On March 09, 2020, the Dow Jones Industrial Average (DJIA) hit the lower circuit for the first time since 1997. The triggers for the crash in the Dow were multi-fold. Firstly, the rapid spread of the Coronavirus led to the global pandemic assuming larger dimensions. That is seen as a clear dampener for growth. Secondly, US bond yields have fallen to the lowest level in 150 years. For the first time in US history, all bond yields (up to 30 years maturity) are quoting at a yield below 1%. Lastly, the oil prices crashed by nearly 30% on March after the OPEC-Russia supply deal fell through. Saudi Arabia’s plan to flood the markets with cheap oil led to a crash in oil prices.
Chart Source: Bloomberg
First, let us look at a brief history of circuit breakers in the US stock markets.
Circuit breakers in the US markets over the years
The need for a circuit breaker was first felt in the aftermath of Black Monday in October 1987 when the Dow crashed by over 20% in a single day. Post the crash, the exchange authorities adopted market-wide circuit filters to prevent panic like on Black Monday. However, the circuit was triggered for the first time exactly 10 years later. October 1997 saw the Dow circuit triggered at the peak of the Asian crisis. But, that circuit filter was in value terms; not percentage terms. The shortcoming was highlighted when the circuit filter failed to prevent the fat-finger flash crash in 2010. Subsequently, in 2013 the US stock exchanges shifted to percentage circuit filters. Now there are 3 levels of circuit filters on indices viz. 7%, 15% and 20%. At 20%, trading is halted for the rest of the day. On March 09, 2020, it was the first 7% circuit filter that got triggered, leading to a 15-minute trading freeze.
How serious is the drop in the US markets?
There are two ways to look at the fall in the US markets. If you look at the Dow, the (2014 points) crash on March 09, 2020 was the largest single day fall in the history of the Dow Jones. However, if you compare with previous falls in percentage terms, this is nowhere close to the Black Monday of 1987.
A quick glance at the above chart tells you that sharp falls in the US markets have been clustered. In the above chart there are basically 3 clusters; the Great Depression of the 1930s, Black Monday 1987 and Lehman Crisis 2008. From that perspective, it is likely that the Dow could create a cluster in 2020 and make way for more sharp cracks in the market.
What does this fall mean for global markets?
According to a report in Fortune, the Dow Jones Index is just 210 points away from a full-fledged bear territory, described as a 20% fall in the index in a short span of time. Of course, this comes on top of a 30.43% return in 2019. With nearly 90% of the gains of 2019 wiped out, there are some serious thoughts for the future.
The Coronavirus has exposed the dependence of world economies on China. Both on the demand and supply side of the value chain, China has proved it is pivotal. That is explained by the fact that even European markets were down 7% on 09th March 2020.
If 1987 was a case of too much insurance in the market, the crash of 2020 was about too much optimism. It is hard to explain a 30% return on the Dow in 2019 when the economy was struggling to grow at 2.5%.
The inverted US yield curve (3-year yields above 5-year yields) has been hinting at deflation for some time now. Apart from the sharp fall in yields, it is the sharp fall in oil prices that reeks of a slowdown. After all, “liquidity can get indices to the top, but cannot hold it there”.
What does this mean for India? Historically, Indian markets have bottomed out when oil prices have crashed. This was true in 1991, 2003, 2009 and 2016. With a ~85% dependence on crude imports, this could be a big trigger for Indian markets.
Continuing on the India story, the narrative from here on could be more about mid caps than about large caps. After all, the large caps are still vulnerable to weakness in oil prices, commodity prices and GDP growth. Mid caps, on the other hand, could actually benefit from these 3 trends.
The sharp crash in the Dow has reopened the debate about too much liquidity chasing too little growth. That is the fiscal challenge to contend with!