February 25, 2020

Coronavirus & Markets Update

By Michael McKeown, CFA, CPA - Chief Investment Officer

Coronavirus & Markets Update

Global equity markets sold off by 3.5% on Monday as investors reacted to more news on the Coronavirus. The S&P 500 Index was at all-time highs three trading days prior.  Safe havens, including gold and treasuries, climbed in price.

The concern for human health and life is, of course, the most important aspect of this tragedy.  Still, to the extent it affects daily activity, it does have a real economic impact.

Cases have been rising in China throughout the past two months.  Apple announced last week that its supply chain would be disrupted.  It took the announcement of 7 deaths in Italy for investors to respond this week.  Investors fear that supply chains in Europe could also be affected if the virus spreads.  More cities on lockdown around the world would lower growth expectations further.  Travel restrictions and other measures are already affecting many people and businesses.

Source: John Hopkins University

Many market strategists are comparing the current virus outbreak to previous episodes, such as SARS in 2003 in China.  We have looked at models comparing past outbreaks and pandemics with market performance but know that history does not always repeat itself.  The sample size of similar outbreaks is small and we recognize this as an ‘unknown, unknown.’ The severity and duration of the coronavirus cannot be predicted by the past.

This strand of the coronavirus is similar to influenza viruses.  According to experts, however, what makes Coronavirus unique compared to more recent outbreaks is that its symptoms do not become apparent for many days. This allows the potential for greater infection among the population.  Still, the fatality rate is less than 2%.  Many governments and companies are working on a vaccine; however, it would likely take over a year to produce, even if it was viable.

The number of confirmed cases in China has begun to plateau.  Of course, many suspect the data reported from China may be understated.  It may be weeks or months before data from around the world also begins to slow down.  There has been an increase in the rate of recovery, a clear positive.

Source: John Hopkins University

What are investors to do?

Even if we knew the dollar amount that earnings would fall due to the Coronavirus, it does not mean there exists a timing tool to get in and out of the equity markets profitably.

On average, stocks experience a 13% peak to trough fall in prices every calendar year.  The reasons vary.

The year-to-year return premium that stocks offer over bonds is quite volatile.  We can see calendar year results of down 50% to up 50%.  Investors earn those long-term returns of 10% from stocks for enduring the year-to-year volatility. 

The long-term value in stocks is in the terminal value of businesses.  This value is mostly attributable to cash flows and earnings from greater than five years out.  The short-term business results matter, but not as much as the results further out. As Ben Graham said, “In the short-run, the market is a voting machine.  In the long-term, it is a weighing machine.”

Building liquidity into portfolios for times like these is important.  Our mantra the past few years has been to ‘make sure bonds act like bonds.’  What this means is that we want the bonds in portfolios to be available to rebalance into stocks when those depressed prices inevitably come about.  We do not want to see bond portfolios selling off in tandem with stocks.  High yield bonds were down 1% on Monday and would be an area to consider if yields increased. 

Our objective is maintaining flexibility while sticking to investment plans.  This includes dollar-cost averaging and prudent rebalancing.  Our historical data and analysis show the process works, and it remains our focus.

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