are the bright spots? The bright spots are we have the ability to reduce the spread of the disease. Earlier this week, #staythefuckathome was trending on Twitter. Simple, powerful, true. Look at this model of cases in California.
Forget the economy and markets. What is this graph saying? If we do nothing, California will require 800,000 hospital beds by the end of April. The state has significantly less than 100,000 beds. With social distancing, that peak hits about 375,000. With a full shelter in place order — something Americans would likely not comply with and something our federal government likely would not enact — California might get through this unscathed. Unlucky the beginning of that sentence means the end is not happening.
Other bright spots? Well, getting cash in Americans hands was the right idea. I have rarely agreed with anyone in the Trump administration, but Treasury Secretary Steven Mnuchin had it right: Americans are being forced to not work and their bills are not stopping, so they need money, now. Unfortunately, the cash will likely not reach any Americans before several weeks has passed. Additionally, the cash payments represent just 15% of the relief bill that Trump has signed. Where is the rest of the money going?
About $260 billion will shore up our unemployment fund as 3 million Americans, the most ever in history, filed for unemployment benefits last week. By the way, if you think looking at the coronavirus graph two weeks ahead is depressing, build a graph of what you think unemployment might look like. Some estimates are 75% of restaurants will close. Not just Cheesecake Factories. 75% of all restaurants. Anyway, $340 billion is going to state and local governments. $350 billion to small business loans, and, of course, $60 billion as requested by the airlines. Oh wait, that amount won’t be enough? Who could have guessed? I’ll do a post on moral hazard and perverse incentives before too long.
Side bar: We really are living in interesting times. Take a deep breath, write your feelings down, stare at your ceiling. We will get through this, and you will want to remember what the March 2020 You felt during these wild times.
I read a great one liner on the internet today. You don’t get hit by the bus you see coming. It’s fair to say in December 2019 nobody was expecting a pandemic to ruin the first quarter of 2020. But it’s also fair to say America did little to nothing with the warnings we had coming out of China. Had we acted sooner, the exponential growth curve of cases wouldn’t be so exponential and by “overreacting”, we could have saved an incredible amount of suffering. But we didn’t act. And now we have further to fall.
Forget folding@home, get used to eating@home: Opentable’s year over year reservations across their 60,000 restaurant partners have plummeted in recent days to -100%