During the coronavirus crisis, Stock Indexes have been dropping for days. Theoretically, the markets made revisions on cash flows and returns. Based on those revisions they calculated new intrinsic prices for the stocks. Of course, none can predict exactly what the future holds. It is a very uncertain situation and that increases risk which lowers values.
Some panic may also have happened. Market values are not always equal to intrinsic values. Panic leads to undervaluation while excessive optimism to overvaluation. It is possible that stocks were overvalued. There are four different values.
undervalued P2 - intrinsic P2 - intrinsic P1 - overvalued P1
where P2 is new price after and P1 previous price before
The drop of stock prices will continue all the way from overvalued P1, pass intrinsic P1, pass intrinsic P2 until they reach undervalued P2.
It is not only panic that leads to undervaluation. Intrinsic values should guide the movement. What determines a stock price is the guess on which direction it will move. This is reinforcing the upwards or downwards move. Suppose that the stock price has reached new intrinsic price. If an investor guesses that it will continue to drop and can’t or doesn’t want to hold the stock till the rebound, he will sell. Most likely there will be a rebound. It will be the opposite picture of what we have seen during the downwards movement. Prices will be going up for days. Probably they will not reach the previous prices but may come close.
This will only happen when things stabilize, shut down stops, a drug for treatment has been found and vaccine is on the way. There will be revisions on cash flows and returns and a new intrinsic P3 calculated, between intrinsic P2 and intrinsic P1. Market prices will most likely pass intrinsic P3 and be overvalued. This is what happens to upwards movements. Momentum leads to overvaluation which could be tiny, small, medium, big or huge. This opposite happens to downward movements, they lead to undervaluation.
So, prices will start from undervalued P2, pass intrinsic P2, pass undervalued P3, pass intrinsic P3 until they reach overvalued P3.
undervalued P2 - intrinsic P2 - undervalued P3 - intrinsic P3 - overvalued P3 - intrinsic P1 - overvalued P1
“Smart money” will make lots of money. They took a short position at the peak and will take a long position at the bottom. A long position is betting on prices rising. The question in this case is if “smart money” is also “dirty money” meaning that there may be a “dirty trick” behind the spread of coronavirus.
We know what is going to happen in the end. A drug and a vaccine will be found and things will get back to normal. What we do not know is when this will happen, what things will happen till that time and what impact they will have on the economy. There is absolutely no doubt that the economy will suffer but this is not depicted correctly by Stock Indexes' movements.
Stock prices are to a large degree based on expectations but real economy is also affected by expectations to a smaller degree. Airlines will see a sharp decline on their income. If they would adjust expenses immediately they would have no problem. The think is that they can’t. They still have to pay salaries, rents, loan installment. Even if they could, they would still have to operate below break even point. Other companies face similar situations. Airlines is an extreme example, easy to understand.
Coronavirus pandemic is a strange situation. It is possible that things will go back to normal when a drug and a vaccine have been found. Things may be even better than before. People may want to catch up with what they missed during the shut down, going out, traveling, shoping etc. They may even want to enjoy life more since all came close to death because all had a chance of not making it. Those that are laid off will cut down consumption though.
One “crazy” idea that may work is to defer all payments for the months the crisis lasts. That would have to be universal otherwise it will not work. If airlines and other companies can defer payments, they will not become insolvent and will not have to stop operating. This means that employees will not get paid so they will not be able to pay rents, loan installments, etc. Those should be deferred as well. This goes on and on and becomes universal.
This will also allow an almost total shutdown for a short period of time that will help combat the virus. Only the absolutely necessary will be operating like supermarkets, hospitals, pharmacies, tv stations, telecommunications providers, gas stations, police etc. It will be like the world stopped for a while and started again from the point where it stopped. It will be like pausing a movie on VCR and then starting again. During the stop period there will be a huge drop in GDP but it will rebounce right away.
Should USA elections be postponed? Can we have the superpower in an election period during a global crisis of such magnitute?