February 27, 2020
Human tragedy has a unique way of illuminating life’s true priorities. Our thoughts and prayers go out to all those affected by the Coronavirus. Given the growing uncertainty, taking a breath and remaining calm is warranted.
Investors have seen a noteworthy correction with the S&P 500 falling more than 8% over the past week. The retreat comes as a result of the Coronavirus epidemic threatening to turn into a global pandemic. However, the fact that this decline in US equities developed alongside softening economic data should not be overlooked.
Ultimately, the stock market is a colossal discounting mechanism, continuously digesting, absorbing, and adjusting valuations based on all available information. Despite the emergence of the Coronavirus in January, its existence did not matter much to the markets until late last week. Indeed, the Nasdaq 100 was up over 11% in 2020 prior to this recent correction.
We suspect the softening economic data, as seen by the Purchasing Managers’ Index (PMI) dropping below 50, implying economic contraction, exacerbated concerns the epidemic could weigh further on global economic activity. In China, numerous factories are closed, workers and consumers are quarantined, and barriers to international commerce are emerging that hamper trade. Should this persist, the drag on near-term earnings would require a revaluation, which is likely what we are experiencing especially if similar measures are adopted outside of China.
Fear is a powerful element in the stock market. However, the bigger threat to equities tends to be the shocks the market does not expect or appreciate. We continue to hear reassuring protocols being implemented regarding the pandemic, even though closing towns, quarantining cruise ships, and isolating high risk populations may sound upsetting. The number of cases in China is falling, suggesting the steps taken thus far have been effective. And while pockets of affected communities are still appearing outside of China, the response being deployed, for now, seems appropriate given the risks of a global pandemic. Most importantly, government resources are being allocated and the threat taken seriously.
While there are too few historical examples of a global pandemic to compare to the Coronavirus, the commodities markets may be instructive here. For instance, when a resource is in short supply, the price of that commodity surges higher and creates repercussions throughout the economy such as shifts in purchasing behavior and even rampant speculation. Yet for commodities, these events inevitably produce a flood of capital into the affected sector. New supplies are found, technological advancements are made, and other efficiencies uncovered that help bring supply and demand back into balance. A similar allocation of resources is occurring within global health to contain the Coronavirus. Other recent examples can be found in the energy industry as increased global demand drove oil prices to nearly $150 per barrel in 2008, only to have increased investment produce new technologies that even today keep downward pressure on prices.
Similarly, capital and resources are being poured into addressing the Coronavirus. The recent rise in patients outside of China will draw even more resources. While a solution has yet to be found, signs of improvement are being made and a cure, vaccine, or care protocol could all reverse the situation quickly. It is the attention and resources being marshaled that give us reassurance that, while temporary economic disruptions are likely, it is much too soon to abandon equities and ignore the commodities playbook. After all, the investment environment remains favorable and a slow growth, low inflation, low interest rate environment has been extremely beneficial to investors. Not only was 2019 a very strong year, but the gains thus far in 2020 are also impressive. So a correction is not unsurprising or unwarranted.
Whether the current pullback will continue and mark the end of a decade-long bull market, we do not know. But exiting after sharp corrections, predicting the end of bull markets, and making emotional decisions can also be harmful to long term investment returns.
The situation certainly has awoken the world to the risks of a global pandemic and the under-investment in global health. Hopefully, some good can come from this tragic experience, with governments being better prepared to prevent worse outbreaks in the future.
Thank you for reading.
Robert Stimpson, CFA, CMT
Co-Chief Investment Officer & Portfolio Manager
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