In your investing lifetime, you may only see a situation like the recent novel coronavirus (COVID-19) a few times. This is a circumstance where complete candor is necessary. The truth is that we can’t yet gauge the full economic impact, and by the time we can, the volatility may have passed.
Markets Have the Virus. Right now, markets are reacting to the news because the outcome is unknown. In a way, COVID-19 has “infected” markets all around the world. In times of market uncertainty, some traders believe the best approach is to sell. Fear is driving decisions. Nobody would blame you if this uncertainty gave you a bit of anxiety, as well.
In reality, it is true that markets were not set up for a massive global shock like COVID-19 given where financial assets were priced coming into the year. At 2019 year-end, valuation metrics such as Price/Earnings, Price/Book and Cash Flow Yield all stood in the 75%+ percentile compared to historical averages. Investors continued to remain bullish on the market for two important reasons:
- The economy has remained strong and all indication from Washington is that a pro-economic environment will continue. With unemployment at all-time lows, the consumer (which represents 70% of economic spending) has been the backbone of this economy.
- Interest Rates remain historically low and the Federal Reserve has given no indication of increasing rates in 2020. Low interest rates are a tail-wind for equity valuations and a deterrent for investing money in the bond market.
The magnitude of US and MSCI China declines over the last week appears to price in a full year earnings decline of 25%-30% in China, and 15-20% in the US and Europe. Our sense is that the earnings results may be worse than expected in China, and better in the US. If the virus is somewhat contained to Asia, the impact could be minimal. While the US is reliant on Chinese supply chains (retail and electronic companies appear to be most exposed), the Asia-Pacific region represents 11% of S&P 500 revenue exposure, with roughly a third of that in China directly.
Furthermore, large S&P 500 selloffs (including SARS, ZIKA, EBOLA) have historically been followed by a rebound within 6 months if there’s no recession, which we do not expect given the strength of the US consumer. And for all the talk of collapsing interest rates, the spread between the 10 year and 30 year US Treasury is steepening, not inverting.
What to do?
It’s important to remember that, in terms of market declines, the recent drop isn’t unprecedented. In fact, in the last six day-to-day declines of 3% or greater, the market rebounded higher a month later. Past performance is no indication of future returns, and it’s uncertain whether history is a good teacher in this instance. Therefore risk-appropriate, properly diversified portfolios are crucial to investment success.
You Don’t Buy Snow Tires in a Blizzard. By working together to develop an investment strategy that fits your risk tolerance, time horizon, and goals, we have been preparing to weather turbulence. When a blizzard hits, the people who already own snow tires are usually happier than those venturing out into the cold, hoping they’re still in stock. In the same way, it’s generally best to make decisions during periods of low market volatility. We’re in the middle of the storm right now.
Here to Support You. This may be the time you need a trusted financial professional most. During most volatility, we advise you to “stay the course,” and that generally proves to be the best course of action. In times like this, however, it’s easy to question conventional wisdom. Be courageous…do what’s right, even when it feels wrong. Be patient when others are not. Fidelity Investments did some research on its clients. The results showed the best investors were clients who had died and clients that forgot they had an account at Fidelity. Active investors (market timers) fair worse than investors that stay disciplined and stick to a plan. With that being said, there comes a point in every market correction where it is time to buy.
Remember, we are here to help you and your family during this time. Whatever decisions you make, please allow us to support you through them. Feel free to reach out to us with any questions or concerns.
Martin and Reid