US Stock Markets Tank 30% – Will the Meltdown Continue?

The risk of a sudden stop in global economic activity, due to the coronavirus outbreak and the recent oil shock, had prompted massive selling in the US stock markets, with all three major indices tanking by approximately 30% until March 12th. Right now, the market is dominated by fear and without an end in sight, the worst-case scenario continues to be priced in.

What could turn the tide?

So far, the US Federal Reserve had cut its benchmark interest rate by 50 basis points and just had announced three rounds of 3-months repo operations that will inject 1.5 trillion dollars in liquidity. That confirms all major banks are facing serious challenges and with assistance from the Fed, could things turn the other way around?

Although the massive drop is easily understandable due to deteriorating economic prospects, it does not mean markets will go to zero. From a technical point of view, the likelihood of a sharp rebound is very high, given the current extreme oversold conditions. In the longer-run, we might witness continues pressure on risk assets (stocks), but the short-run favors a technical rebound, or “dead cat bounce” as analysts like to call it.

It is true that gold and bonds had outperformed, confirming the strong demand for safe assets, but same as 2008, when the global financial crisis started, the massive drop in yields had been followed by a strong rebound. CFD traders must understand that market participants are not always in sync with what happens in the economy at any given time. Institutional investors are allocating capital based on their expectations for the future.

A recession or depression ahead?

Stock markets had always acted as an early signal for what lies ahead from an economic standpoint. The 30% drop and the VIX (Chicago volatility index) standing at 70, we will surely have a recession in 2020 or 2021. The issue, though, had to do with the huge amount of debt outstanding at a global scale.

The world hadn’t seen such a high level of indebtedness since WWII and the same as it happened then, a period when the debt had to be reduced had occurred. Depending on how things will progress in the near term, the same thing could happen during the next 2-3 years. We could be at the end of a long-term debt-cycle, as Ray Dalio, a famous US investor, in claiming, and the economic implications will be severe if that turns out to be true.

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