2020 2 27 Facemask Photo Scaled

Coronavirus and Market Volatility

With the recent uptick in market volatility and with all the scary and contradictory headlines floating about, we wanted to give you our thoughts on the coronavirus (COVID-19) outbreak as pertains to investment portfolios.

Over the past week, U.S. stocks have dropped significantly, with multiple consecutive days in the red. The Dow Jones Industrial Average is now in correction territory, down more than 10% from the record high it achieved on February 12th. The pullback illustrates just how quickly markets can fall when they’re expensive to begin with, especially when investors have grown accustomed to markets shrugging off bad news and climbing a wall of worry.

The question becomes, how deep might this correction go, might it turn into a full-blown bear market, and how long might all of this last?

A correction is defined as a decline of 10% in one of the major U.S. stock market indexes. A bear market is defined as a decline of 20%. Since World War II, there have been 26 market corrections, excluding the current one. The average decline was 13.7% over four months, and it took four months, on average, to recover each time. Over the same lookback period, there have been 12 bear markets with an average decline of 32.5%. These bear markets have lasted 14.5 months on average and have taken approximately two years to recover.

The present situation is somewhat unique in that everyone, from investors to governments to front-line health care workers, is working with limited and imperfect information. This makes it difficult to judge what the near-term impact of the coronavirus might be. As recently as a few weeks ago, U.S. markets had largely ignored the virus. Now, what looked like a relatively contained epidemic has turned into the potential for a global pandemic, with people getting sick in places like Italy and the U.S. This has set markets on edge, because of the uncertain impact on supply chains and economic growth.

The word “pandemic” is scary, and it conjures up all sorts of horrible mental images from the news and from popular culture. We would urge readers to keep in mind that pandemic is a scientific term used to describe how widespread an illness might be, not how lethal it is.

When the H1N1 “swine” flu became a pandemic in 2009, it infected nearly 61 million Americans and resulted in 12,469 deaths. Though even a single death is one death too many, the mortality rate in the U.S. was roughly 0.02%. The swine flu now circulates around the globe as a seasonal virus and is of limited health concern. (By comparison, what we think of as the “flu” – influenza – resulted in 61,200 American deaths during the 2018-2019 flu season. Already this season, 26 million people have been sickened by the flu.)

While it is perhaps still too early to know for sure, the coronavirus looks to be following a path similar to H1N1. In Wuhan, China, the mortality rate has been 2-4%. But Wuhan is where the illness originated, and hospitals have been overwhelmed. Outside of Wuhan, the World Health Organization (WHO) estimates the mortality rate to be around 0.7% at this time. According to the Chinese Center for Disease Control and Prevention (CCDCP), diagnosed cases peaked about two weeks after the country shutdown Wuhan, and it looks as though proper quarantine procedures can help to curb the disease’s spread. The question is whether and to what degree other countries will be able to contain their own outbreaks, given that China is somewhat unique in its ability to implement societal controls.

On Monday, Dr. Tedros Adhanom Ghebreyesus, the WHO’s Director General, said the following:

“For the moment, we are not witnessing the uncontained global spread of this virus, and we are not witnessing large-scale, severe disease or death. Does this virus have pandemic potential? Absolutely. Are we there yet? From our assessment, not yet.”

As health authorities continue to put quarantine measures in place, and as the illness becomes better understood in terms of its symptoms and transmission mechanisms, our hope is that the situation improves. The virus appears to be mostly a concern for the elderly and for people with compromised immune systems, much like the flu.

As we try to gauge the impact of the coronavirus on client portfolios, it can be instructive to look at other recent outbreaks and the market’s reaction to them:

  • During the SARS outbreak in 2003, the S&P 500 Index declined by roughly 14%.
  • During the Ebola outbreak in 2014, the S&P 500 Index declined by roughly 7%.

It is difficult to infer much from the 2009 H1N1 outbreak, because markets were primarily wrestling with the aftermath of the financial crisis during that time. But the market’s response to the coronavirus appears to be thus far in line with prior situations, though the data is admittedly limited.

The broader concern this time around is the negative potential impact on global supply chains, tourism, consumer activity, and overall economic growth, given that the world economy was already slowing down. In a recent communication to clients, Goldman Sachs noted its expectation for a severe decline in Chinese economic activity in the first quarter. This would have a ripple effect in the U.S., as Chinese demand for U.S. exports declines.

A true, global pandemic and its resulting quarantine procedures could potentially slow the U.S. economy enough to push it into recession territory. It is this fear that has driven, in large part, the stock market declines we’ve witnessed in the past week. At a minimum, even if the virus doesn’t push the economy into the red, it is likely to curb economic growth and corporate earnings in the near term.

That said, and to paraphrase Dr. Ghebreyesus, we’re not there yet. We’ve known for some time now that a recession is a statistical likelihood, we just haven’t known what might trigger it. And we still don’t. Therefore, the prudent course is to remain invested, as the opportunity cost of sitting in cash is too high.

We urge readers to remember that stocks were up significantly in 2019. The S&P 500 Index, for example, returned 31.5% last year. Even after the recent pullback, stocks are still up considerably over the past twelve months, let alone the past several years. Corrections are a natural part of stock market investing, and they occur with some regularity. Sometimes they happen for specific reasons, as we’re experiencing with the coronavirus. Other times, they happen for no clearly defined reason at all.

Our recommendation is to hold tight and to ride things out. If news were to turn positive in the coming days and weeks, then stocks could reverse course just as quickly as they’ve dropped, and we wouldn’t want to be on the wrong side of that trade. If the situation deteriorates further and if stocks continue to slide, then we’ve seen from prior corrections that the recovery period is tolerable, if not short.

Rest assured that we are monitoring the situation, and we will take steps to insulate portfolios or, quite possibly, to take advantage of buying opportunities, as circumstances dictate. Please call or email should you have any questions or concerns.