By Nigam Arora
Stock market investors are watching the coronavirus spreading far beyond China.
It is no longer mostly in Asia. Italy has reported six coronavirus deaths and an accelerating number of cases. At a time like this, it is nice to see Berkshire Hathaway’s /zigman2/quotes/200060694/composite BRK.B -0.72% Warren Buffett assuage investors. Buffett‘s advice — don’t buy or sell on the headlines — is especially applicable now.
There is a gem in Buffett’s annual letter , which was released over the weekend, that nobody is talking about. He writes: “ Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater.” He continues that the combination of what he calls “The American Tailwind” and “compounding wonders” will make equities “the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware!”
Let’s explore this issue with the help of a chart.
Note the following:
• Take a close look at the scale on the right side of the chart to fully visualize how far this stock market has come since the point marked as an Arora buy signal in March 2009.
• The stock market bull is now over 10 years old. Investors are suffering from a recency bias. Please see “This 25-year stock market chart shows investors are under a spell of bullishness.”
• Many investors simply cannot come to terms with the idea that there can be a substantial pullback in the stock market. Buffett is clearly aware of, and accepting, of such a scenario. There is a probability of 25% of a major pullback. No one rings the bell at the top. Before you send me hate mail, keep in mind that immediately after Donald Trump’s election, The Arora Report gave a buy signal at a time when most analysts were predicting a big fall in the market. Shortly thereafter, I called for Dow 30,000. Please see “Here’s the case for Dow 30,000 in Trump’s first term.” The Arora Report also gave a buy signal in March 2009, which turned out to be the start of this bull market.
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• If the market goes down, it will not do so in a straight line. Investors ought to pay attention to the support zones shown on the chart.
• The first support zone shown on the chart is the zone of recent congestion before the latest breakout in the stock market.
• The second support zone shown on the chart is around the low point in December 2018 when the stock market had fallen about 20%. The chart shows the Arora buy signal on Christmas Eve 2018, which turned out to be the low.
• The third support zone shown on the chart is around the zone from where the stock market took off after Trump’s election.