What a difference a week can make! After weeks of looking past the potential for the Coronavirus to decimate the global economy, markets have suddenly reversed course and now see the threat to the expansion as significant. Risk assets have sold off globally, with the S&P 500 dropping close to 10% in a matter of days, moving into negative territory for the year, and back to levels last seen in October. Meanwhile, US bond yields are at record lows, as investors rush to purchase safe-haven assets. Gold also rallied.
The Coronavirus outbreak has been unsettling, but we believe we need to keep the threat in perspective. First, the current market rout comes on the back of a year with incredible performance across all asset classes, making any pullback seemingly more dramatic. Let’s not forget, US equity markets gained roughly 30% in 2019 alone! Valuations were admittedly high in equities going into this year, so a drop back to more normal levels required very little to shake investors’ nerves. Second, fundamentals in the US have remained relatively steady, and regardless of the magnitude of the spread to pandemic levels, life will continue to go on. On the bright side, record low yields have spurred more housing demand, with low financing costs for home purchases. Additionally, business investment data has shown a pickup in the last quarter, with companies seeing growth prospects ahead. Meanwhile, employment and consumer spending remain robust, while corporate profits prior to the outbreak were seeing growth outpacing expectations. Of course, we cannot be blind to the potential for the demand and supply shocks the global economy will face, but these effects should be transitory in nature. Unless a prolonged period of shutdowns and supply chain disruptions lingers, economies should be able to weather this storm, particularly with the backing of central banks and potential fiscal stimulus. That said, several investment banks have now cut their profit growth forecasts to zero for the year, and many fear the risk of recession has moved higher. However, these same banks still predict the S&P 500 to be significantly higher by year end. It remains to be seen what the impact of the Coronavirus will be, but for now, risk markets are taking a get-out-now, ask-questions-later approach. We believe that specific industries and economies will be particularly hard hit, including travel, luxury goods makers, and potential hardware producers, particularly focused in China. That said, certain healthcare and pharmaceutical names, as well as in-home entertainment services, and other niches could benefit from the disruption.
At this time, we are considering reducing some limited exposure to equities, with the thought that there may be a more attractive entry point in the future as we foresee more pain ahead. Headline risks remain high, with the 24 hours news flow creating a pandemic of its own, sowing fear for the general public and investors alike. Despite the fact that this virus is significantly less lethal and widespread than the common flu, people are racing for cover, and this type of panic generally overreacts in financial markets. Fortunately, our long-term strategic allocations are purposefully built for events such as this, with downside risk protections in place. As a reminder, our goal for all portfolios is to participate in upside gain while minimizing significant drawdowns such as the one seen this week. Diversification and employing non-correlated assets to offset stock market declines is imperative, as unknown downdrafts can show up at any time. The events of this week have played out much as we would anticipate, with our more conservative models faring well, and more aggressive portfolios participating in the downside. Again, we encourage clients to maintain perspective, and remember that staying invested through several instances similar to this one over the last decade has proved immensely profitable. As always, we continue to remain extremely focused on monitoring unfolding market dynamics and reacting only when appropriate. Please feel free to call our office with any questions you may have.