Economy is like a machine, which has multiple interlocked gears that need to function in harmony. As Ray Dalio explains in How the Economic Machine Works, anytime there is a problem in one gear, the other gears will be affected by that problematic gear, and the machine will eventually break. Coronavirus has caused many supply chain problems because Chinese towns and factories remain shut down to curtail the spread of the virus. As Chinese manufacturers are key supply chain players in many industries, these shutdowns result in a slowdown in global growth. In this week’s blog post, I will talk about if coronavirus is the black swan that will take down this aging bull market.
First, let us talk about globalization. According to Investopedia, globalization is the spread of products, technology, information, and jobs across national borders and cultures. In economic terms, it describes an interdependence of nations around the globe fostered through free trade. After globalization, all the domestic bottlenecks associated with running businesses were kept at bay. Even though globalization prevents domestic bottlenecks and uncontrolled inflation, it did cause us to be overly dependent on China for manufacturing. Said differently, with Chinese factories shut down, we have run into an international bottleneck. This means that we are likely to see a rise in inflation as US companies try to find other “more expensive” manufacturing options. As manufacturing costs increase, the prices you see for goods at your local Walmart or Target are likely to rise as well. With this increase in prices, you, the consumer, are going to feel your pockets being squeezed. Since you are left with less money to spend on other things, the economy starts to slow down. At this point, companies start reporting lower revenue and profits, and consequently, the hiring slows, wage growth stagnates, and unemployment possibly rises. This is the time when the stock market panics and realizes that a recession could be right around the corner.
Now, you might be thinking that the Federal Reserve said that it would lower interest rates to support the economy. Yes, lowering interest rates incentivizes people to borrow and spend more money, which helps stimulate and grow the economy. However, lowering interest rates is not going to solve the supply chain problem i.e. it is not going to lower the cost of production and the prices you see for goods at the store. In fact, interest rates and inflation are inversely related. In other words, as interest rates decrease, inflation increases. The Federal Reserve would have to decide if it wants to increase the money supply and stimulate growth, or bring inflation down. It can not resolve both the problems at the same time. Personally, I do not think that we would see very high inflation, but again, stagflation always remains a possibility. Stagflation is a situation with persistent high inflation combined with high unemployment and stagnant demand in a country’s economy.
Coming back to the question: Is Coronavirus The Black Swan For The Stock Market? If this virus outbreak is not contained, then yes, coronavirus would cause a slowdown in global economic growth, and likely push the United States into a recession. Until this supply chain problem is fixed, the stock market is likely to go lower before it goes back up.
Hope you learned a little and found this blog post helpful. We talked about uncontrolled coronavirus outbreak that could end this aging bull market, and potentially push the United States into a recession. As always, you can sign up for our free mailing list here. You can sign up for our paid subscription services here. Like us on our Facebook page here. Thank you!
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