2020-02-06

That 1998-1999 Analog Again

At the bottom of the 2018 decline I wondered, could it be 1998 again? What a Tantrum, Is 1998 in Play? Things were proceeding somewhat similarly by May: 1998 Redux: Bonds Not Behaving Yet, 1966 Rising?. The Federal Reserve wouldn't go "full 1998" until October 2019, when it started doing repo operations and expanding the balance sheet. That move lines up with 1999 though, when the Fed eased on Y2K fears.
Here's the 2019 analog with QQQ:
To press the inexact analogy, coronavirus is the new Y2K. Clearly these are different issues, but they absorb attention. Both are unknowns. There was concern about what would happen when the year 2000 started. Companies were spending money on the problem. COBOL programmers were being paid. Today, we don't know how long the Chinese economy will be hampered. Companies have shut their doors or announced delays in production because of supply chain problems.

Analogs tend to play out because of higher order factors though. History doesn't literally repeat. History rhymes because human nature and human psychology do not change. What's going on when bull markets enter their final phase? I'm reminded of the line from The Matrix when Agent Smith tells Morpheus that the early versions of the matrix were a paradise, but humans were waking up because they realized it was a false reality. Similarly, let me posit that even bullish investors start having a nagging feeling that the good times can't go on. Y2K and now coronavirus become this great fear that causes authorities such as the Federal Reserve to overreact. Their actions to keep the bull market alive in the face of a threat become the factor that brings about the bull market's suicide.

In 2000, it was the turn of the calendar that revealed no apocalypse. Stocks ran into March, the Fed announced it would no longer provide liquidity, and then it was all over. If the analog fits and coronavirus proves to be an overblown risk, stocks will rally off their highs with the Fed providing liquidity. Supply chain disruptions in China will create pricing pressure later this year. The Fed will turn hawkish, either discuss rate hikes or announce the end of repo, and the advance will terminate.

More immediately, if the analog holds, there's still a great deal of stock-specific risk should companies announce an earnings hit from coronavirus. The hit won't come until the April reporting season, though firms could warn earlier. The market has not priced this risk in, outside of sectors directly hit such as Macau casinos and airlines.

Here's an example from 1999, in the midst of the melt-up. IBM share plummeted 19.3 percent on Y2K fears and an earnings warning.

Wired: IBM's Y2K Fears Drop Stocks
Wall Street was stunned by news that the world's biggest computer maker, IBM, will have poor earnings in the fourth quarter and the first quarter of 2000. IBM, one of the 30 Dow components, slumped 21-3/4 to 91. The company posted mixed third-quarter results due to slower spending as big clients made fixes related to computer problems associated with the year 2000.

But more importantly, IBM warned of much lower than expected earnings into early next year.

..."I think when IBM said it would take a couple of quarters to get over the Y2K problem, it bothered a lot of people. I just believe the Street is interpreting that there are deeper problems," said Charles Payne, head analyst at Wall Street Strategies.

Payne said despite a slew of strong earnings from top companies, firms reporting profits a penny or two above consensus estimates "are being greeted with a yawn."
I highlighted the drop in the chart below:
The Federal Reserve was on everyone's minds too:
"Those statements that the Fed is not going to target asset prices suggests the market doesn't have to worry about Fed tightening if the market goes higher," Ascani said. "It probably helped the market. The Nasdaq just didn't want to give up its gains."

At a gathering of financial analysts, Kelley said he was concerned that the nation's tight labor market might lead to a boom-and-bust cycle in the US economy. But he said the Fed's primary responsibility was to tailor its interest rate policy to conditions in the overall economy and that targeting asset prices is "not the business that we're in."

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