In recent days, the US financial market’s relative calm has fallen victim to rising fears relating to the coronavirus – more technically referred to as covid-19. In just two days, the S&P500 and Dow have “skinnied” by more than -6% and the loss over the last week roughly -7.5%. Many international markets are down even more sharply, especially amid already weak or recession-like economic data. This is a stark contrast from the very attractive gains the market was enjoying in February as the narrative around the new virus seemed to be calming/contained from when it first began hitting newswires a month ago.
On the surface, the current coronavirus worry may appear irrational. Information on how it is spread and just how deadly is may be strike us as relatively light on detail; but the public’s fear is growing based on how the narrative by both the media and health officials focuses mostly on the number of infected and how many lives so far claimed. Hard to find are stories that place those numbers in context of other better known health risks like the common flu or pneumonia (which covid-19’s symptoms apparently are very similar); and when one reviews details of other known viruses or past scares, the current coronavirus actually seems both less common and less deadly than say the flu, which claims thousands of lives in the US and elsewhere each and every year during this season. But we are not health experts, and it is entirely possible that no one fully appreciates the severity of the issue at this stage given how new and limited is the info (and perceived credibility of info source – aka China). The reality is that elevated uncertainty is almost never friend to financial markets in the short-run.
So with that investors must return to a focus on fundamentals for context about the likely path on the financial markets:
- Past health-related scares suggest that the economic impact of covid-19 will be transitory/temporary. Yes, there will be an economic impact, especially with many governments responding in an outsize way via quarantines and travel restrictions. Global supply chains are being disrupted.
- The US is often viewed as a safe-haven both from an investment perspective and also an economic perspective. This is causing money from around the globe to move toward US save-haven assets like treasuries; and this flow is swiftly distorting the shape of our yield curve back toward inversion (recall, many look to the yield curve as a reliable advance indicator of recession).
- Yield curve inversion is quickly renewing focus on the Fed and short-term interest rates. The Fed would prefer to remain on pause in 2020 amid an election year AND otherwise sound economic backdrop (pre-coronavirus), but the market is quickly suggesting it is again too tight.
- The recovery/upswing in US corporate profits that appeared materializing with the release of 4Q earnings in Jan + Feb is likely now being pushed back.
- Any contraction from coronavirus is likely to result in a snap-back effect as the virus becomes contained and supply chains and consumers need to catch-up on lost time. In other words, a V-shaped recovery if the current worry is short-lived (couple more weeks).
- With interest rates plumbing all-time lows there are several stimulative effects and implications:
- Odds of a housing boom are rising. Quickly, almost every individual could explore a home refinance and experience interest savings (and improvement to their budget). And lower rates improve housing affordability in a market that remains skinny on supply relative to household formation. Housing is an area of the economy that provides very direct trickle-down effect on lots of other industry/activity.
- The yield on treasuries and bonds is again below the average stock’s dividend yield. Historically this is a strong “buy” signal as investors observe that even ignoring superior growth potential of stocks, the recurring yield from stocks is more attractive than “safer” assets.
- Several technical indicators are already signaling the selloff experienced over recent days is overdone (too much, too fast). This is especially true within a more established up-trend. That is not to suggest the market will enjoy a sharp recovery the short-term, but the most intense selling pressure may already have occurred.
- Election year politics keep uncertainty elevated, especially with such a different-mindset candidate currently leading Democratic primaries. History still shows however that it matters less who wins a Presidential election and more about the underlying trajectory and fundamentals of the economy.
As coronavirus appears to either peaking or slips from the spotlight (that the world is not ending), we suspect the recent flight to safe-haven assets and strong appreciation of the US dollar may quickly reverse. If/as that would occur, it is conceivable that international investments are poised to more strongly rebound (aided by appreciating foreign currencies); cyclical areas of the market like financials and energy will enjoy more robust recovery; and the presently inverted US yield curve will re-steepen. Again however, the longer the coronavirus fear and outsized governmental caution persists, the damage to the global economy increases. Historically, epidemic scares proved both transitory (short-lived) and buyable events producing attractive forward returns to investors willing to take a longer-term view.
We hope these comments are helpful. We maintain that clients who are invested and have “buckets of time” directly synced with the time horizon and purpose of the money invested are in good position to weather this current scare and need not abandon their current approach. We also are pursuing a risk-dialed down and intentional approach. As Warren Buffet is often quoted, “be greedy when others are fearful, and fearful when others are greedy”. Buckets of time investing enables you to stay the course and look beyond current worries.