After falling more than 600 points to close January in the red, the Dow Jones Industrial average opened February on the road to recovery. But as Wall Street greedily buys the latest stock market dip, one economist warns that investors could be making a fatal mistake.
This time, Mohamed El-Erian says, is different.
“Buying the dip” proved to be a lucrative strategy throughout the decade following the financial crisis. So it’s not surprising that investors are returning to this familiar tactic to cope with the coronavirus outbreak.
By 11:05 am ET on Monday, the Dow Jones Industrial Average had rallied 301.4 points or 1.07% to recover to 28,557.43.
The S&P 500 raced 1.03% higher to 3,258.76.
The Nasdaq outperformed its peers, climbing 1.4% to 9,278.64 now that the dust has settled from the World Health Organization formally declaring the coronavirus outbreak a global health emergency.
Except the dust hasn’t really settled at all.
The coronavirus death toll has already blown past SARS levels and continues to swell, forcing Chinese officials to evaluate cuts to their 2020 growth forecasts.
Economists estimate that the fallout from the virus could drive China’s first-quarter GDP growth as low as 4.5% year-on-year [Bloomberg], which would be the worst mark on record. The ripple effects from that rapid slowdown would extend throughout the global market.
That leaves investors with a dilemma: Is the coronavirus outbreak the catalyst that knocks overextended stock market valuations back to conventional levels, or is it a temporary blip in an unstoppable bull run?
Dow Jones bulls believe it’s the latter. But Allianz Chief Economic Advisor Mohamed El-Erian argues that it’s the former [Financial Times].
By combatting stock market volatility so aggressively in the post-crisis decade, central banks trained investors to operate with a “fear of missing out” mentality.
But banks are running out of ammunition.
Europe’s powder has run dry, and the U.S. Federal Reserve doesn’t have much more room to cut interest rates without bringing them dangerously close to zero.
El-Erian warns that the coronavirus outbreak could trigger a “structural break” in a stock market where greed has run rampant for years:
The coronavirus…has the potential to constitute a structural break for markets: that is, a big enough shock that fundamentally shifts sentiment.
Previously, markets had been underpinned by the belief that central banks were always willing and able to repress volatility and boost asset prices. That fuelled investors’ fear of missing out on a seemingly never-ending rally.
As recently as this month, CNN’s “Fear & Greed Index” – a composite measure of investor sentiment – surged as high as 97 on a scale of 0 to 100, indicating “extreme greed.” By Jan. 31 – the day the Dow crashed 600 points – the index had plunged to 44.
For one day, at least, the stock market was ruled by “fear.”
This article was edited by Sam Bourgi.
Last modified: February 3, 2020 4:06 PM UTC