The Coronavirus was largely unknown six weeks ago, but it has since morphed into a global phenomenon. At this stage it is hard to know if the media pundits are providing a valuable public service or are hyping a story for more viewers and Likes. Fortunately, we have sources like the Centers for Disease Control and the World Health Organization to give perspective. Through the end of February, there have been over 87,000 reported cases and nearly 3,000 deaths.
Panicked Selling: While the coronavirus has been a human tragedy, it has also negatively impacted global markets with waves of panicked selling. Equity markets have sold off hard based on increased reports of the coronavirus spreading outside of China. Although there are reports that the number of new cases in China is declining and Chinese workers are beginning to go back to their jobs, there is a greater fear of the economic fallout on a global basis. Ironically, equity markets first ignored the early reports of the coronavirus in January. During February, new records were set for the S&P 500, Nasdaq, the Dow Jones Industrial Average, and the European Stoxx 600. In fact, he S&P 500 set an all-time record high of 3,386 as recently as February 19, just before plummeting 13.0% in the next seven trading sessions. As an indication of the panic, The Wall Street Journal reported that this was the fastest decline on record from a record high to a correction of below -10%. Markets across the globe suffered similar declines.
Past Epidemics: Although it is difficult determine the global impact, the Severe Acute Respiratory Syndrome-SARS epidemic in 2003 reduced Chinese GDP by an estimated -0.8%. Analysis by Charles Schwab found that for the 13 global epidemic outbreaks since 1981, the MSCI World Index gained 0.8% in the month after the outbreak, and 7.1% after six months. Morningstar examined the companies that they followed after the SARS outbreak and found no significant long-term effect. In addition to SARS, other notable outbreaks that did not have a significant global impact include the avian flu in 2006, swine flu in 2009, Ebola in 2014, and Zika in 2016.
Forecasts: Recent analysis from Goldman Sachs and Deutsche Bank indicates that the virus will reduce Chinese GDP by -1.5% for the first quarter of 2020 and by -0.3% for calendar year 2020. US GDP is seen being reduced by as much as -0.5% in the first quarter and by -0.1% for the full year. On a global basis, GDP is seen down -0.2% for 2020. This analysis essentially sees a negative impact in the first quarter and then a recovery. Only time will tell.
History indicates that the market overreacts to short-term headlines and these outbreaks do not have a negative impact on longer-term performance. Nevertheless, the current coronavirus may prove to have a bigger impact because China now represents a much larger share of the global economy. Data from the World Bank shows that China’s GDP was at $1.3 Trillion in 2003 during the SARS outbreak and now GDP is $13.6 Trillion. In addition, global exports grew from $438 billion in 2003 to $2.5 Trillion in 2018. Finally, visitors from China to the U.S. grew from 157,000 in 2003 to 2.8 million in 2018. Consequently, there is much greater downside potential than in the past.
Chinese Economy: Although the Chinese economy appeared to be improving by the end of 2019, the coronavirus is clearly causing a downdraft. The Chinese National Bureau of Statistics reported that the official February manufacturing survey declined from a stable level of 50.0 in January to 35.7 in February, the lowest manufacturing level ever recorded. In addition, the official services data showed a decline from 54.1 in January to 29.6 in February. Although there are reports of Chinese workers beginning to go back to work and some recovery is expected, it is clear that Chinese economic growth will be significantly impacted.
Market complacency had become pervasive over the past 11 years. The U.S. has been in the longest economic expansion on record, and the S&P 500 has been in the longest bull market without a -20% bear market on record. It is important to remember that historically, market corrections (down more than -10% from a recent high) occur almost once a year and bear markets (down more than -20% from a recent high) occur every 4.5 years. Based on these averages, it puts the current decline in perspective.
Interest Rates: One notable aspect of the current market decline has been the precipitous decline in interest rates. The 10-year U.S. Treasury bond interest rate has declined to a record-low level of 1.13%. Part of this decline is due to concerns of weaker economic growth, but a flight to quality is a greater factor. When market participants grow fearful, they seek safe havens by buying U.S. Treasury bonds. These panicked purchases drove the price of the bond up and the yield down and caused long U.S. Treasury bonds to gain over 30% in the last year. As fears eventually subside, the price will go down and the yield will rise, setting the stage for huge Treasury bond losses.
Federal Reserve: In reaction to the coronavirus economic threat, the U.S. Federal Reserve is likely to reduce interest rates at the upcoming FOMC meeting on March 17th and 18th. The difficulty is that the Fed is best positioned to deal with weak aggregate demand, and the coronavirus represents a supply-side shock related to disrupted supply chains. Lower interest rates would help keep the U.S. dollar lower (to help maintain U.S. exports), but lower interest rates don’t create what is really needed-a vaccine.
Recovery: Although the U.S. is described as starting from a good place with solid economic fundamentals, it is difficult to know the ultimate outcome. Many economists see a V-shaped recovery, with a negative impact in the first quarter and then a second quarter recovery. If the coronavirus proves worse than expected (and worse than historic epidemics) then there may be an L-shaped recovery.
It’s not 2008: While the market sell-off has been reported as the worst decline since October 2008, it should not be compared to the 2008 global market meltdown and Great Recession. Back then, there were significant fundamental issues related to over-valued real estate and highly speculative financial transactions. We don’t know when the number of global coronavirus cases will begin to decline, but it does not appear to be on a scale similar to the massive systemic breakdown from the past.
A Good Run: The quick sell-off erased over 10% of value through the end of February, and it could get worse before it gets better. Nevertheless, it is helpful to remember that the S&P 500 gained 31.5% in 2019. In addition, it is up 490% as we approach the 11th anniversary of the bull market starting March 9, 2009.
WHAT YOU SHOULD DO: Although there is much we don’t know about the ultimate coronavirus impact, there is also much we do know:
-First, remember that emotional reactions to short-term headlines are the biggest risk. As hard as it is, investors should not abandon long-term investment objectives.
-Use the current market volatility to rebalance portfolios back into alignment with your long-term investment objectives and asset allocation plan.
-If you have cash to be invested, then this sell-off looks like a good time to invest potentially one third of your idle funds. Then set a date in three months to invest another third or if the market drops another 10%. Finally, set a date in six months to invest the last third or sooner if the market drops by 20%. If the market declines further, you will be getting in at lower prices. If the market moves upward, your first purchases will be at lower prices. No plan is fail-safe, but this strategy is a way to get into the market without making one big move.
|Last 3||Last 12|
|Major Benchmark Performance:||Months||YTD||Months|
|US Large Cap-S&P 500||-8.23%||-5.50%||-8.27%||8.21%|
|US Small Cap-Russell 2000||-8.42%||-8.81%||-11.36%||-4.93%|
|Foreign Developed-MSCI EAFE||-9.04%||-8.05%||-10.94%||-0.58%|
|Foreign Emerging Mkts-MSCI EEM||-5.27%||-2.95%||-9.68%||-1.88%|
|US Bonds-Barclays Aggregate||1.80%||3.68%||3.75%||11.69%|
|Long Treasury-20 Yr+ US Treasury Bonds||6.87%||11.04%||14.34%||32.48%|
For more information see: Cornerstone Investments LLC
Jeff Johnson, CFA
March 1, 2020