COVID Crash Curriculum

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COVID is a time many of us would like to forget.

But there are lessons buried in this chapter of history. Ones that are surprisingly relevant today.

Let’s explore how stocks reacted to the pandemic, and see what we can apply to today.

The Beginning

On January 23, 2020, China completely locked down the city of Wuhan, home to 11 million people.

Wuhan was where the virus originated. And with hindsight, we can see this lockdown was a sign of things to come.

Take a look at the chart below. It shows the S&P 500 performance from Dec 31st 2019 to March 22nd 2020. The dawn of the pandemic.

Source: Yahoo Finance

Throughout the early part of 2020, COVID-19 was widely known. But it was thought to be a Chinese problem. We shut down most flights from China, and investors considered the problem solved.

The selloff in U.S. stocks didn’t begin until February 20. Interestingly, the market peaked just one day before stocks began to crash.

What was the catalyst for the market collapse? COVID cases soared in Italy, Iran, South Korea, and elsewhere. The market began to realize that this virus was going to cause problems on a global scale.

Here’s a longer-term chart, which shows just how sudden and violent the COVID crash was.

Source: Wolfstreet.com

About a third of the S&P 500’s market cap was wiped out in a month. It was one of the most brutal selloffs in history.

Of course, the recovery was also remarkably fast. The Federal Reserve slashed interest rates to zero in record time. The U.S. government gave out trillions of dollars in PPP loans. Stimulus checks went out.

The S&P 500 had fully recovered within 4 months. And it went on to continue to set new all-time highs, despite the lockdowns causing massive economic damage.

We entered a period of wild speculation which led to meme stocks, a crypto revival, and an explosion in the popularity of gambling.

COVID Learnings

So, what lessons can we take away from COVID?

The first is that it can take a while for markets to digest things. China locked down the entire city of Wuhan on January 23rd. It should have been clear from that point that this virus was going global. But it would be another month before stocks began to fall.

Secondly, governments can make a bad situation worse. The COVID lockdowns had limited effectiveness. 97% of people ended up getting the virus anyway. Gobs of money printing cushioned the shutdowns, but also spiked our debt and caused the highest inflation we’ve seen in decades.

Third, modern stock markets are psychotic. Despite the fact that the entire world was shut down for more than a year, stocks repeatedly soared to all-time highs. We’re in an extended mania period.

Below is a longer-term chart, covering the COVID period to today. Note how the pandemic crash looks like a tiny little dip in the rear view mirror.

One interesting note is that in 2022, markets crashed again, with the Nasdaq falling around 36%. But then ChatGPT came along, spawned the AI bubble, and today we’re even higher.

My feeling today is that we should not attempt to fight this market by being overly bearish. I have a few hedges (long-dated puts) in my portfolio, but as I’ve said, they are a very small allocation (around 1%). I view small hedges like this as an insurance policy. If they’re ever needed, it’ll be much appreciated.

But still, this market is clearly irrational. Trying to time its downfall is tricky. So having too much downside protection is risky.

The bulk of my preparation isn’t puts and shorts. Over the past few years I have significantly reduced my exposure to most American stocks, which remain at nosebleed valuations. In crashes, more expensive stocks tend to fall a lot more.

In this environment, I much prefer natural resources, emerging markets, and precious metals. Hard assets that will hold value through inflation and market chaos.

If we do get a crash, these assets should fall a lot less. And the upside remains strong.

2026: Energy Crisis Edition

Today feels a bit like the early weeks of COVID.

Everyone knows there’s a potentially massive disaster a few months out. But the market is partying like it’s 1999.

The Strait of Hormuz remains closed. The war with Iran could restart at any time.

We know the energy shock will hit Asia and Europe first. They import a huge portion of their energy from the Middle East, and the bulk goes through the Hormuz.

Americans assume we’re bulletproof because we produce our own energy. This simply isn’t true. Higher fuel prices are already hitting American consumers hard.

And in today’s globalized world, everything is interconnected. Fertilizer plants in the Middle East and Asia are shutting down due to a lack of feedstock. As are plastics plants. This WILL affect us.

The world economy is teetering. And stocks are soaring to new highs. Meanwhile U.S. consumer sentiment just hit a new all-time record low.

It makes me extremely uneasy.

But for now, all we can do is prepare our portfolios for what may lie ahead. For me, that means a healthy amount of cash, and plenty of investments which should fare well in an inflationary environment. Assets that will hold up better in a crash scenario.

We’ll continue to explore this strange market in the days and weeks ahead.

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